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FORECASTING PERFORMANCE

Chapter 11. FORECASTING PERFORMANCE. Presented by: Teerachai Supojchalermkwan Krisna Soonsawad. Introduction. Growth and return on vested capital is the most important value driver We cannot predict the future but a careful analysis can tell us how a company may develop

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FORECASTING PERFORMANCE

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  1. Chapter 11 FORECASTING PERFORMANCE Presented by: Teerachai Supojchalermkwan Krisna Soonsawad

  2. Introduction • Growth and return on vested capital is the most important value driver • We cannot predict the future but a careful analysis can tell us how a company may develop • Five basic step needed to develop a financial forecast • The five steps are often iterativerather than sequential

  3. 5 steps to develop financial forecast • 1. Determine the length and level of detail for the forecast. • 2. develop a strategic perspective on future company performance. • 3.Translate the strategic perspective into financial forecasts. • 4.Develop alternative performance scenarios • 5.Check the overall forecasts.

  4. Step 1: Determine Length and Detail of the Forecast • All continuing value approaches are based on an assumption ofsteady state performance. • Constant Rate of Return on all new capital invested during the continuing value period • The company earn a constant return on its base level of invested capital • The company grows at a constant rate and reinvests a constant proportion of its operating profits in the business each year.

  5. - Continued • Recommend using a forecast period of 10 to 15 years • A detailedforecast for 3 to 5 years. • In addition to simplifying the forecast, this approach also forces you to focus on the long-term economics of the business, not just the individual line items of the forecast.

  6. Step 2: Develop Strategic Perspective • - Means crafting a plausible story about the company’s future performance. • What ultimately drives the value of the company is the assessment of whether and for how long a company can earn returns in excess of its opportunity cost of capital. • superior value to customer through a combination of price and product • Achieve lower costs than competitors • Using capital more productively than competitors.

  7. Industry Structure Analysis Model(Porter Model)

  8. Customer Segmentation Analysis External Shock Structure Conduct Performance Feedback • Macroeconomics • Technology • Regulation • Customer Preference/Demographics

  9. Competitive Business System Analysis Product design and development Procurement Manufacturing Marketing Sales and Distribution Product attributes; quality; Time to market; Technology Pricing; Advertising Promotion Packaging Brands Access to Sources cost Outsourcing Sales Effective Costs Channels Costs Cycle Time; Quality

  10. Step 3: Translate the Strategic Perspective into Financial Forecast • Begin with an integratedincome statement and balance sheet • The most common approach to forecasting the income statement and balance sheet for non financial companies is a demand driven forecast.

  11. Translate the Strategic Perspective into Financial Forecast (Continue) • Build the revenue forecast. This should be based on volume growth and price changes. • Forecast operational items, Such as operating cost, working capital, property, plant, and equipment (PPE), by linking them to revenues or volume • Project non-operating items, such as investments in unconsolidated subsidiaries and interest expense • Project the equity accounts. Equity should equal last year’s equity plus net income and new share issues less dividends and share repurchases. • Use the cash and/or debt accounts to balance the cash flows and balance sheet. • Calculate the ROIC tree and key ratios to pull the elements together and check for consistency.

  12. Stocks vs Flows The first issues you will face is whether to forecast the balance sheet directly or indirectly • The stock approach would forecast end-of-year inventories as a function of the year’s revenues • The flows approach would forecast the change in inventories as a function of the growth in revenues Stock vs Flow example

  13. Inflation (1+Nominal rate) (1+ Real rate) Expected inflation = + 1 • Forecast and cost of capital could be estimated in nominal rather than real currency units. • For consistency, both the financial forecast and the cost of capital must be based on the same expected general inflation rate. • This means inflation rate built into the forecast must be derived from an inflation rate implicit in the cost cost of capital.

  14. Step 4: Develop Performance Scenarios Once the scenarios are developed, an overall value of the company can be estimated. This will involve a weighted average of the values of the independent scenarios, assigning probabilities to each scenario. Example of a steel company

  15. Step 5: Checking for Consistency and Alignment • Is the company’s performance on the value drivers consistent with the company’s economics and the industry competitive dynamics? • Is revenue growth consistent with industry growth? • Is the return on capital consistent with the industry’s competitive structure? • How will technology changes affect return? Will they affect risk • Can the company manage all the investment it is undertaking?

  16. Some Data to Guide your forecast The percentage of companies that are able to achieve top third performance relative to their peer Companies rarely outperform their peers for long periods of time. • You should not assume that the company you are evaluating will always outperform the industry because of the competitions

  17. Some Data to Guide your forecast Company performance varies from industry averages. • In term of revenue growth, more than 70% of companies are more than +/- 20% from the in industry average

  18. Some Data to Guide your forecast Average Industry ROIC • Industry average ROICs and growth rate are linked to economic fundamentals Average Industry Revenue Growth

  19. Example: Heineken Business as Usual Case

  20. Some Data to Guide your forecast • You should not assume that all industries will eventually earn just the cost of capital • You should not assume that high-return industries without significant barriers to competition will earn high returns if barriers are removes • Growth rate will decline as the industry matures

  21. HEINEKENCase • Length & Level of Detail - 5 year detail forecast - Next 10 year summary forecast • Develop Strategic Perspective

  22. Develop Performance Scenario • 1. Business as usual - Most Likely • 2. Price War - Pessimistic • 3. Market Discipline/Analysis - Optimistic • In this chapter, we will focus on analyzing in detail of the business as usual scenario

  23. Forecast individual line items for the short - term horizon • Revenue • Operating expense • Depreciation • Financing Cost • Taxes • Working Capital

  24. Forecast individual line items for the short - term horizon • Revenue • Estimate demand • Volume growth • Operating expense • Depreciation • Financing Cost • Taxes • Working Capital

  25. Balance Sheet Forecast Assumption

  26. Questions ??

  27. Thank you for your Attention

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