Business entities need to plan for the future, must consider alternative management strategies and prepare capital and operating budgets, and must also consider alternative funding and cash budget possibilities. An important part of the planning process is the preparation of prospective financial statements that attempt to predict the outcome of the business entitys activities in future periods.
PREPARATION OF PROSPECTIVE FINANCIAL STATEMENTS
The preparation of prospective financial statements requires considerable knowledge of the business and the factors that are likely to determine its future results. The following key factors related to future results must be considered in the preparation of such statements:
Factors related to the specific entity Factors related to the industry Factors related to the market Factors related to the economy
Factors Related to the Specific Entity
The principal cost elements of the entity doing business must be considered. Depending on the entity, these elements may include such costs as payroll and benefits, needed employees, raw materials, products the entity sells, freight or shipping, and advertising.
Another consideration is the availability of resources. For example, are the expert, specialized, or skilled workers available to meet the needs of the entity under the plan as initially proposed? Are the raw materials and/or products for resale available? Can the delivery system be organized to accomplish the task? Are the company physical facilities sufficient for the uses and for the capacities contemplated?
Factors Related to the Industry
Factors related to the industry in which the entity is operating must be considered. Is the industry one in which companies are very competitive? Are competitive industries emerging? Is obsolescence emerging within the industry? Are there regulatory considerations and requirements? Is new technology being introduced into the industry? What are the economic conditions within the industry?
Factors Related to the Market
Market factors must be considered. What are the trends in business or consumer demand related to the services or goods being sold by the entity? Are competitive companies emerging, perhaps with new or different products? Is unique marketing required? Are there pricing developments to be factored into the forecast?
Factors Related to the Economy
Numerous factors related to the economy must be considered. What are the economic conditions in the country? What are critical economic trends? Is the economy inflationary, deflationary, or stable? What is the trend with regard to labor availability? What are the financing considerations in relation to the economy? What are interest rates? Are there significant factors related to long-term versus short-term financing? Is a public stock offering a possible financing option?
ATTESTATION SERVICES PROVIDED FOR FINANCIAL FORECASTS AND FINANCIAL PROJECTIONS
Forecasts and projections are important in an organization. They are also of great interest to financial analysts and others in the business environment who make decisions about future business behavior. Because of outsider interest, public accountants are engaged to provide professional services. There are three types of engagements that a certified public accountant may undertake in relation to financial forecasts and projections:
Examination: An accountant evaluates the preparation, underlying support, and presentation of the financial statements, and expresses an opinion on them Applying agreed-upon procedures: Users establish the nature and scope of the engagement, and only the results of the procedures performed are provided Compilation: An accountant prepares the prospective statements from information and assumptions provided, and no assurance is given
Examination
When the examination is of a financial projection, the accountants must determine whether the hypothetical condition or course of action (which will not necessarily occur) is consistent with the purpose of the projection. The accountants must evaluate the support underlying assumptions in the same manner as is done for a forecast.
Upon completion of a financial forecast examination, assuming the accountants have collected sufficient evidence to provide a reasonable basis for the standard report to be issued, that report will state in part:
In our opinion, the accompanying forecast is presented in conformity with guidelines for presentation of a forecast established by the American Institute of Certified Public Accountants, and the underlying assumptions provide a reasonable basis for management forecast.
Upon completion of a financial projection examination, the standard report would include a description of the hypothetical assumption and the opinion would state that the underlying assumptions provide a reasonable basis for management forecast assuming the occurrence of the hypothetical assumption.