How Do You Forecast a Balance Sheet?

A balance sheet provides a financial snapshot of a company at a specific moment, detailing what it owns (assets), owes (liabilities), and the amount invested by owners (equity). It follows the accounting equation: Assets = Liabilities + Equity.

Forecasting a balance sheet projects these components into the future, offering insights into a company’s anticipated financial health. This projection is foundational for financial planning and budgeting, aiding strategic decision-making by showing the effects of business strategies on future financial standing.

Understanding Balance Sheet Components

The balance sheet is structured around three main categories: assets, liabilities, and equity. These are further divided into current and non-current classifications based on liquidity or maturity.

Assets are items of economic value owned by the company. Current assets convert to cash or are consumed within one year. Examples include cash, accounts receivable (money owed by customers), inventory (raw materials, work-in-progress, finished goods), and prepaid expenses.

Non-current assets are not converted to cash within a year. Property, plant, and equipment (PP&E) are long-term physical assets like land, buildings, and machinery. Intangible assets, such as patents or trademarks, are non-physical assets providing long-term value.

Liabilities are financial obligations owed to external parties. Current liabilities are due within one year. Examples include accounts payable (amounts owed to suppliers), accrued expenses (costs incurred but not yet paid), and short-term debt.

Non-current liabilities are obligations due beyond one year. Long-term debt, such as bonds or mortgages, is a primary example. Deferred revenue, payments received for goods or services yet to be delivered, is also a non-current liability if the delivery extends beyond a year.

Equity represents the owners’ stake, the residual interest in assets after deducting liabilities. Share capital reflects funds raised by issuing stock. Retained earnings are cumulative net profits not distributed as dividends. Treasury stock refers to shares repurchased by the company.

Key Inputs and Assumptions for Forecasting

Forecasting a balance sheet relies on inputs and assumptions from the projected income statement and cash flow statement. These statements provide data that drives changes across balance sheet accounts.

Sales forecasts from the income statement drive several balance sheet items. Increased sales lead to higher accounts receivable and inventory. The cost of goods sold (COGS) forecast influences accounts payable.

Depreciation expense from the income statement affects PP&E’s net book value. The cash flow statement reconciles cash changes, directly feeding the balance sheet’s cash balance. It also details debt and equity transactions.

Growth rates, like sales or expense growth, set the scale of future operations. Working capital ratios are important for projecting current assets and liabilities. Days Sales Outstanding (DSO) measures average days to collect revenue after a sale, helping project accounts receivable based on future sales.

Days Inventory Outstanding (DIO) indicates average days inventory is held before sale, helping forecast inventory levels relative to projected COGS.

Days Payables Outstanding (DPO) measures average days a company takes to pay suppliers, used to project accounts payable based on projected COGS or purchases.

Capital expenditure assumptions determine future PP&E investments, based on strategic plans. Debt and equity assumptions cover new debt, repayment schedules, dividends, and share repurchases, directly impacting liabilities and equity. Formulating these inputs involves historical data, industry benchmarks, and strategic alignment.

Step-by-Step Balance Sheet Forecasting Process

Forecasting a balance sheet involves systematically projecting each line item, building on established inputs and assumptions. This process begins after projecting the income statement and cash flow statement, as they provide figures that flow into the balance sheet.

Forecasting assets begins with cash, often the “plug” figure determined by the cash flow statement. The ending cash balance from the projected cash flow statement becomes the cash balance on the forecasted balance sheet.

Accounts receivable are projected by multiplying forecasted sales by the assumed Days Sales Outstanding (DSO) and dividing by 365 days. For instance, if annual sales are projected at $36,500,000 and DSO is 45 days, accounts receivable would be $4,500,000 ($36,500,000 45 / 365).

Inventory is calculated by multiplying the forecasted cost of goods sold (COGS) by the assumed Days Inventory Outstanding (DIO) and dividing by 365 days. If COGS is projected at $20,000,000 and DIO is 60 days, inventory would be $3,287,671 ($20,000,000 60 / 365).

Property, Plant, and Equipment (PP&E) is projected by taking the beginning PP&E balance, adding any projected capital expenditures, and subtracting the forecasted depreciation expense for the period. For example, if beginning PP&E is $10,000,000, capital expenditures are $2,000,000, and depreciation is $1,000,000, the ending PP&E would be $11,000,000.

Projecting liabilities involves similar calculations based on operational drivers. Accounts payable are forecasted by multiplying the forecasted cost of goods sold (or purchases, if available) by the assumed Days Payables Outstanding (DPO) and dividing by 365 days. If COGS is $20,000,000 and DPO is 45 days, accounts payable would be $2,465,753 ($20,000,000 45 / 365).

Debt balances are projected by taking the beginning debt, adding any new borrowings, and subtracting any scheduled principal repayments, typically detailed in a debt schedule.

For equity accounts, retained earnings are projected by taking the beginning retained earnings balance, adding the net income from the forecasted income statement, and subtracting any projected dividends. For example, if beginning retained earnings are $5,000,000, net income is $1,500,000, and dividends are $500,000, the ending retained earnings would be $6,000,000. Share capital is forecasted based on assumptions about new share issuances or share repurchases, which would either increase or decrease the account balance.

Reconciling the Forecasted Balance Sheet

After projecting all balance sheet line items, the final step is to reconcile the forecasted balance sheet. This ensures the accounting equation (Assets = Liabilities + Equity) holds true. Any imbalance indicates an error or need for adjustment.

A “plug” figure, typically cash or a debt account, ensures the balance sheet balances. If projected assets do not equal liabilities plus equity, the difference is absorbed by adjusting cash or debt. For instance, higher assets than liabilities and equity could mean increased cash, while lower assets might imply a need for more debt or reduced cash.

The forecasted cash flow statement determines the cash plug. Its ending cash balance, accounting for all inflows and outflows, ensures the balance sheet equation holds true. If a company generates more cash than it uses, the cash balance increases; if it uses more, the cash balance decreases, or debt may increase to cover the deficit.

After achieving a balanced forecasted balance sheet, review the results for reasonableness. Assess if the projected financial position aligns with strategic objectives and economic realities. If cash balance or debt levels seem unusual, revisit and adjust underlying assumptions. This iterative process ensures the forecast is mathematically correct and strategically sound.