The Financial and Economic Forecast

Abstract

In this chapter, we focus on forecasting financial statements. The main aim is to provide a method to forecast financial statements based on a series of assumptions. These assumptions are crucial for the analysis and should come from a mixture of historical quantitative analysis and qualitative analysis related to the business and the economic environment through which a firm interacts. In the first part of the chapter, we focus on how to perform a qualitative analysis to set the input parameters in the forecasting plan. While in the second part, we move to the description of the quantitative steps to construct a forecasting plan. In this part, we provide a novel forecasting method that starts from the planning of the financial outflows and revenues that allow us to assess the business’ financial sustainability.

Appendix—Drafting a Forecast Budget: Combining New and Classic Approaches

Starting from the company balance sheet analyzed in Chapter 1, we first determine the break-even operating income given the fixed and variable costs and other assumptions regarding the financial outflows (Step 1). Subsequently, this break-even income is used as a reference when following the “classic” method of drafting a forecast budget to prepare a forecast Income Statement and Balance Sheet (Step 2). Therefore, the goal is to show how to combine these two methods to achieve an efficient forecasting tool.

2.1.1 Step 1: Determining the Break-Even Revenues

As for the company’s cost structure, while the cost of goods sold is variable, the cost of services and labor are of a more fixed nature. The impact of the cost of goods sold is expected to decrease to 80%. Half of the costs of services (and other expenses) and one-quarter of the costs of labor are variable costs, whereas the remainder is fixed. Therefore, for each euro of revenue, the contribution margin in T + 2 is as follows:

$$\begin{aligned}&\mathrm{Contribution\,margin }\%\\&=1-\mathrm{INC}.\% \mathrm{Variable\, costs}\\&=1-\frac{\mathrm{19,977,023}\times 80\%+\mathrm{1,543,478}\times 50\%+\mathrm{150,529}\times 50\%+408,980\times 25\%}{\mathrm{19,977,023}}\\&=\mathrm{15.2483}\%\end{aligned}$$

Consequently, the fixed costs are:

$$\begin{aligned}\mathrm{Fixed\, costs}&=\mathrm{1,543,478}\times 50\%+\mathrm{150,529}\times 50\%+\mathrm{408,980}\times 75\%\\&=\mathrm{1,153,738.5}\end{aligned}$$

And the future forecast parameters are as following.

2.1.2 Economic Assumptions

• Percentage of contribution margin: 15.2483%

• Fixed costs: 1,153,738.5 euro

2.1.3 Trade Assumptions

• Average days of inventory: 108 days

• Average days of working receivables: 113 days

• Average days of working payables: 54 days

2.1.4 Investment Assumptions

• Investments in fixed capital and sales of assets: respectively, 150,000 euro and 20,000 euro (CAPEX = 130,000)

• Depreciation coefficient of 20%, amortization, and depreciation that will no longer be carried out due to disposals of 2000 euro. There is a historical amortization cost of 9,209.

2.1.5 Financing Assumptions

• Loan for M/LT financial debt: 100,000 euro

• Capital to be contributed: 50,000

• M/LT financial debt repayment: 30,000 euro (one annual repayment), of which 20,000 euro in capital repayment and 10,000 euro in interest rates

• The interest rate on loans: 2%⁴

• Target remuneration percentage before tax, based on calculations made by the company owners: 1,774,299 euro.

These parameters determine the target operating revenues for T + 3. Since the capital repayment on the loans is lower than the depreciation charged to the income statement (20,000 lower than 20% on 150,000, net of the 2,000 + historical amortization → 20,000 < 37,209), we use the following formula (2.26):

$$\begin{aligned}&\mathrm{Revenues}\\& \quad=\frac{\mathrm{Fixed\, costs}+\left(\mathrm{Depreciation}+{\mathrm{Interest \,expense}}_{\mathrm{mlt}}\right)+\mathrm{Net\, income \,target }(\mathrm{before\, taxes})}{1-\mathrm{VC\%}-\frac{\mathrm{Monetary\, cycle}}{360}{\mathrm{i}}_{\mathrm{\%},\mathrm{short}}}\\&\quad=\frac{\mathrm{1,153,738.5}+\left(\mathrm{37,209}+\mathrm{10,000}\right)+\mathrm{1,774,299}}{\mathrm{15.2483\%}-\frac{167}{360}2\mathrm{\%}}\\&\quad=\mathrm{20,776,104}\end{aligned}$$

Therefore, compared to historical values, revenues have increased by 4% (20,776,103–19,977,023)/19,977,023.

2.1.6 Step 2: Forecasting the Budget Balance (“Classic” Method)

We now propose a reinterpretation of a forecast budget balance of the same company case presented earlier, using the same parameters that were previously defined, but considering a variation in revenues of 4% and other additional information, all elaborated in compliance with a “classic” method. In general, the forecast parameters can be summarized as follows (Table 2.3).

Table 2.3 Forecast parameters T + 3

Afterward, we apply the methodology illustrated in paragraph 2.3 to attain the main aggregates of the forecast balance sheet and income statement. The starting point to do so is the estimate of the forecast turnover:

$$\begin{aligned}{\mathrm{Revenues}}_{\mathrm{for}.}&={\mathrm{Revenues}}_{\mathrm{hist}.}*\left(1+\mathrm{Var}.\mathrm{\%\, turn}.\right)\\&=\mathrm{19,977,023}{\hbox{\EUR}}*\left(1+4\mathrm{\%}\right)\\&=\mathrm{20,776,104}{\hbox{\EUR}}\end{aligned}$$

Afterward, we proceed with the estimate of the operating costs and the forecast EBITDA:

$$\begin{aligned}{\mathrm{Cost\, of\, goods\, sold}}_{\mathrm{for}.}&={\mathrm{Revenues}}_{\mathrm{hist}.}*\mathrm{Inc}.\mathrm{ \%\, CSM}\\&=\mathrm{20,776,104{\hbox{\EUR}}}*80\mathrm{\%}\\&=\mathrm{16,620,883{\hbox{\EUR}}}\end{aligned}$$

$$\begin{aligned}{\mathrm{Cost\, of\, services}}_{\mathrm{for}.}&={\mathrm{Cost\, of\, services}}_{\mathrm{hist}.}*\left(1+\mathrm{Var}.\mathrm{ \%\, CS}\right)\\&=\mathrm{1,694,007{\hbox{\EUR}}}*(1+2\mathrm{\%})\\&=\mathrm{1,727,887{\hbox{\EUR}}}\end{aligned}$$

$$\begin{aligned}{\mathrm{Cost\, of\, labor}}_{\mathrm{for}.}&={\mathrm{Cost\,of\, labor}}_{\mathrm{hist}.}*\left(1+\mathrm{Var}.\mathrm{ \%\, CL}\right)\\&=\mathrm{408,980{\hbox{\EUR}}}*\left(1+1\mathrm{\%}\right)\\&=\mathrm{413,070{\hbox{\EUR}}}\end{aligned}$$

$$\begin{aligned}{\mathrm{EBITDA}}_{\mathrm{for}.}&={\mathrm{Revenues}}_{\mathrm{for}.}-{\mathrm{Operating\, costs}}_{\mathrm{for}.}\\&=\mathrm{20,776,104{\hbox{\EUR}}}-\mathrm{18,761,840{\hbox{\EUR}}}\\&=\mathrm{2,014,264{\hbox{\EUR}}}\end{aligned}$$

The Trade Area parameters make it possible to estimate the NOWC and the partial tax liabilities, which will be equal to the taxes of the previous year:

$$\begin{aligned}{\mathrm{Inventory}}_{\mathrm{for}.}&= {\mathrm{dd\, Revenues}}_{\mathrm{for}.}*\mathrm{dd\, Inventory}\\&=\frac{\mathrm{20,776,104{\hbox{\EUR}}}}{360}*108\\&=\mathrm{ 6,254,540{\hbox{\EUR}}}\end{aligned}$$

$$\begin{aligned}{\mathrm{Working\, receivables}}_{\mathrm{for}.}&= {\mathrm{dd\, Revenues}}_{\mathrm{for}.}*\mathrm{dd\, receivables}\\&=\frac{\mathrm{20,776,104{\hbox{\EUR}}}}{360}*113\\&=\mathrm{6,535,057{\hbox{\EUR}}}\end{aligned}$$

$$\begin{aligned}{\mathrm{Working\, payables},\mathrm{ not\, incl}.\,\mathrm{ tax\, liabilities}}_{\mathrm{for}.}&= {\mathrm{dd \,Revenues}}_{\mathrm{for}.}*\mathrm{dd\, }{\mathrm{payables}}_{.}\\&=\frac{\mathrm{20,776,104{\hbox{\EUR}}}}{360}*42=\mathrm{2,423,879{\hbox{\EUR}}}\end{aligned}$$

$$\begin{aligned}{\mathrm{Partial\, tax\, liabilities}}_{\mathrm{for}.}&= -{\mathrm{Taxes}}_{\mathrm{his}.}\\&=-\mathrm{69,254{\hbox{\EUR}}}\end{aligned}$$

Through the parameters of the Investment Area, it is possible to estimate the forecast depreciation, EBIT, and fixed capital:

$$\begin{aligned}{\mathrm{Depreciation}}_{\mathrm{for}.}&={\mathrm{Dep}/\mathrm{Am}}_{\mathrm{his}.}\\&+\left({\mathrm{Investments}}_{\mathrm{for}.}*\mathrm{\% dep}/\mathrm{am}.\right)\\&-{\mathrm{Am}./\mathrm{Dep}.\mathrm{ disinvestments}}_{\mathrm{his}.}\\&=\mathrm{9209{\hbox{\EUR}}}+\mathrm{150,000{\hbox{\EUR}}}*20\mathrm{\%}-\mathrm{2000{\hbox{\EUR}}}\\&=\mathrm{37,209{\hbox{\EUR}}}\end{aligned}$$

$$\begin{aligned}{\mathrm{EBIT }}_{\mathrm{for}.}&={\mathrm{EBITDA}}_{\mathrm{for}.}-{\mathrm{Depreciation}}_{\mathrm{for}.}\\&=\mathrm{2,014,264{\hbox{\EUR}}}-\mathrm{37,209{\hbox{\EUR}}}\\&=\mathrm{1,977,055{\hbox{\EUR}}}\end{aligned}$$

$$\begin{aligned}{\mathrm{Fixed capital}}_{\mathrm{for}.}&={\mathrm{Fixed capital}}_{\mathrm{his}.}+\mathrm{Investments}\\&-\mathrm{Disinvestments}- {\mathrm{Dep}./\mathrm{Amortization}}_{\mathrm{for}.}\\&=\mathrm{6,808,863{\hbox{\EUR}}}+\mathrm{150,000{\hbox{\EUR}}}-\mathrm{20,000{\hbox{\EUR}}}-\mathrm{37,209{\hbox{\EUR}}}\\&=\mathrm{6,901,654{\hbox{\EUR}}}\end{aligned}$$

At this point, the parameters of the Financing Area allow estimating the partial equity (not including the operating profits, which will be estimated later) and the M/LT financial liabilities:

$$\begin{aligned}&\mathrm{Partial\, shareholder\, capital}\\&\quad={\mathrm{Shareholder\, capital}}_{\mathrm{his}.}+\mathrm{Equity\, issue}-\mathrm{Equity \,distribution}\\& \quad=\mathrm{7,293,716{\hbox{\EUR}}}+\mathrm{50,000{\hbox{\EUR}}}-\mathrm{20,000{\hbox{\EUR}}}\\&\quad=\mathrm{7,323,716{\hbox{\EUR}}}\end{aligned}$$

$$\begin{aligned}{\mathrm{MLT\, fin}.\,\mathrm{liabilities}}_{\mathrm{for}.}&={\mathrm{MLT\, fin}.\,\mathrm{ liab}.}_{\mathrm{his}.}+\mathrm{MLT\, fin}.\,\mathrm{ loans}-\mathrm{Repayment\, MLT\, loans}\\&=\mathrm{4,980,996{\hbox{\EUR}}}+\mathrm{100,000{\hbox{\EUR}}}-\mathrm{20,000{\hbox{\EUR}}}\\&=\mathrm{5,060,996{\hbox{\EUR}}}\end{aligned}$$

Subsequently, the estimate of partial liabilities is calculated by adding partial equity, M/LT financial liabilities, partial working payables, and partial tax liabilities (deposits). At this point, we can calculate the short-term financial debt (not including financial charges) by subtracting the partial liabilities and EBIT margin (which includes the non-estimated values of the liabilities, such as finance charges, taxes, and profits) from the overall assets:

$$\begin{aligned}{\mathrm{Short}-\mathrm{term\, fin}.\mathrm{ debt}}_{\mathrm{for}.}&=\mathrm{Tot}.\mathrm{ assets}-\mathrm{Partial\, liabilities}-\mathrm{EBIT }\\&=\mathrm{19,691,252{\hbox{\EUR}}}-\mathrm{14,738,337{\hbox{\EUR}}}-\mathrm{1,977,055{\hbox{\EUR}}}\\&=\mathrm{2,974,860{\hbox{\EUR}}}\end{aligned}$$

Therefore, the income statement and balance sheet will be structured as follows (Table 2.4):

Table 2.4 Partial balance sheet and income statement T + 3

Afterward, it is possible to calculate the financial charges, completing the income statement and balance sheet:

$$\begin{aligned}{\mathrm{Fin}.\,\mathrm{ charges}}_{\mathrm{for}.}&=\mathrm{Average\,\, fin}.\,\mathrm{ liabilities}*\mathrm{Financing \,costs }(\mathrm{cost \,of \,debt})\\&=\mathrm{8,436,786{\hbox{\EUR}}}*2\mathrm{\%}\\&=\mathrm{168,736{\hbox{\EUR}}}\end{aligned}$$

$$\begin{aligned}{\mathrm{EBT}}_{\mathrm{for}.}&={\mathrm{EBIT \,margin}}_{\mathrm{for}.}-{\mathrm{Fin}.\,\mathrm{ charges}}_{\mathrm{for}.}\\&=\mathrm{1,977,055{\hbox{\EUR}}}-\mathrm{168,736{\hbox{\EUR}}}\\&=\mathrm{1,808,319{\hbox{\EUR}}}\end{aligned}$$

$$\begin{aligned}{\mathrm{Taxes}}_{\mathrm{for}.}&={\mathrm{EBT}}_{\mathrm{for}.}*\mathrm{Inc}.\mathrm{\% \,Taxes}\\&=\mathrm{1,808,319{\hbox{\EUR}}}-\mathrm{904,160{\hbox{\EUR}}}\\&=\mathrm{904,160{\hbox{\EUR}}}\end{aligned}$$

$$\begin{aligned}{\mathrm{Net\, profit}}_{\mathrm{for}.}&={\mathrm{EBT}}_{\mathrm{for}.}-{\mathrm{Taxes}}_{\mathrm{for}.}\\&=\mathrm{1808,319{\hbox{\EUR}}}-\mathrm{904,160{\hbox{\EUR}}}\\&=\mathrm{904,160{\hbox{\EUR}}}\end{aligned}$$

Finally, we complete the balance sheet by including the net income in the shareholder capital, the taxes in the working payables, and the finance charges in the net financial debt (Table 2.5):

Table 2.5 Final balance sheet and income statement T + 3

It is evident that the target gross remuneration is higher than the one attained in Step 1. This is due to the lower amount of net short-term financial debt compared to the NOWC and, consequently, to the lower short-term financial charges in general.