Prospective analysis: forecasting

Financial statement analysis is conducted with a forward-looking perspective, often requiring a clear forecast to summarize insights. Managers rely on forecasts to develop business strategies and set performance goals, analysts use them to convey their evaluations of a firm’s future to investors, and lenders depend on them to evaluate the likelihood of loan repayment. Additionally, forecasts are utilized in various settings, including security analysis, where they are often summarized as an estimate of the firm value. This estimate aims to capture, in a single metric, the manager's or analyst's view of the firm's prospects. Prospective analysis involves two primary tasks: 1. forecasting, and 2. valuation. In this note we focus on forecasting. Rather than being a standalone process, forecasting integrates insights from business strategy, accounting, and financial analysis. There are, however, specialized techniques to create the most effective forecast. This note outlines a framework for structuring forecasts, provides guidance for starting, examines the connections between different analytical steps and forecasting, and details methods for projecting earnings, balance sheets, and cash flows.