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