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Adapted from Smith and Kihlstrom (1999) Integration of Financial Statements: From Smith and Kihlstrom (1999 ) Assumptions Ending Balance Sheet Cash Flow.

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Presentation on theme: "Adapted from Smith and Kihlstrom (1999) Integration of Financial Statements: From Smith and Kihlstrom (1999 ) Assumptions Ending Balance Sheet Cash Flow."— Presentation transcript:

1 Adapted from Smith and Kihlstrom (1999) Integration of Financial Statements: From Smith and Kihlstrom (1999 ) Assumptions Ending Balance Sheet Cash Flow Statement Income Statement Beginning Balance Sheet Sales Forecast

2 Four key questions to be answered in a sales forecast 1) When will the venture begin to generate revenues? 2) Once revenues are being generated, how rapidly will they grow? 3) Over what span of time (3 years, 5 years, 10 years, etc.) should the forecast be made? 4) What is an appropriate forecasting interval (weekly, monthly, annually, etc.)?

3 General rules of financial forecasting  Build and support a schedule of assumptions  Begin with a forecast of sales  If the sales growth is expected to track inflation, consider forecasting sales in real terms  When using historical data to forecast, consider a weighting scheme which focuses on the firm’s most recent experiences  For new ventures, choose several “yardstick” firms and compare to aid in developing underlying assumptions regarding expected performance  Integrate the pro forma balance sheet and income statement variables through formulas Part 1

4 General rules of financial forecasting  Consider time span. To assess financial need, project until the firm expects follow up financing. To determine venture value, extrapolate to the point of harvest  Determine the planning horizon of the venture to establish forecasting intervals  Test the model’s rationality by tracing line items across financial statements  Apply sample scenarios and compare outcomes to estimations  Try a basic sensitivity analysis to ensure the model yields reasonable results when magnitudes and growth rates of key variables change Part 2

5 New company assumptions Part I 1) Development will require 18 months, during which no sales will be made 2) Initial sales of $10,000 in the 19th month 3) Sales will grow 8% per month in real terms for three years and at the inflation rate thereafter 4) Cash operating expenses during the development period of $15,000 per month, plus inflation 5) Inflation at 3 percent per year 6) A $200,000 production facility will come on line at the end of month 18. The facility is to be leased by the company for the first 5 years of operations with monthly payments of $3,000 7) Gross profit of 60% of sales revenue on materials costs with trade discounts 8) Selling expenses of 15% of sales. 9) Administrative expenses of $2,000 per month beginning in month 19, growing at the inflation rate, plus 15 percent of sales (Included in development period operating expense total)

6 New company assumptions Part II 10) Entrepreneur’s salary of $3,000 per month through the first full year of sales (included in initial operating expenses), increasing thereafter by $500 per month 11) Corporate tax rate of 45%. No loss carry forward 12) All sales are for credit. The average collection period is 45 days. No discount for prompt payment 13) The inventory turnover rate is 5 times per year, measured against ending inventory 14) The company desires to maintain the greater of 30 days’ sales in cash or $10,000 15) All materials are purchased on credit, with terms of 2/10 net 30. The company anticipates paying in time to receive the discount. The payables period is 10 days 16) The entrepreneur will borrow any funds necessary at a rate of 1% per month 17) Initial investment by the entrepreneur of $200,000. Additional financing by borrowing on a line of credit

7 (Forecast generated monthly, selected months shown) New company sales forecast


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