business forecasting
TRANSCRIPT
Future analysis
Forecasting summarises future expectations of:
Business strategy Accounting Financial analysis
Projects future expected scenario,keeping past in view
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Financial Statements
Forecast should consist of the following statements:
Balance sheet Profit and loss account Cash flow
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Future prediction There should be a believable story about the future performance of the company. For eg.
“Sales is expected to grow at more than average industry expected rate of growth in this BPO company. This is because of the quality of the management team, the investors and the past track record of the company in getting and retaining customers.”
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Strategic perspective The strategic rationale should be based on careful understanding of
the company industry and general economic scenario
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Strategic perspective
Value is driven by the excess of return over cost of capital over a long period of time. This comes out of competitive advantage, which could be due to:
Superior product, service Lower costs Better utilisation of assets and
capital6www.bizkul.com
Strategic perspective
Porter model Customer segmentation Competitive business systems SWOT analysis
Source: Valuation : Tom Copeland, Tim Koller, Jack Murrin
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Porter model
Substitute products / services Supplier bargaining power Customer bargaining power Entry/exit barrier
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Substitute products Porter model
Speed post and courier service competing in the service industry
Replacement of glass containers by metal cans
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Supplier bargaining power Porter model Shortage of technology experts
commanding premium for services rendered
Unique products or products with a difference commanding better price due to requirement of buyer
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Customer bargaining power Porter model
Driving down of prices by customers of software services companies
Customers moving from wholesale stores to retailers as retail stores are driven to pass on some of their margins to their customers
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Entry / exit barriers Porter model
Limited availability of persons with skill sets
Minimum capital requirement for setting up of BPO in a specific area
Cost of exit, closure and retrenchment may be prohibitive due to statutes
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Customer Segmentation Explicit identification of reason of
selection of one company’s product over another
Analyses the level of difficulty in differentiation by competitors
Looks at profitability of customers, based on their need and cost of servicing them
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Customer Segmentation Customer perspective
– Product attributes have different impact on different kinds of customers (small manufacturers may need after sales service unlike bigger industries)
– Variation in product offerings may impact sales as some customers may prefer some bundled product offerings as compared to others which are stand alone
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Customer Segmentation Customer perspective
–Segmentation of groups of customers force analysts to understand why customers prefer one product over other (eg. in courier service some customers want detailed tracking of parcel, others do not)
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Customer Segmentation Producers perspective
–Different customers have different costs of servicing
Advantage of segmentation is that this helps identify existing and potential competitive advantages
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Competitive Business System Analysis from product design to after sales
service– Product design, development, procurement,
manufacturing, marketing, sales & distribution Attempt to understand competitive advantage,
whether through lower costs, better capital use or superior customer value – (eg. A company may have advantage of
greater labour productivity, which needs to be addressed by some alternate cost saving or variation in product offering etc)
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Competitive Business System Product design, development (product
attributes, quality, time to market, IP) Procurement (Access to sources, costs,
outsourcing) Manufacturing (Costs, cycle time, quality)
Marketing (Pricing, advertisement, packaging)
Sales and distribution (Sales effectiveness, costs, channels, transportation)
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SWOT analysis Strengths Weaknesses Opportunities Threats
Check for links and patterns in these heads
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Capture strategy into financial forecasts Initially start with profit and loss
accounts and balance sheet Cash flow can be next derived
from these Prepare by keeping key ratios and
assumptions in mind
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Forecasting methodology Understand business strategy Develop a complete picture Develop a complete financial
forecast of the BS, P&L and CF statements
In short term calculate detailed numbers, in long term summarise trends expected
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Forecasting methodology Compute sensitivity analysis, for
key drivers Compute probability scenarios, in
the minimum, compute the following scenarios:–Normal–Optimistic–Pessimistic
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Forecasting methodology Consistency checks
–key ratios and internal consistency– industry parameters
Cash flow and liquidity–How will company raise funds–How will funds be utilised
Verify that the final numbers reflect the overall strategy of business
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Starting point Make a start What are the key drivers of the
business – now and in the future? What do you think are possible
starting points?
Translate your business story in words into financial numbers
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Financial forecasts The general approach is to start
with demand, based on which profit and loss statement is drawn up
Demand translates into sales
Revenue numbers are sensitive to volumes and prices
They also depend on product mix
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Starting point for start-ups
In the case of early stage companies which have not yet turned profitable the following are the key drivers of the business forecast for valuation purposes
Cash burn Stake that the promoters are willing to
offer to the private equity investor/venture capitalist
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Financial forecasts Expenses are based on sales Capex depends on capacity required
to generate revenues projected as well as utilisation of capacity
Revenue expenses are calculated based on trends and requirementsOne cannot just run an analysisOne has to understand trends And then - Plan for the future
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Revenues forecast Dependent on industry and business
– Eg. retail industry, based on number of stores
– ITES based on number of seats– Manufacturing dependent on product mix
Starting point– Demand and supply– Market size and market share– Break even point– Growth trends
Understanding normal industry behavior is Necessary but not sufficient
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Earnings trends Generally observe 3 to 5 years Check economic cycles – ie
seasonal/cyclic industries etc Check and remove unusual items Understand relevance of items to
normal earnings
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Adjustments/changes to earnings Remove one time items Remove abnormal/super earnings
which may not be sustainable Remove items not at market value
or not at arms length Account for changes in accounting
policy (gross vs. net income etc.) Consider if future business can be
based on past earnings and strategy 30www.bizkul.com
Forecasting earnings Past trends Average of past few years Industry trends Market share Forecast based on expected
strategy
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Some difficulties faced Incorrect adjustments Adjustments only partially done, ie
in asset & not in impact of asset on earnings/expenses (eg. land & rent on land)
Error in calculation of growth Error in base calculation of
earnings32www.bizkul.com
Expenses forecast Expenses to be listed, item by item
– Key drivers to be identified (eg salary – driven by no. of people as well as expected salary costs)
– Industry benchmarks may be used for cross referencing (variations/deviations are to be justified)
Capex– Based on requirement to reach target revenues– Also impacts depreciation & cash flow
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Balance sheet and Cash flow forecast Balance sheet accounts to be
individually forecast–Based on expected sales and utilisation
of assets, company policies (debtors collection period etc)
Cash flow–Based on forecast of balance sheet and
profit and loss account–Consistency check is important after
getting the first set of numbers34www.bizkul.com
In Summary Forecasting is the first step of
prospective analysis It is the start for any valuation
process The best way to forecast is to do it
comprehensively and in detail including all key financial statements
The forecast must stand up to scrutiny; must be internally consistent
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