Long-Term Financial Statements Forecasting Reinvesting Retained Earnings

Sergei Vasilievich Cheremushkin

The Valuation Journal, 2010, vol. 5, issue 2, 46-87

Abstract: The purpose of the study is to contemplate different approaches to the problem of reinvesting retained earnings in order to construct an adequate financial model. Actually, an optimistic forecast may imply exponential growth of income through reinvestment of retained earnings. If the retained earnings are kept as cash, that will result in decreasing return on invested capital, not to mention this to be unrealistic scenario. In a growing market the firm usually expands its business, acquiring new long term assets/fixed assets, increasing capacity and sales. So, the main task in the accurate forecast is to find a reliable relationship between capital expenditures and sales, taking proper account of operating margin of sales, generated by new assets. In this paper a variety of research methodologies, such as spreadsheet modeling, ratio analysis, regression analysis and others are applied to long - term financial statement forecasting. The practical implications of the paper are that it distinguishes the revenue-driven and capital-driven forecasts, which considerably diverge in treating the retained earnings and imply differences in balancing the statements. The algorithm for balancing statements was considered by estimating the interest expense based on the debt at the beginning of the year, by determining the short-term and long-term debt financing policies and by establishing the rules for investing excess cash in financial assets. This provides some valuable insights for working out algorithms in construction of financial statements forecasting models for both managerial and valuation purposes.

JEL-codes: G31 M41 (search for similar items in EconPapers)
Date: 2010
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Persistent link: https://EconPapers.repec.org/RePEc:vaj:journl:v:5:y:2010:i:2:p:46-87

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