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Profit Forecasting

The document discusses profit forecasting and its importance for business planning and success. Profit forecasting involves estimating future performance based on past results and accounting for factors that could impact profits. It requires developing budgets for items like sales, expenses, and profits. The process coordinates activities across a business and communicates plans to motivate managers and allow for monitoring of performance against goals. Benefits of profit forecasting include planning, coordination, communication, motivation, and control.

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Komal Shujaat
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10K views

Profit Forecasting

The document discusses profit forecasting and its importance for business planning and success. Profit forecasting involves estimating future performance based on past results and accounting for factors that could impact profits. It requires developing budgets for items like sales, expenses, and profits. The process coordinates activities across a business and communicates plans to motivate managers and allow for monitoring of performance against goals. Benefits of profit forecasting include planning, coordination, communication, motivation, and control.

Uploaded by

Komal Shujaat
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
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PROFIT FORECASTING

Forecasting, particularly on a short-term basis (one year to three


years), is essential to planning for business success. This process,
estimating future business performance based on the actual results
from prior periods, enables the business owner/manager to modify
the operation of the business on a timely basis. This allows the
business to avoid losses or major financial problems should some
future results from operations not conform with reasonable
expectations. Forecasts - or Pro Forma Income Statements and
Cash Flow Statements as they are usually called - also provide the
most persuasive management tools to apply for loans or attract
investor money. As a business expands, there will inevitably be a
need for more money than can be internally generated from profits.

Profit forecast is the amount of profit a company expects to make at


the end of the period. The monthly profit and loss forecast will consist
of the following:

o Sales
o Cost of sales
o Gross Profit
o Overheads
o Total Overheads
o Miscellaneous income
o Net Profit

FACTORS AFFECTING PROFIT FORECASTING


Preparation of Forecasts (Pro Forma Statements) requires
assembling a wide array of pertinent, verifiable facts affecting your
business and its past performance. These include:

Data from prior financial statements, particularly:

1. Previous sales levels and trends

2. Past gross percentages


3. Average past general, administrative, and selling expenses
necessary to generate your former sales volumes

4. Trends in the company's need to borrow (supplier, trade credit,


and bank credit) to support various levels of inventory and
trends in accounts receivable required to achieve previous
sales volumes

Unique company data, particularly:

1. Plant capacity

2. Competition

3. Financial constraints

4. Personnel availability

Industry-wide factors, including:

1. Overall state of the economy

2. Economic status of your industry within the economy

3. Population growth

4. Elasticity of demand for the product or service your business


provides ( Demand is said to be "elastic" if it decreases as
prices increase, a demonstration that consumers can do
without or with less of the goods or service. If demand for
something is relatively steady as prices increase, it is
"inelastic.")

5. Availability of raw materials

Once these factors are identified, they may be used in Pro Formas,
which estimate the level of sales, expense, and profitability that seem
possible in a future period of operations.

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STAGES IN MAKING PRO FORMA INCOME
STATEMENT:
The important stages are as follows:
1. communicating details of profit forecasting policy and guidelines
to those people responsible for the preparation of pro forma
income statement;
2. determining the factor that restricts output;
3. preparation of the sales budget;
4. initial preparation of various budgets of pro forma income
statement;
5. negotiation of budgets with superiors;
6. coordination and review of budgets of pro forma income
statement;
7. final acceptance of pro forma income statement;
8. ongoing review of budgets.

Communicating Details of the Profit Forecasting Policy


Many decisions affecting the profit forecasting process will have been
taken previously as part of the long-term planning process. The long-
range plan is therefore the starting point for the preparation of pro
forma income statement. Thus top management must communicate
the policy effects of the long-term plan to those responsible for
preparing the current year’s pro forma income statement. Policy
effects might include planned changes in sales mix, or the expansion
or contraction of certain activities.

Determining the Factors that Restricts Performance


In every organization there is some factors that restrict performance
for a given period. In the majority of organizations this factor is sales
demand. However, it is possible for production capacity to restrict
performance when sales demand is in excess of available capacity.
Prior to the preparation of the budgets, it is necessary for top
management to determine the factor that restricts performance, since

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this factor determines the point at which the annual profit forecasting
process begins.

Preparation of the Sales Budget


The volume of sales and the sales mix determine the level of a
company’s operations, when sales demand is the factor that restricts
output. For this reason, the sales budget is the most important plan in
the annual profit forecasting process. This profit forecast is also the
most difficult plan to produce, because total sales revenue depends
on the actions of customers. In addition, sales demand may be
influenced by the state of the economy or the actions of competitors.

Initial Preparation of Budgets of Pro forma Income


Statement
The budgeted or pro forma income statement is prepared after the
operating budgets have been completed. The managers who are
responsible for meeting the budgeted performance should prepare
the budget for those areas for which they are responsible. The
preparations of the budget should be a bottom-up process. This
means that the budget should originate at the lowest levels of
management and be refined and coordinated at higher levels. The
justification for this approach is that it enables managers to
participate in the preparation of their budgets and increases the
probability that they will accept the budget and strive to achieve the
budget targets.

Negotiation of Budgets of Pro forma Income Statement


To implement a participative approach to profit forecasting, the pro
forma statement should be originated at the lowest level of
management. The managers at this level should submit their budget
to their superiors for approval. The superior should then incorporate
this budget with other budgets for which he or she is responsible and
then submit this budget for approval to his or her superior. The
manager who is the superior then becomes the budgetee at the next
higher level.

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Coordination and Review of Budgets of Pro forma
Income Statement
As the individual budgets move up the organizational hierarchy in the
negotiation process, they must be examined in relation to each other.
This examination may indicate that some budgets are out of balance
with other budgets and need modifying so that are beyond a
manager’s knowledge or control.

Final Acceptance of the Pro Forma Statement


When all the budgets are in harmony with each other, they are
summarized into main pro forma statement. After this pro forma
statement has been approved, the budgets are then passed down
through the organization to the appropriate responsibility centers. The
approval of pro forma statement is the authority for the manager of
each responsibility center to carry out the plans in each budget.

Pro forma Income Statement Review


The profit forecasting should not stop when the operating budgets of
pro forma income statement have been agreed, periodically, the
actual results should be compared with the budgeted results. These
comparisons should normally be made on a monthly basis; so that it
has the maximum motivational impact. This will enable management
to identify the items that are not proceeding according to plan and to
investigate the reasons for differences

BENEFITS OF PROFIT FORECASTING


Profit forecasting serves a number of useful purposes. They include:
1. planning annual operations;
2. coordinating the activities of the various parts of the
organization and ensuring that the parts are in harmony with
each other;
3. communicating plans to the various responsibility centre
managers;

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4. motivating managers to strive to achieve the organizational
goals;
5. controlling activities;
6. evaluating the performance of managers.

Planning
The profit forecasting process ensures that managers do plan for
future operations, and that they consider how conditions in the next
year might change and what steps they should take now to respond
to these changed conditions. This process encourages managers to
anticipate problems before they arise, and hasty decisions that are
made on the spur of the moment, based on expediency rather than
reasoned judgment will be minimized.

Coordination
The profit forecasting serves as a vehicle through which the actions
of the different parts of an organization can be brought together and
reconciled into a common plan. Without any guidance, managers
may each make their own decisions, believing that they are working
in the best interests of the organization.

Communication
Through the profit forecasting, top management communicates its
expectations to lower level management, so that all members of the
organization may understand these expectations and can coordinate
their activities to attain them.

Motivation
The profit forecasting can be a useful device for influencing
managerial behavior and motivating managers to perform in line with
the organizational objectives. Profit forecasting provides a standard
that under certain circumstances, a manager may be motivated to
strive to achieve.

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Control
A profit forecasting assists managers in managing and controlling the
activities for which they are responsible. By comparing the actual
results with the budgeted amounts for different categories of
expenses, managers can ascertain which costs do not conform to the
original plan and thus require their attention.

LIMITATIONS OF PROFIT FORECASTING


De-motivation
Generally profit forecasting increases motivation but it could also be a
reason of de-motivation of employees if they feel that the budgeted
figures are way too high to achieve.

Budgetary Slack
Budgetary slack or padding the budgets can occur as managers will
intentionally blow up their budget figures for fear of top
management’s reprimanding them.

Bad Decision Making


Unrealistic budgets can lead managers to make decisions that might
be detrimental to the company. A good example of over-ambitious
sales budget will lead to disastrous impact like giving steep discount
to increase volume, etc.

Doesn’t Reflect Complexities


No matter how well prepared a budget might be, it will never be able
to reflect truly the reality/complexities faced by the company.

Regularly Updating
There is a need to revise/update the budget which at the time was
based on a certain set of circumstances/best information.

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