[ \" Easiest and naivest way is linear extrapolation: gathering the historic fin

Question

[ " Easiest and naivest way is linear extrapolation: gathering the historic financial data and deriving a growth rate (CAGR) for any line on the income statement (sales, gross profit, operating profit, net income etc). If historically profit ratios have been constant you can just forecast sales and derive the rest as a percentage of sales. Check competitors to confirm profit margins are close to industrial average.

You can check management reports and see if there are any projects that can boost future sales. Maybe a successful R&D is coming through.

A more comprehensive way is understanding the product, assess the macro environment (GDP growth) and the prospects of that market. Can the company increase market share? Do a Porter analysis.

Break down the income and expense components of the earnings and see how each item can change in the future (e.g. a cheese factory needs to buy and store milk, what volumes can it support using existing assets?). In other words create a model of what drives the company.

Although all forecasts suck anyway, still forecasting each “moving part” of the company with forward looking quantitative and qualitative justifications is more reliable than just applying a flat rate based on historic performance.

In summary company valuation should include meeting with management and visiting the company unless everything is available and can be researched from your computer. " ]

What are your thoughts on this author's take on forecasting earnings? Why would we want to forecast a company's earnings? How would managers and investors use this information? Which of these approaches do you agree with? Which ones do you think would be of little value and why?

Explanation / Answer

I agree with the author when it comes to the forecasting revenues for the company. This forecast would help the lenders such as the financial institutions such as the creditors etc. in knowing as to whether the company would be able to generate in enough cash flows through its operations so that it could pay its creditors.

The owners of the shares of the company and also the other players in the security markets want to know whether the company would be able to generate in enough return for them so that they are able to continue with making an investment in the company.

The comparison between the actual and thee estimated earnings affects the prices of the securities in the stock market.

The forecasting of earnings is very useful for the management of the company since it could be used as a benchmark for the management. This technique outgrows the process of budgeting and all of the components of the budget could be compared with the actual data in order to see as to how the company is performing.

The most advantageous technique is the Time Series forecasting. This is the technique which measures in the data over a period of time. It could be hourly, daily, weekly or monthly etc. this include the trend of cyclical, seasonal, irregular components as well. This is the best method of forecasting since it uses the historical data which shows the events of the past that must be consider when making this forecast. It also takes into account the seasonal patterns which reveals the seasonal fluctuations in the sales figures. This method also helps in the analysis of the trends and also helps in the measurement of both the financial and endogenous growth.

The other technique include the following:

The above techniques are of a little value since these do not take into account the history of the sale of the company, its previous trends etc.

Related Questions

Navigate

• Browse (All)
• Browse #
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.