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Integrated forecasting as a tool in the context of estimates of financing requirements and company valuations

Concept of integrated forecasting

An integrated forecast consists of mutually compatible projected P&Ls, projected balance sheets and projected cash flow statements. It routinely constitutes a key element of company valuations and is of particular importance for companies in crisis situations. An integrated restructuring plan is the starting point for developing a restructuring concept, for example, as the basis for financing decisions, or for the discharge vis-à-vis creditors who, being aware of the debtor’s (imminent) illiquidity, have given their approval for a part-payment agreement (cf. IDW* Standard 6, subsection 2); *[Institute of Public Auditors in Germany – Institut der Wirtschaftsprüfer, IDW]. The main focus here is on the liquidity forecast (cf. IDW Practice Statement 2/2017, subsection 5).

Preparing a forecast

The projected P&L is of particular importance when forecasting the future chances of success. The starting points for the forecast are a detailed sales forecast on the basis of a price and quantity structure, or possibly broken down into the most important product and customer groups as well as the corresponding forecasts for the cost of materials. In addition, separate sub-plans such as investment and staffing plans will also be integrated. In practice, relatively detailed forecasts for the income statement are normally only made down to the level of EBIT (earnings before interest and tax) while, frequently, less importance is attached to the financial result and taxes on corporate income and business profits.

Forecasts for the projected balance sheet can be generated, for example, on the basis of performance metrics. ‘Payment target in days’ is a metric that can be used to generate forecasts for trade receivables where sales revenues form the basis of the calculation. The trade payables can then be estimated accordingly using the forecasts for the cost of materials. Forecasts for inventories can be carried out, for example, by taking into account the storage periods or stock turnover.

A projected cash flow statement can be derived from the projected P&L and the projected balance sheet.

Practical relevance of integrated forecasting

In practice, balance sheet forecasts are frequently neglected. While there is usually still a short or medium-term investment plan that forms the basis for the forecasting of fixed assets, in practice, the forecast for net working capital is frequently one of flat growth, i.e. no changes are forecast for net current assets. Yet, it is precisely net working capital that is of considerable importance for a company’s liquidity. A forecast for the latter will highlight the potential amount of capital required. That is why integrated forecasting is indispensable particularly for companies in crisis situations that would also like to initiate restructuring measures.

Then again, in the context of company valuations, balance sheet forecasts have a material influence on a company’s indebtedness. In the context of deriving the financial result, it is especially important to calculate the gearing ratio properly since indebtedness affects not only the level of distributable profits but, in particular, also the level of the beta factor and, thus, the discount rate (see also PKF Newsletter 11/2018, ‘Particularities of the valuation of highly indebted companies’).

Please note: The quality of integrated forecasting naturally depends not only on mathematical accuracy but notably on the quality of the underlying information. Bearing in mind the uncertainties of forecasts, the assumptions that underlie integrated forecasting should be plausible, i.e. verifiable, consistent and without contradictions (cf. IDW Practice Statement 2/2017, subsection 5).

Conclusion: Integrated forecasting provides high added value particularly for companies in crisis situations, or those businesses that have to perform a well-founded company valuation because, without such forecasting, it is not possible to carry out a proper estimate of the financing requirements. Furthermore, through integrated forecasting, the factors that affect the gearing ratio become transparent – their impact on enterprise value should not be underestimated.

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