Managers and external users of financial information are more concerned with what the future holds for an organization than its past history because what has happened has happened and reporting systems are incapable of changing history. Financial forecasts on the other had can be used for budgeting as well as planning purposes. The forecasts offer expected results based on historic facts. Investors and share holders around the world base their decisions on financial and economic forecasts. Public companies are special under constant pressure to perform according to budgeted expectations and forecasts. Failure to do so results in lower stock prices and financial difficulties. Forecasting comes under the broad subject of predictive accounting. The four main aspects of predictive accounting are:
• It improves projecting financial performance by monitoring whether processes are in control. In-control processes are predictable; out-of-control processes are unpredictable.
• It seeks to understand the future.
• It is based on the premise that the actions of an organization are repeatable processes.
• It uses processes that describe the way the organization works.
Financial forecasts assist firms in identifying finance (external and internal) requirements as well as asset requirements. In short financial planning is a process by which firms identify their goals and cost and plan how to meet them. One of the main advantages of financial forecasting is that it identifies interactions between various elements of a firm, for example how inventory changes affect finance costs. It also makes clear which financing options are more suitable in the long term and which ones would cause problems. By incorporating external factors such as the rate of inflation and interest rates in to the forecast, the organization is able to avoid surprises.
Financial plans are of various types and vary according organization structure, size and the market in which it operates. A business that is just starting out should ideally make a 2 or 3 year forecast whereas a business which is well established can make a reliable 5 year forecast. A magazine publisher should only forecasts its sales for the following year since it cannot predict changes in the market and consumer trends in the coming years by its current state of sales. A manufacturing company or a company which has long lead times regarding construction of new plants, long lead times for development, approval and testing procedures can rely on a 10 year forecast. The time period should be long enough to ensure that any periodically paid material cost has not been ignored and the time period should be short enough so that variations in the level of activity are not averaged out. Before any extrapolation techniques are used the past data should be examined to determine their appropriateness to their intended purpose.
Turnover for British Airways was down by 1.7% as compared to 2003. It is this figure whish I have used to forecast sales for the next 10 years. The reasons are as follows:
1. Global instability and foreign affairs problems leading to continuing decrease in passenger traffic.
2. The US economy has not yet recovered from depression.
3. The revenue form cargo and passenger operations account for 92% of group revenue and a decrease in trade and passenger traffic coupled by increases in oil prices all combine to cause a decreasing trend in turnover.
Cost of Sales has decreased by 3.5% in 2004 as compared to 2003 whereas in 2002 this figure was still higher. I have taken cost of sales as a percentage of Turnover because in 2004 British Airways have made many efficiency measures which have reduced costs. The future size and shape project (FSAF) made savings in manpower, capital expenditure, asset disposals, procurements, and distribution costs. For the year 2004 BA made savings of 869 million pounds and by introducing travel agents’ commission restructuring on ba.com the company made savings of 257 million pounds. BA has set itself a 10% operating margin but projected decreases in turnover and increases in oil costs can cause impediments to this plan. The administration expenses have also been taken of the basis of percentage of sales.
The figure share in operating profits in associates has not been taken on the basis of percentage of sales because the trend suggests that associates will be adding significantly towards BA’s profits and this trend has been projected as a percentage of previous year figures.
The figure of 13 million pounds as other income and charges for the year 2004 was primarily a lease transfer payment; this figure was 4 million pounds in 2003. It is an abnormal amount and I have divided this figure by a factor of 3 to reflect normal reality.
Interest expense again has not much to do with turnover as broadly interest costs remain similar for BA due to equity and long term loans. However, due to decreases in the interest payable amount of up to 55 million pounds in 2004, interest payable can be viewed as a decreasing figure by 15% but interest payable will remain higher or equal to an estimated 150 million in the next ten years.
Taxes have simply been taken as a percentage of sales as the deferred tax figure are affected by the profit chargeable to tax figure and hence the turnover figure. Other values have been taken on a percentage of sales bases.
