A balance sheet forecast is a projection of assets, liabilities, and equity at a future time. It approximates what a business anticipates owning and expects to owe.

Financial modeling encompasses a variety of forecasts that help business leaders make decisions in the present to control future outcomes. A balance sheet forecast is one such projection usually completed in tandem with an income statement forecast. 

A comprehensive understanding of balance sheet forecasting is a major skill to hone when perfecting the craft of financial modeling.

This FAQ will explain balance sheet forecasts and their importance while providing a foundational approach to performing them. 

What Is A Balance Sheet Forecast?

The balance sheet represents a business’s financial position at a certain time. 

As such, it stands to reason that the balance sheet forecast attempts to predict the business’s financial position in the future under a given set of circumstances. 

A balance sheet forecast is just one component of a three-statement financial model. 

The other two components are the income statement forecast and cash flow forecast.

The outputs of a three-statement financial model are the forecasted statements, and the inputs are the assumptions that drive the changes in the financial model.

It is important to note that the balance sheet depends on changes in the income statement.

How To Forecast A Balance Sheet

A balance sheet has three primary components: assets, liabilities, and equity. 

Equity is also commonly referred to as “Net Assets” since its accounting formula is assets minus liabilities.

While there are various approaches to forecasting a balance sheet, most analysts focus on some primary line items in each section.

Assets

Analysts pay close attention to accounts receivable, inventory (if applicable), other current assets, property plant and equipment (PP&E), and long-term assets.

Liabilities

Liabilities are broadly grouped into two primary line items: accounts payable and debt. The distinction between the two is important as they have different accounting treatments, the most obvious of which is that debt bears interest expense.

Usually, interest expense is not considered accrued in a financial forecast. 

Equity

Finally, special attention is paid to shareholders’ capital and retained earnings, which are the primary components of shareholder equity.

Working Capital Items

Line items related to working capital include AR/AP and inventory (if applicable). These line items require their own specific forecasting methodologies.

This is because time is a component in their ending balances, so forecasting is done by utilizing their respective days outstanding.

Accounts Receivable Days = average trailing 12-month AR / trailing 12-month sales revenue x 365

Inventory Days = average trailing 12-month inventory / prior 12-month COGS x 365

Accounts Payable Days = average trailing 12-month AP / prior 12-month COGS (or purchases) x 365

These formulas can be used to back into the receivables balances by changing the number of days outstanding. 

For example, AR  = days outstanding x annual revenue / 365.

PP&E

Property, plant, and equipment is forecasted using the formula:

Opening balance + CAPEX – depreciation expense = closing balance

Debt

Debt is forecasted using the formula:

Opening Balance + interest expense – repayments = closing balance

Equity

Shareholder capital is forecasted using the formula:

Opening balance + new capital issuance – capital repurchases

Retained Earnings

Retained earnings are forecasted using the formula:

Opening balance + net income – dividends

Forecasting A Balance Sheet: 4 Steps

The process of forecasting a balance sheet can be broken down into four primary steps:

  1. Project the income statement up to depreciation and interest expense.
  2. Using the formulas above, project the balance sheet up to retained earnings.
  3. Finalize income statement projection by calculating depreciation, interest, and estimated tax expense.
  4. Finally, the retained earnings are calculated using the net income calculated in step 3 and used to finalize the balance sheet projection.

Why Is A Balance Sheet Forecast Important?

The primary reason for creating forecasts is to understand how decisions made in the present will impact the organization in the future.

Analyzing historical data and trying to predict the future is an important accounting process that helps business leaders develop comprehensive plans and learn from past results. 

Financial forecasts are used as a roadmap to help leaders navigate the uncertainty of their particular environments. They are also used to develop strategies for responding to expected market conditions and business drivers. 

The balance sheet forecast is a vital accounting tool for estimating the impact of income statement line items and cash flow expectations on a business’s future financial position.

In most cases, it proves helpful for understanding future debt obligations and equity value creation.

Balance sheet forecasting is also used to estimate the impact of merging and acquiring new businesses.

When analysts determine whether an acquisition or merger is beneficial, they forecast the balance sheet to understand the impact on: 

Understanding Key Forecasting Techniques for Financial Planning

Knowing the underlying forecasting methods is crucial as organizations aim to improve their financial strategy and planning processes. 

Three primary techniques provide a solid base for financial analysis and the decisions that come with it: qualitative, time series, and causal forecasting. 

Let’s break down all three and how they lend themselves to sophisticated financial planning.

Qualitative Forecasting: Expert-Led Predictions

Qualitative forecasting is a process that relies on the long-term experience of professionals and a detailed look at past events to provide a guideline for the future. 

It is typically used when a company is new or has a very limited pool of quantitative data. It is a process informed by expert knowledge of the industry and the market and their highly complicated projections.

Time Series Forecasting: Data-Driven Projections

When a business has a lot of past data, time series forecasting can identify trends and cycles. 

For example, suppose a company has had two years of record sales after the Olympics; this year, it’s the World Cup. 

Time series forecasting will probably identify that as a likely pattern and suggest that next year’s sales will be above average, too.

Causal Forecasting: Understanding Relationships Between Variables

Causal forecasting analyzes the relationship between different factors and how they affect the financial outcome. This is very different from pattern analysis, which tracks performance over time. 

Causal forecasting also does that, but it takes it much further.

It asks: What is the cause of performance? What are the factors that affect performance? Market conditions? Economic policies? Consumer behavior? What happens when one of those factors changes? 

Because causal forecasting analyzes the relationship between different factors, it provides a deeper understanding of what affects performance and, therefore, the ability to develop more precise projections.

Using Datarails to Perform Balance Sheet Forecasting

Every finance department and FP&A analyst knows how challenging it can be to build an accurate balance sheet forecast. 

Datarails is an enhanced budgeting and forecasting FP&A software that can help your team create and monitor budgets faster and forecast more accurately than ever before.

Read more about how Datarails helped a residential mortgage provider shorten their forecast cycle by 3 days each month.