# Forecasting and projection of income of a business entity

Income Statement Forecast – For projections and forecasting income of any business entity, the following components of business financial analysis are needed to be investigated.

• Sales revenue
• Cost of Goods (Gross Revenue)
• Total or Specific General Expenses
• Depreciation expenses
• Tax expense.

By computing all the above, you can arrive at net income or the bottom line item of the income statement.

1. Sales Revenue:- The analysis begins from this top-line item. All subsequent items will usually be based on sales revenue. We can forecast sales revenue in several different ways. Firstly, you can model sales revenue as a simple growth rate from previous years. It means that any subsequent year would be past years sales revenue multiplied by one plus growth rate.

Secondly, you can model the sales revenue as a factor of GDP or some other macroeconomic matrix. This means that revenue for each year will depend on a regression formula based on the historic value of revenue sales and the input of that year GDP.

Finally, you can also model sales revenue on direct rupees value. However, this method is the least dynamic and less accurate and used when quick forecasts are needed.

1. Cost of Goods:- Cost of goods sold is the measure of direct cost incurred in the production of any goods or services. It includes material cost, direct labor cost, and direct factory overheads. It is directly proportional to the revenue. The cost of goods is deducted from the revenue of sales to find the gross profit. Most of the time we take past figures for the cost of goods sold over sales revenue and use this percentage to predict future percentages. Alliteratively we may model the specific cost of goods items. These may be split into raw material, work in progress, finished goods, labor cost, direct material cost or some other live items depending upon the particular business operation. We can forecast it as a percentage of sales revenue or using whole rupee value.
2. Selling, general and administrative expenses: – For a more robust model, you have to split this part into individual components. This is done because each individual line item has different drivers. For example, rent expense is generally fixed every month, so a fixed rupee value is more appropriate than a percentage of sales revenue. However advertising expenses in more related to the sales revenue, so the percentage of sales revenue will be more accurate to project the correct picture.
3. Depreciation Expenses:- Depreciation expense relates to the gradual use of machinery, property, plant, and equipment to their benefit of generating revenue. Since, economic benefits of using items last for more than one accounting year, the forecasting is done through a depreciation schedule, using a percentage of the opening balance. This expense is used to reduce the value of the plant, properly and machines due to wear and tear over a period of time.
4. Interest expenses: – It is one of the core expenses found in the income statement. The company necessarily incur expenses related to the cost of borrowing, capital leases of assets or any other cost relating to raising the funds. Interest expense can be found through using debt schedule. This schedule outlines each individual item of debt on their own schedule or a summary of schedules that shows the total of all balances and interest expense. The interest expense is found by multiplying the opening balance in each period with the interest rate. This interest expense is then added back to the opening balance and then is reduced by any principal repayment to find the closing balance.
5. Tax expense: – This expense is found as a percentage of earnings before tax (EBIT). This is also known as the effective tax rate or cash tax rate. EBT must be found by subtracting all the previous expense line items from sales revenue. After multiplying EBT by the historical effective tax rate, we are able to forecast tax expense.

Summary

After projecting income statement live items, the income statement is projected and forecasted asunder.