PROSPECTIVE ANALYSIS : FORECASTING
Prospective Analysis
2
Prospective
Analysis
Forecasting Valuation
Strategy analysis
Accounting analysis
Financial analysis
Why forecasting?
Managers Analysts Banker and debt market participants
Forecasting: comprehensive approach
4
Performance
Forecast
Earnings
Forecast
Cash Flow
Forecast
Balance Sheet
Forecast
Forecasting
growth in sales
Increases in Working Capital
Decreases in cash inflows
Prospective Analysis
5
ForecastsGrowth of
sales
Expenses follow
the sales’ growth
Investment in
plant track sales
Key drivers
Sales
forecast
Profit margin
forecast
Prospective Analysis
6
Points of departure
Period of time in which the
prospective analysis starts
2010
20092008 2011 2012 20152007
The past
performances
of the business
are well-known
Past, present
and future
information
are integrated
togetherPurpose:
Getting to a good and reasonable
valuation of the business
Prospective Analysis
7
Firms strategy: What lines of business is it likely to be in? Are new products likely? (Customer acceptance for
new?) What is the product quality strategy? At what point in the product life cycle is the firm? What is the firm’s acquisition and takeover
strategy?
Market for the products: How will consumer behaviour change? What is the elasticity of demand for products? Are substitute products emerging?
Main questions
Behavior of sales growth: mean reverting
Behavior of earnings
Random walk: next year’s earnings equals last year’s earnings.
Starting point Take in to account: long-term trend Adjust for earnings changes in most
recent quarter that deviates from the trend
Behavior of ROE: mean reverting
Behavior of ROE components:
• Operating asset turnover and Net financial leverage : stable
• Spead and NOPAT margin: most varied• Point of departure for rate of return and profit
margins: most recent figure, consider the industry norm and sustainability of strategy
• Point of departure for Operating Asset turnover, financial leverage and net interest rate: current period level, consider technology & financial policy changes
“The art of financial statement analysis requires not only knowing what the “normal” patterns are but also expertise in identifying those firms that will not follow the norm.”
Detailed forecastStep 1: sales forecast Approaches:
Last year’s sales + increases in expansion + comparable growth (warning: mean reverting)
Size of target market + degree of market penetration + time (when)
Sales forecast for whole company or break down into major biz segments forecasts
Detailed forecastStep 2: Expense and earnings forecast Most expenses are related to sales:
COGS, SG&A How about R&D? Interest expense?
Depreciation? Adjusted for recent changes in strategy Sales & expenses forecasts -> earnings
forecast
Detailed forecastStep 3: Balance Sheet forecast Forecast major items:
OWC and operating long-term assets: fraction of sales
Liability and Equity: depends on policies on capital structure, dividends, and stock repurchases
Three critical assumptions?
Detailed forecastStep 4: Cash flow forecast Using forecasts of earnings and balance
sheet accounts
Sensitivity analysis
“Best guess” vs broader range of possibilities
Start with key assumptions underlying a set of forecasts
Examine sensitivity to the assumptions Consider: historical patterns of
performance, changes in industry conditions, company’s strategy