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1.4 Financial Forecasting

The balance sheet and income statement in Figure 1.3 presents a static image of the project, as it looks at one point in time and the cash flows it produced in the time period just preceding that point in time. To conduct a valuation of a project, however, we need to figure out how a project will do over time, through the life of the project. Specifically, we need to figure out future payoffs, or cash flows, from the project if we are to use Equation 1. To do this, we need to figure out what the future balance sheets and income statements for this project will look like. So, we will have to learn how to forecast balance sheets and income statements. This is the goal of Chapter 3, “Financial Forecasting.” Chapter 3 discusses simple, but commonly used, tools and techniques for forecasting income statement and balance sheets (and, indirectly, cash flow statements). A critical element of forecasting a balance sheet is to make sure that all the expected future balance sheets balance (that is, that the asset side equals the sum of liabilities and owners’ equity). As you will discover, enforcing this constraint will give you the first critical input for Equation 1, expected future cash flows.

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