- An additional use of financial statements
is in financial statement forecasting.
We can use the structure of accounting
to create a disciplined, high-level forecast of the future.
In particular, we can use financial statement forecasting
to figure out a company's financing needs for the future.
Am I going to need to borrow money?
Am I going to need to search for new investment
by shareholders or partners?
There are some simple ideas that underlie the process
of financial statement forecasting.
If I'm Walmart and my sales go up by 20%,
what else is going to go up by about 20%?
My cost of sales.
If I sell more stuff to people,
that means I need to buy more things
from my suppliers.
My cost of sales will go up.
If my sales go up, I will also need more employees.
My wages will go up.
I'll probably use more electricity.
My utilities will go up.
Some things naturally increase as sales increase.
Now with respect to the balance sheet,
if I'm going to have 20% more sales,
I'm just going to naturally need more cash.
I'm going to need more inventory.
I'm probably going to have more accounts payable
with my suppliers.
In short, the amount of some financial items
increase naturally with an increase in sales.
In contrast, some items don't increase naturally
as sales increase but instead go up
as the result of long-term planning.
For example, the bank doesn't hear through the grapevine,
hey, their sales are going to up by 20%.
We should increase their loans by 20%.
No, you have to go to the bank
and negotiate a new loan.
Some things go up through long-term planning.
Some things go up through choices.
Did I decide to borrow money or not?
Did I decide to pay a dividend or not?
Those are financing choices.
Now, consider depreciation expense on the income statement.
You know that depreciation is the estimate
of how much buildings, machines, and equipment
wear out during the year.
This amount is tied not to my sales
but to the level of my buildings,
my machines, my property, my plant, my equipment.
My interest expense is tied to how much I have in loans.
My income tax expense is based on my taxable income
and the income tax rate.
We can use these notions in forecasting.
The key point we see from all this
is that there are some systematic relationships
among the financial statement numbers.
Some things go up naturally.
Some things go up only based on decisions.
We can use these relations to do
a systematic, quantitative forecast
of what's going to happen next year based on our plans.
We can use that financial statement forecast
to be able to help us determine
what our financing needs are.