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Forecasting

•  Why Forecasting? •  What is Forecasting? •  The 7 Steps of Forecasting •  Calculating Breakeven •  Breakeven Chart

Why Forecasting?

•  Forecasting is the core of any business plan

•  A business without a forecast is like a trip without a destination

•  Forecasting is the process of identifying that destination and then establishing a rough map for your business’ future activities

Why Forecasting?

•  Advantages of careful forecasting: –  Attain profit targets –  Prevent problems –  Identify better ways to operate –  Spark new ideas –  Achieve your destination

Why Forecasting?

Objective Profit & Setting Meaningful Planning Objectives

•  Systematic approach

–  Carefully reasoned assumptions –  Evaluating business practices –  Conscious planning and forethought

•  The final product of your forecasting effort is your projected cash flow

What Is Forecasting?

It seems like a mysterious process… •  No Magic •  No Crystal Ball

What Is Forecasting?

•  Careful analysis of past & current business practices •  Extrapolation of current trends

–  Sales –  Expenses –  Major economic shifts such as inflation

•  Creative examination, evaluation, and revision of the assumptions you use to operate your business

Analysis takes time – invest the time for a more profitable future.

Forecasting – The Seven Steps

1.  Identify all fixed and variable costs 2.  Determine your breakeven sales level 3.  Evaluate the odds of reaching breakeven 4.  Determine when you will reach breakeven 5.  Plot the breakeven level on a graph against two curves:

reasonable growth and pessimistic growth 6.  Translate graphs into an income forecast 7.  Translate the income forecast into a cash flow

Step #1: Identify all Fixed and Variable Costs

•  Fixed Costs – Remain Constant –  Depreciation on plant & equipment –  Rent/mortgage payments –  Interest –  Executive & office salaries –  General office expense –  Property taxes

Step #1: Identify all Fixed and Variable Costs

•  Variable Costs – Change With Output –  Cost of goods sold –  Factory labor –  Sales commissions –  Material –  Freight-in (and out) –  Variable factory expenses

•  Heat

–  Direct labor –  Sales expense

Step #2: Breakeven Analysis

•  Breakeven refers to the level of sales necessary to cover all of the fixed and variable costs

•  The point where the business neither makes a profit or a loss

•  Increased sales do not necessarily mean increased profit –  If the selling prices is reduced to stimulate sales, the breakeven point

may be forced upward –  The business could never achieve sufficient sales to break even

Step #2: Breakeven Analysis

•  Breakeven Analysis: –  A planning tool –  A decision tool –  A pricing tool –  An expense tool

Step #2: Breakeven Analysis

KEY:

FC = Total Fixed Costs in Dollars

VC = Total Variable Costs in Dollars

S = Total Sales in Dollars

GM = Gross Margin

GP = Gross Profit (or Sales minus Variable Costs

•  Basic Formula BES = FC + VC •  Variations with Different Combinations of Available Data

-  BES = FC/(1-(VC/S)) OR -  GM = GP/S -  GP = S – VC -  B/E = FC/GM

Step #2: Breakeven Analysis

Total Costs

Break-even point

Net Profit

40

200

$300

100

$0 20 40 60 80 120 100 140

Loss

Sales Income

Profit

Variable Costs

Fixed Costs

Income and Costs (thousands of dollars)

Units Produced and Sold (thousands of dollars)

Do your assumptions make sense?

Step #3: Evaluate the Odds of Reaching Breakeven

Breakeven Sales Goals in Months

1 2 53 4 6 7 8 9 10 11 12

Breakeven

0

$100

$200

$300

$400

$500

Sales

Thousands of Dollars

Step #4: When Will You Reach Breakeven?

•  Important questions to ask about your sales levels: 1.  How fast will sales grow? Will they decline or stabilize? 2.  How rapidly can you develop new customers and will your efforts pay? 3.  What is the average sale per customer? Can in be increased? 4.  What is the frequency of repeat sales? Can it be increased?

Step #4: When Will You Reach Breakeven?

Continued… Important questions to ask about your sales levels: 5.  What is the state of the economy in general? In your

industry? 6.  Are there cyclical trends in your industry? How can they (and

how do they) affect you? 7.  What is the nature of your competition? Is it getting

stronger or declining, or is new competition entering the market?

Step #5: Plot the breakeven level on a graph against TWO curves

•  Reasonable growth vs. pessimistic growth –  Curve 1 – Reasonable sales assumptions –  Curve 2 – Worst case sales assumptions

•  The area between the two sales lines will indicate the

amount of contingency reserves you would be wise to carry.

Step #6: Income Forecasting

•  In Step # 1, you identified your fixed and variable expenses

•  In Steps # 2 through # 6, you experimented with different ways of constructing sales forecasts

•  Now: Inspect the changes that you expect in your business month by month

–  This will show the actual profit or loss to expect from your venture

–  Becomes your projected or pro forma income statement

Step #7: Cash Flow

•  Single most important part of the forecasting process

•  Projected cash flow is the basis of your cash budget

–  Shows the timing of cash flows –  Enables you to ensure adequate cash reserves and

working capital •  Profitability does not necessarily equal liquidity

–  Some ventures making profits go out of business because they run out of cash

–  Anticipate problems and plan strategies in advance

Forecasting

~ Q & A ~