FINANCIAL STATEMENT FORECASTING

Definition
To forecast means to form an opinion beforehand i.e. to make a prediction. Thus financial forecasting means
a systematic projection of the expected action of finance through financial statements. It involves
determining the future financial requirements of the firm.
Importance of financial forecasting
(a) It facilitates financial planning i.e. determination of cash surplus or deficit that are likely to occur in
future.
(b) It facilitates control of expenditure so as to minimize wastage of financial resources
(c) It motivates the employees who aim at achieving targets set
(d) It helps to explain the requirement of funds for the firm together with the funds of the suppliers
(a) It also helps to explain the proper requirements of cash and their optimum utilisation is possible and so
surplus/excess cash, if any, invested otherwise.
Elements of Financial Forecasting:
Financial forecasting involves preparation of proforma financial statements and also the preparation of Cash
Budget. Therefore, it includes the preparation of:
(a) Pro-forma Income Statement
(b) Pro-forma Balance Sheet; and
(c) Cash Budget.
Methods used in financial forecasting.
(a) Use of cash budgets: A cash budget is a financial statement indicating sources of revenue, the
expected expenditure and any anticipated cash deficit/ surplus.
(b) Regression analysis: It is a statistical method which involves identification of dependent and
independent variables to form a regression equation y=a + bx on which forecasting is based.
(c) Percentage of sales method: One of the items that have a great influence on forecasting is sales.
Hence items in the balance sheet which re related to sales are expressed as a percentage of sales. The
following steps are involved:
(d) Time series
Steps in financial statement forecasting
1. Identify balance sheet items that are directly related to sales e.g.
(i) Net fixed assets i.e. acquisition of new machinery which increase production hence increase
sales.
(ii) Current assets: an increase in sales due to increase in stock raw materials, work in progress and
finished goods. Increased credit sales will increase debtors while more cash will be required to
buy more raw materials in cash.
(iii) Current liabilities: increased sales will lead to purchase of more raw materials.
(iv)Retained earnings: this will increase with sales if and only if, the firm is operating at a profit.
(v) Long term capital items such as ordinary share capital, preference share capital and debentures
are not directly impacted by an increase in sales as they are used to finance long term projects.
2. Express the above identified items as a percentage of sales i.e. determine the relationship between the
item and current sales.
3. Determine the increase in total assets as a result of increase in sales.
4. Determine total increase in spontaneous sources of finance (current liabilities) and increase in retained
earnings.
Retained earnings = net profit - dividend paid
Net profit margin = Net profit

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 Sales
Therefore net profit = net profit margin x sales
5. Get the external financing needed which is the difference between increase in users of funds(c) and (d)
6. Prepare the proforma financial statements- these are projected statements at the end of the forecasting
period.
Note: information could be given which necessitates the determination of forecast sales, this will be
determined using the following formula:
Sn =So(1+ g)n
Where:
- Sn = sales n years from now
- So=current sales
- g=growth rate
- n= forecasting period
Assumptions of percentage of sales method
The fundamental assumption is that;
(a) Theres no inflation in the economy .i.e. the increase in sales is caused by an increase production and
not increase in selling price.
(b) The firm is operating at full capacity hence, the increase in production will require an increase in fixed
assets
(c) The capital remains constant during the forecasting period i.e. no issue of ordinary or preference
shares and debentures
(d) That the relationship between the balances sheet items and sales remains the same during the
forecasting period.
(e) The net profit margin will be achieved and shall remain constant during the forecasting period

CASH BUDEGT
A Cash Budget is a forecast of how much cash will be required during a specific period in future. Therefore,
expected cash receipts and expected cash payments are estimated by preparing this budget. However, the

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estimates are prepared for weeks or months depending upon the requirement of cash. This budget is prepared
after the preparation of all functional budgets.
This budget is intended:
(a) To see that adequate amounts of cash are available for capital as well as revenue expenditures.
(b) To make an arrangement of cash in advance if there is any expected shortage of cash.
(c) To see that the surplus amount of cash, if any, is employed in any profitable investment outside the
business.
Components of a cash budget
(a) Cash receipts
(b) Cash payments
(c) Net cash flows during the period
(d) New financing needed
Advantages of cash budget
(a) It gives a clear idea of how much cash is required at what time and necessary arrangements may be
made for the purpose.
(b) It helps in identifying possible cash deficit and hence arranges how to finance the deficit in advance
e.g. through loan or overdraft taken from bank or outsiders.
(c) Since the surplus amount of cash can be known by its preparation, benefits of Cash Discount may be
derived by making payments before due date.
(d) Helps to identify any possible cash surpluses in advance and take steps to invest the surplus on a short-
term basis (so earning interest)
(e) The firm may consider rescheduling payments to avoid bank borrowing, e.g. delay purchase of non-
current assets, agreement to pay rises, payment of drawings/dividends
Methods of preparing cash budgets
(a) Receipts and Payments Method;
(b) The Adjusted Profit and Loss Method;
(c) The Balance Sheet Method.
QUESTION TWO
Kanya Limited is in the process of preparing a budget for the year 2015. The following estimates relate to
six months ending December 2015.

Month Sales Material purchases Wages Overheads

Sh. 000 Sh. 000 Sh. 000 Sh. 000
July 60,000 45,000 600 120
August 62,000 36,000 600 122
September 50,000 40,000 720 150
October 55,000 22,000 700 140
November 68,000 30,000 6,800 132
December 70,000 32,000 6,500 143
Additional information;
(i) 60% of sales are made on cash basis
(ii) Debtors are expected to settle their accounts as follows;
50% one month after sale
40% two months after sale
5% three months after sale
The balance is considered as bad debts
(iii) Creditors for materials are paid one month after purchase.

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 (iv)Wages and overheads are settled in the month in which they are incurred
(v) A commission of 5% on sales is paid every month
(vi)An equipment costing sh.105,000 will be acquired in September and payment will be made in
November 2015.
(vii) Cash balance as at 1 October 2015 is expected to be sh.160,000
Required:
For each of the months October, November and December 2015, prepare
(i) Debtors collection schedule
(ii) Cash budget. [12 marks]
QUESTION TWO
Waza Ltd. produces a product that has the following sales and purchases forecast for the year 2016
Month Sales Purchases
Sh. "000" Sh. "000"
April 1,500 1,000
May 1,600 1,100
June 1,600 900
July 1,700 900
August 2,000 800
September 2,000 1,300
October 1,800 1,400
November 1,800 600
December 2,000 600
Additional information:
(i) Of these sales, 60% are collected during the month, 30% are collected the next month and 10% are
collected two months after sale.
(ii) Suppliers are paid one month after delivery of goods
(iii) Corporation tax for 2015 amounting to sh.200,000 will be paid on September 2016.
(iv)Contractors retention monies amounting to sh.500,000 will be paid on 30th June 2016
(v) In October the company is due to receive sh.600,000 for a civil suit.
(vi)The monthly administration expenses amounting to sh.330,000 include factory depreciation charge of
sh.40,000 and preliminary expenses of sh.30,000
(vii) A machine worth sh.130,000 will be paid for in November 2016.
Required: Prepare a cash budget for the period 1st June to 31st December 2016. [20 marks]

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