What are Projected Financial Statements?
Projection of the financial statement means to estimate the statements like Income statement, Balance sheet, and statement of cash flow. The projection of financial statements emphasizes the current trends and expectations to arrive at the perfect financial picture that management wants to attain in the future.
Projected financial statements show the summary of the statement of income, balance sheet, and cash flow statement which helps the managers to take future decisions accordingly. It plays a big role in the business planning process as it forecasts the future financial position of the company.
Projected statements are also known as "pro forma financial statements" which means "as a matter of form". It is a very important part while preparing a business plan for a new business or making strategic plans for ongoing business. It is also useful to attract investors so that more and more investments are made in the business which will be helpful for expansion.
Explaining projected financial statements
The financial projection is all related to the assumptions taken for forecasting the data of financial statements. Mostly, assumptions are made based on past data and knowledge. Projections are not exactly correct as predictions are not 100% accurate at the future performance of an organization. All businesses require projected financial data to present to their investors and creditors.
For managing the business properly, financial projections play a vital role. Making projected financial statements seems a boredom work for small businesses but it is as easy as creating normal financial statements.
Types of projections
Short term projections
Short term projections mainly cover one year and breaks into monthly projections. This type of projection is mostly useful for small businesses where the only plans related to increasing sales and revenue are considered.
Long term projections
Long term projections cover mainly the next three to five years and is used in large businesses for creating strategic plans for expansion and development are made. It also attracts investors so that they invest a large amount in their business.
Importance of projected financial statements
- It helps to find out the additional requirement, which is there for assets to support increased revenue and also create a positive impact on the financial statement.
- It helps in predicting the future outcomes of any business
- It supports the business planning process.
- Business growth becomes easy as financial projections help to measure how much debt or equity will be required for the business in the future.
- Businesses never run out of cash as it generates additional cash and revenue whenever required.
- For applying for a loan from banks or any other institution, Projected financial statements are very much important.
- As well as creditors also ask for projected statements to know the capability of the business to reimburse the debts.
Important data and statements required for financial projections
- Historical financial data
- The balance sheet of previous years
- The income statement of previous years
- Cash flow statement of previous years
- Market conditions and possible changes
- Projected fixed assets
Historical financial information
Historical data regarding various financial ratios like return on equity, liquidity ratio, profitability ratios, etc are analysed before preparation of financial projections. Past year's data is very much useful to estimate future outcomes of the company.
The balance sheet of previous years
Previous years data such as current and non-current assets, short-term and Long-term liabilities, current and non-current liabilities, etc are used to analyse and prepare projected balance sheets.
The income statement of previous years
Previous years' data such as sales, expenses, cost of goods sold, gross profit, net profit, depreciation, etc are used to analyse and prepare projected income statements. By using sales forecast and expense budget, projection of income the statement is made.
Cash flow statement of previous years
Cash inflows and outflows of previous years help to estimate the future requirements of cash in the business. This helps to know the amount of financing required in the future and accordingly projected financial statement is being prepared. Cash flows are an important part of the business as it shows the liquidity of any business. Financial projections of cash flows are helpful to fulfil any urgent need for cash in the future time and forecast the cash crises if happen further.
Market conditions and possible changes
Market conditions play a vital role in the projection of financial statements. Market structure is analysed for projection and business plan is made accordingly. Demand and supply of goods and services, amendments and business reforms, inflation and deflation, etc are certain conditions that help to forecast the data and make financial projections.
Projected fixed assets Fixed assets are analyzed and their life is estimated so that in the future cash flow for purchasing specific assets should be there. Projection is necessary to fulfil the future need of assets to maximize the earnings of the business.
The sequence of projecting financial statements
- Income statement
- Balance sheet
- Cash flow statement
Projecting Income Statement Line Items
Projecting work begins from an income statement in which past values are compared with the present values and then, future values are forecasted. The statement of income is projected to analyse the net income and make future business plans accordingly.
The mainline items to forecasts are as below:
- Sales revenue
- Cost of goods sold
- Direct expenses
- Depreciation expense
- Interest expense
- Tax expense
These items are important for preparing the income statement and will help to project the net income of the company.
Balance Sheet Line Items
The financial forecast of balance sheet items is done simultaneously with the items of the income statement. This will be helpful to project the financial items one by one and forecast each of the items properly to complete the forecasting of financials completely.
The mainline items to forecasts are as below:
- Account’s receivables
- Other current assets
- Property, plant, and equipment
- Other long-term assets
- Account’s receivables
- Other current liabilities
- Long-term debts
- Deferred tax liabilities
- Bonds payable
- Shareholder's capital
- Retained earnings
- Dividend distribution
Working Capital Line Items
Accounts Receivables, Inventory, and Accounts Payables are projected using a unique method as all these accounts are also included in the operating cycle. These accounts are used to find out outstanding days also. The specific formula is used to calculate the outstanding days.
Cash flow statement line items
The cash flow statement forecast is mostly related to the items of the income statement and balance sheet only. The cash flow statement is consisting of three main activities which are as below:
- Operating activity
- Investing activity
- Financing activity
Operating activity items are taken from the balance sheet and statement of income like net income, depreciation, inventory, accounts receivables, etc. Net cash inflow from such operating activities is calculated and from that future requirement of operating, cash is estimated.
Inflow and outflow of cash through investment activities such as purchase or sale of any asset is calculated and future requirement of cash for purchasing in the future is forecasted which helps to increase the earnings of the business.
Financing the activity comprises cash flow from taking and issuing loans from banks or financial institutions. This helps for making a good business plan for expansion. It makes it easy to forecast future need of capital regarding operating as well as investing activities.
Projected financial statements are helpful to be prepared in advance for any worst outcomes from any business plan or decisions. It is not necessary that projection is always helpful to reduce the business risks and uncertainty instead it helps to get ready to tackle any bad situation in the future. It is prepared using current situations and facts. It helps to find out the additional inflows which will be needed in the future to remain solvent.
Context and Applications
The topic is significant in the professional exams for both undergraduate and postgraduate courses, especially for:
- B. Com (Bachelor of Commerce)
- BBA (Bachelor of Business Administration) in Finance
- MBA (Master of Business Administration) in Finance
- CA (Chartered accountant)
- CFA (Chartered Financial Analyst
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