Modeling Projected or Forecasted Financial Statements (without a plug!) Book

Forecasting or projecting financial statements out into the future is an essential skill for an MBA, finance or accounting professional. Unfortunately, with so much content required to be covered in a short period of time of time, not many MBA students have the time and opportunity to develop the skills to forecast or project financial statements into the future. As tutors, we have helped many finance students and professionals master the art and science of projecting or forecasting financial statements without using a plug! We summarize our approach in the book ‘Modeling ‘Projected or Forecasted Financial Statements (Without a Plug!)‘

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“What is the different between a projected financial statement and a forecasted financial statement?”

This is a question we often get! There is a clear difference! Albeit a subtle difference. The Public Companies Accounting Oversight Board (‘PCAOB’) which oversees auditors and sets standards clearly differentiates the difference between a forecast and a financial projection and a financial forecast.  The PCAOB defines the term financial projection and financial forecast in Attestation Standards Section 301 titled “Financial Forecasts and Projections” . The PCAOB has defined a financial forecast and a projected forecast as follows:

“Financial forecast—Prospective financial statements that present, to the best of the responsible party’s knowledge and belief, an entity’s expected financial position, results of operations, and cash flows. A financial forecast is based on the responsible party’s assumptions reflecting the conditions it expects to exist and the course of action it expects to take. A financial forecast may be expressed in specific monetary amounts as a single point estimate of forecasted results or as a range, where the responsible party selects key assumptions to form a range within which it reasonably expects, to the best of its knowledge and belief, the item or items subject to the assumptions to actually fall. When a forecast contains a range, the range is not selected in a biased or misleading manner, for example, a range in which one end is significantly less expected than the other. Minimum presentation guidelines for prospective financial statements are set forth in Appendix A [paragraph .68].”

“Financial projection—Prospective financial statements that present, to the best of the responsible party’s knowledge and belief, given one or more hypothetical assumptions, an entity’s expected financial position, results of operations, and cash flows. A financial projection is sometimes prepared to present one or more hypothetical courses of action for evaluation, as in response to a question such as, “What would happen if . . . ?” A financial projection is based on the responsible party’s assumptions reflecting conditions it expects would exist and the course of action it expects would be taken, given one or more hypothetical assumptions. A projection, like a forecast, may contain a range. Minimum presentation guidelines for prospective financial statements are set forth in Appendix A [paragraph .68].”

Note the key difference between a projected financial statement and a forecasted financial statement:

  • a forecasted  financial statement is based on reasonable expectations of those preparing the prospective financial statements.
  • Whereas, a projected financial statement is based on reasonable expectations AND one or more hypothetical assumptions made by those preparing the prospective financial statements.

Forecasting or projecting financial statements out into the future is an essential skill for an MBA, finance or accounting professional. Projected Financial Statements are essentially financial statements for the next few years built on expected or planned performance estimates such as revenue growth, cost of operations, planned investments, etc. Projected Financial Statements are useful in a number of ways including understanding the impact of various operational activities, financial policies or strategies on financial statements. Projecting financial statements also identifies cash requirements, funding needs and assists in communication, planning, etc. Financial statements include the income statements, balance sheets, cash flow statements and statement of changes in shareholder’s equity.

Ingredients Required to Project Financial Statements

The key ingredients required to project financial statements are:

  • Historical income statements;
  • Historical balance sheets;
  • A good understanding of the business model; and
  • Management plans for the immediate future.

Historical income statements and balance sheets provide a good base on which future performance drivers can be assumed or predicted. A good understanding of the business model will help better estimate future performance drivers. Management plans for the immediate future are very important especially if expansion, new investments or change in strategy or financial policy are expected because these will impact the projected numbers in multiple ways.

Most of the ingredients required to project financial statements can be found in the company’s annual report or Form 10K. The section titled Management Discussion and Analysis (MD&A) in a company’s Form 10K is a good starting point.  Information about management plans can be found in industry reports, earnings calls and media reports.

Components of an 3 Statement Financial Model

A 3 statement financial model must have the following components. This is a basic model. Your financial model could have many more components but it should include the components listed below.

  • Performance Drivers (Assumptions)
  • Income statements
  • Balance sheets
  • Cash flow statements
  • Supporting schedules
    • Debt schedules
    • Free cash flow
    • Debt and dividend payments

Planning & Structure of a 3 Statement Financial Model

You can structure your forecasted financial statements model in many ways. What is important is that you should have all the important components in the model and that the model must be intuitive to follow. An intuitive model is especially important if it is going to be reviewed by others.

You can have a separate tab for each of the above components or you can have the entire model in one single tab. The best way to structure the model will depend on the complexity of the model, the specifics of your situation and personal preferences. If you are modeling a simple 3 statement model with few supporting schedules, a one page model may be sufficient. However, if you want to model many nuances and need many schedules, a model with multiple tabs maybe a better way to proceed.

Modeling Projected or Forecasted Financial Statements (without a plug) – Simplified

If you are looking to learn how to model a projected or forecasted financial statement, Modeling ‘Projected or Forecasted Financial Statements (Without a Plug!) is a good resource. This is especially true for MBA, CFA or undergraduate finance students interested in understanding how to forecast or project financial statements into the future in Microsoft Excel or Google Sheets. This book is also helpful for executives and others interested in understanding and modeling financial statements. It is a wonderful resource for students or professionals interviewing for jobs in the private equity, investment banking or hedge fund industry because it will teach you how to build a basic 3 statement financial model in about 2 hours.

This book assumes that the reader is familiar with basic accounting concepts. For example, the reader is expected to know the structure of an income statement, balance sheet and cash flow statement, the meaning of the term working capital, etc. The reader is NOT expected to be an expert in Microsoft Excel or Google sheets but has to be reasonably familiar with Microsoft Excel.

This book will teach you how to build a simple 3 statement financial model. Different company’s financial statements may have a few different account names and characteristics but the overall structure of a financial statement will be quite similar. Once you can confidently build a simple 3 statement financial model, you can add many bells and whistles to reflect the numerous specifics of any projected 3 statement financial model.

Modeling Projected or Forecasted Financial Statements (without a plug) – Simplified is based on Senith Mathews’ experience tutoring students and executives in financial modeling over the last 10 years and prior to that building models as a management consultant with Arthur Andersen and Mercer Management Consulting (now Oliver Wyman). Modeling Projected or Forecasted Financial Statements (without a plug) – Simplified narrowly focuses on teaching readers how to build a 3 statement financial model in a spreadsheet. It does not go into the underlying accounting concepts or rules.

How to Gain the Most out of Modeling Projected or Forecasted Financial Statements (without a plug) – Simplified

Modeling ‘Projected or Forecasted Financial Statements (Without a Plug!) – is built on our modeling boot camps experience and so it is best you adopt a hands-on boot camp attitude as you read this book to maximize your learning from this book. You should be confident of building a 3 statement financial model on your own after working through this book. You should read this book at least twice to really understand how to forecast financial statements.

Your first read is meant to give you a quick overview of the entire process. You should follow the model spreadsheet as you progress through the book. Read each section one by one. Once you have read a section, review the corresponding region in the Microsoft Excel model. Change the relevant input assumptions to see how that section changes. Dig into each cell of the Microsoft Excel model row by row so you understand the formula and relationships section by section.

Your second read is when you should open up a blank workbook and build the exact 3 statement financial model yourself. We recommend that you re-read the book from the beginning. As you re-read each section re-create that section in a blank workbook. Begin by setting up the same input assumptions and build the projected financial statement section by section. Check each section of your model and proceed to the next section only after you are sure it reflects the sample model. Your final model should reflect the sample model when you are done. Change the relevant input assumptions in your model to check that the model returns reflect the changes in the book’s model.

This should give you the confidence to build a 3 statement financial projection model on your own. Now you are ready to tackle the case studies provided. We recommend you work on the case studies with a friend or a tutor so that you get instant feedback. Good timely feedback boosts your learning process tremendously.

Modeling Standards: What Constitutes a Good Model?

A number of factors constitute a good model. Here is a basic list:

  • Accuracy of the financial model.
  • Intuitive to understand and easy to follow.
  • Organized clearly into components.
  • Flexibility in the model’s design.
  • Adherence with the modeling standards used in the firm or class.
  • Appearance of the model is pleasant and consistent.
  • Print setup is complete.
  • Documentation of purpose, including history, authors and change logs.

Practice Projecting Financial Statements without a Plug

Below we give you three opportunities to practice forecasting financial statements without a plug. Repeat the same techniques as many times to gain practice forecasting financial statements without a plug.

Blank Model

Here is a blank model for you to download. Please forecast the financials without using a plug. This model is very similar to the example you worked on in this book.

Fix a Broken Model

This model is a broken model. The financial statements were forecast using a plug. How will you make this a dynamic model.

Tip: Request a friend to take a dynamic working model and break it tampering with formulas. Review it and fix the model.

Forecast a Public Company’s Financial Statements

Pick a public company you like. Download and read the company’s most recent Annual report and 10-K from the company’s investor relations page. Forecast the company’s financial statements for the next 5 years without using a plug.

Tip: Repeat this as many times as you can. You will learn a ton each time.

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