Projected Balance Sheet

A projected balance sheet is a financial statement that provides an estimation of a company's financial position at a future point in time. It forecasts the assets, liabilities, and equity of a business based on expected future events, such as sales growth, investment decisions, and changes in financing arrangements.

It helps in setting financial goals and devising strategies. This helps to achieve those goals by projecting the resources available and required in the future. By estimating future assets and liabilities, it assists in creating budgets for various departments and activities within the organization. It assists in determining the need for external financing and the most suitable financing options. This is done by evaluating the company's projected capital structure and liquidity position.

A projected balance sheet, also known as a pro forma balance sheet, is a financial statement that anticipates the future financial position of a company based on assumptions and forecasts. It provides a snapshot of expected assets, liabilities, and equity at a specific point in time. Typically covering a future period, such as the next fiscal year or quarter.

The projected balance sheet stems from the need for businesses to plan for future financial scenarios. It evolved as a tool for financial analysts, investors, and business managers. This helps to assess the potential impact of various decisions and external factors on a company's financial health.

The practice of projecting balance sheets traces back to the early days of modern accounting and financial management. It gained prominence with the development of sophisticated forecasting techniques and computerized financial modeling in the latter half of the 20th century.

Creating a projected balance sheet involves several steps:

1. Gather Historical Data: Collect past financial statements, including balance sheets, income statements, and cash flow statements. This helps to understand the company's financial history and trends.
2. Forecast Sales and Expenses: Use market research, industry trends, and internal data to project future sales revenues and operating expenses. Consider factors such as seasonality, economic conditions, and competitive landscape.
3. Estimate Asset Values: Forecast the value of current assets such as cash, accounts receivable, inventory, and fixed assets. It is based on projected sales volumes and production levels. Adjust for depreciation and impairment where applicable.
4. Predict Liabilities: Estimate future obligations, including accounts payable, accrued expenses, and short-term and long-term debt. This is primarily based on expected business activities and financial commitments.
5. Calculate Shareholders' Equity: Determine the expected changes in shareholders' equity, including retained earnings and additional capital contributions, considering projected profits and dividends.
6. Prepare the Balance Sheet: Organize the projected values of assets, liabilities, and equity into the standard balance sheet format, ensuring that the accounting equation (Assets = Liabilities + Equity) is balanced.
7. Review and Adjust: Critically evaluate the projected balance sheet for accuracy, consistency, and reasonableness. Adjust assumptions and forecasts as needed based on feedback from stakeholders, changes in market conditions, or new information.

For individuals who wish to develop a comprehensive understanding of how to make balance sheet projections, enrolling in the Financial Modeling 2-Day Bootcamp can be worth considering. The instructor of the boot camp provides real-world examples to help understand how to prepare forecasts for balance sheets and other key financial statements. Also, it comes with Excel templates that will enable you to practice and strengthen your practical knowledge. 

The best practices for projected balance sheets are as follows:

• Accumulation Of Over Two Years Of Past Data - Considering that context is crucial for financials, individuals require a minimum of two years of past data, which includes cash flow statements and income statements. One must remember that the more data they provide for analysis, the higher the accuracy of the predictions will be.
• Utilization Of Supporting Schedules - Sometimes, balance sheet forecasting requires a bit of help in the form of supplemental information that one can find in supporting schedules. This information can provide more insight into the organization's future financial performance.
• Integration With Financial Statements - It is crucial to ensure that the balance sheet forecasts are in line with the projections for other financial statements. While a company’s cash flow statement displays the increases and decreases in cash, as well as cash equivalents, its income statement shows the net income.
• Ensuring Reasonableness And Consistency - It is vital to assess the projected balance sheet to check whether it is reasonable and consistent. If organizations skip this evaluation, they may fail to maintain accuracy and credibility.
• Sensitivity Analysis And Scenario Planning - Carrying out scenario planning is crucial to stimulate market conditions and strategic moves. This helps in evaluating potential effects on the organization’s financial health. In addition, companies need to comprehend how alterations in the main assumptions impact the estimates. This enables them to make adjustments on the basis of different business or economic scenarios.
• Periodic Review And Adjustments - Lastly, companies must compare the estimates in the projected balance sheet with the actual results. This allows them to refine methodologies and assumptions. Such periodic reviews help organizations make sure that the projections remain accurate and realistic over time.

Let us understand it better with the help of examples:

Example #1

In an imaginary scenario, let's consider a startup technology company projecting its balance sheet for the next fiscal year. Assuming aggressive sales growth projections due to the launch of a new product, the company forecasts a significant increase in accounts receivable and inventory. With expansion plans, they anticipate higher property, plant, and equipment values. On the liabilities side, they predict increased accounts payable and a new long-term loan for financing expansion. Shareholders' equity is projected to rise due to retained earnings from strong profits. The resulting balance sheet reflects a healthy financial position supporting the company's growth plans.

Example #2

The New York Federal Reserve released a report in 2023 forecasting continued contraction of the Federal Reserve's balance sheet for several more years. The report anticipates a reduction in the central bank's assets by approximately $1.5 trillion by 2025, driven by the ongoing tapering of asset purchases and the eventual normalization of monetary policy. This reduction contrasts with the expansionary measures implemented during the pandemic to support the economy.

The projected balance sheet contraction signals a shift in monetary policy towards a more neutral stance as the economy recovers. Analysts suggest that this gradual reduction could have implications for financial markets, including potential impacts on interest rates and asset prices. Investors and policymakers are closely monitoring these developments for their potential effects on economic growth and financial stability.

Projected balance sheets are vital tools for several reasons:

1. Financial Planning: They provide a roadmap for future financial activities, helping businesses set targets, allocate resources efficiently, and plan for contingencies.
2. Strategic Decision-Making: Projected balance sheets enable informed decision-making by forecasting the potential outcomes of various strategies, investments, and operational changes.
3. Risk Management: By highlighting potential financial risks and vulnerabilities, they allow companies to proactively identify and mitigate risks, ensuring resilience against adverse events.
4. Investor Confidence: Investors rely on projected balance sheets to assess the financial health and prospects of a company, influencing investment decisions and shareholder confidence.
5. Resource Allocation: They assist in optimizing resource allocation by identifying areas of surplus or shortage, guiding capital investment decisions, and operational adjustments.
6. Budgeting and Forecasting: Projected balance sheets serve as a basis for creating budgets and financial forecasts, enabling organizations to align their resources with strategic objectives effectively.