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Harvard Business School

9-206-048
Rev. April 18, 1983

Note on Financial Forecasting
An important task of the manager or analyst is that of financial forecasting. In simplest terms, this is a systematic projection of the expected actions of management in the form of schedules, budgets, and financial statements. In this process, past physical statistics, financial ratios, relationships and funds flows, as well as expected economic conditions, policy decisions, and future activities are combined and arranged into a working plan for the desired period. The usefulness of such planning is best seen when one considers the several areas where it is helpful: Forecasting becomes the basis of coordinated thinking about the future and reduces emergency decisions and surprises; it can be used to set standards of performance to measure and control the separate and collective decisions in the various parts of the company; it can also be used to anticipate upcoming financial needs, or the financial effects of new or changing policies. In addition, it forms a good basis for discussing funds needs with prospective creditors.

Pro Forma Operating Statements and Balance Sheets
The most familiar expression of forecasted business activity is a set of pro forma (hypothetical, anticipatory) statements consisting of an operating (income) statement for the period under study, and a balance sheet as of the end of the period. (For the preparation of such a set of statements, much of the reasoning and analytical groundwork introduced in “Note on Financial Analysis,” HBS Case Services No. 206-047, is helpful.) No rigid set of rules exists for constructing pro forma statements, since considerable common sense and judgment are necessary to balance practical considerations, such as the degree of accuracy required, against labor and time involved in the process. The format of the statements may vary from “back-of-the-envelope” figures on key accounts to elaborate and detailed reports, depending on the needs of the manager or analyst. In some cases, valid and precise figures on future activities are also available, while frequently the best data obtainable are based on intuitive assumptions. Lacking more specific information, it is often necessary merely to assume that a past relationship, expressed as a ratio, can validly be extended into the immediate future. In other cases, sophisticated statistical approaches to obtaining estimates of future performance are warranted as a basis for detailed pro forma statements. For purposes of illustration, a more generalized approach is used below to introduce pro forma statement preparation.

This note was prepared as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.
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This document is authorized for use only in MIF_Sep2014_S2_Corporate Finance by Prof . Diego Gutierrez-Colomer e Ignacio Magro at IE Business School from July 2014 to November 2015.

206-048

Note on Financial Forecasting

Pro Forma Operating Statement
This statement is built around an estimate of the expected sales for the forecast period. The basis for this estimate may vary from rule-of-thumb methods to professional economic estimates, market research, and detailed analyses of the competitive situation. Whatever the origin, the financial manager must give due consideration to the reasonableness of the figure he or she puts on the operating...
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