110 PART 1 Introduction to Managerial Finance
sales forecast
The prediction of the firm’s sales
over a given period, based on
external and/or internal data;
used as the key input to the
short-term financial planning
process.
external forecast
A sales forecast based on the
relationships observed between
the firm’s sales and certain key
external economic indicators.
internal forecast
A sales forecast based on a
buildup, or consensus, of sales
forecasts through the firm’s own
sales channels.
- Calculation of the various forecasting techniques, such as regression, moving averages, and exponential smooth-
ing, is not included in this text. For a description of the technical side of forecasting, refer to a basic statistics, econo-
metrics, or management science text.
cash budget (cash forecast)
A statement of the firm’s planned
inflows and outflows of cash that
is used to estimate its short-term
cash requirements.
Hint The firm needs to
spend a great deal of time and
effort to make the sales forecast
as precise as possible. An
“after-the-fact” analysis of the
prior year’s forecast can help
the firm determine which
approach or combination of
approaches will give it the most
accurate forecasts.
LG4 3.3 Cash Planning: Cash Budgets
Thecash budget,orcash forecast,is a statement of the firm’s planned inflows and
outflows of cash. It is used by the firm to estimate its short-term cash requirements,
with particular attention to planning for surplus cash and for cash shortages.
Typically, the cash budget is designed to cover a 1-year period, divided into
smaller time intervals. The number and type of intervals depend on the nature
of the business. The more seasonal and uncertain a firm’s cash flows, the
greater the number of intervals. Because many firms are confronted with a sea-
sonal cash flow pattern, the cash budget is quite often presented on a monthly
basis. Firms with stable patterns of cash flow may use quarterly or annual time
intervals.The Sales Forecast
The key input to the short-term financial planning process is the firm’ssales
forecast.This prediction of the firm’s sales over a given period is ordinarily pre-
pared by the marketing department. On the basis of the sales forecast, the finan-
cial manager estimates the monthly cash flows that will result from projected
sales receipts and from outlays related to production, inventory, and sales. The
manager also determines the level of fixed assets required and the amount of
financing, if any, needed to support the forecast level of sales and production. In
practice, obtaining good data is the most difficult aspect of forecasting.^4 The
sales forecast may be based on an analysis of external data, internal data, or a
combination of the two.
Anexternal forecastis based on the relationships observed between the
firm’s sales and certain key external economic indicators such as the gross
domestic product (GDP), new housing starts, consumer confidence, and dispos-
able personal income. Forecasts containing these indicators are readily available.
Because the firm’s sales are often closely related to some aspect of overall
national economic activity, a forecast of economic activity should provide insight
into future sales.
Internal forecastsare based on a buildup, or consensus, of sales forecasts
through the firm’s own sales channels. Typically, the firm’s salespeople in the
field are asked to estimate how many units of each type of product they expect to
sell in the coming year. These forecasts are collected and totaled by the sales man-
ager, who may adjust the figures using knowledge of specific markets or of the
salesperson’s forecasting ability. Finally, adjustments may be made for additional
internal factors, such as production capabilities.
Firms generally use a combination of external and internal forecast data to
make the final sales forecast. The internal data provide insight into sales expecta-
tions, and the external data provide a means of adjusting these expectations to
take into account general economic factors. The nature of the firm’s product also
often affects the mix and types of forecasting methods used.