PHILIPPINE CHRISTIAN UNIVERSITY

1648 Taft Avenue corner Pedro Gil St., Manila

MASTER IN BUSINESS ADMINISTRATION

STRATEGIC MANAGEMENT 2

“ASSUMPTIONS” and “INCOME STATEMENT FORECAST”

IN-CAMPUS MBA PROGRAM

SUBMITTED BY:

KATRIZIA CERIZE L. FAUNI

SUBMITTED TO:

PROF. EDILBERTO LAGUNDA

Assumptions

McConkey defines assumptions as the “best present estimates of the impact of major
external factors, over which the manager has little if any control, but which may exert
a significant impact on performance or the ability to achieve desired results.”16
Strategists are faced with countless variables and imponderables that can be neither
controlled nor predicted with 100 percent accuracy. Wild guesses should never be made in
formulating strategies, but reasonable assumptions based on available information must
always be made. By identifying future occurrences that could have a major effect on the firm
and by making reasonable assumptions about those factors, strategists can carry the
strategic management process forward.

Assumptions are needed only for future trends and events that are most likely to have a
significant effect on the company’s business. Based on the best information at the time,
assumptions serve as checkpoints on the validity of strategies. If future occurrences deviate
significantly from assumptions, strategists know that corrective actions may be needed.
Without reasonable assumptions, the strategy formulation process could not proceed
effectively. Firms that have the best information generally make the most accurate
assumptions, which can lead to major competitive advantages.

Assumptions are needed only for future trends and events that are most likely to have a
significant effect on the company’s business. It is also needed to be able to reach a
conclusion, to support the conclusion and to strengthen the conclusion.

Assumptions are tools for planning and they are those factors that are considered true, real,
or certain for the purpose of creating a shared understanding of the plan.

Assumptions needs to be:

• Needs to be solid

• Defensible

• Must have best information

• Must Validate the information

• Explain and give examples of why your assumptions are probably true

• Well researched
Examples of Strategic Assumptions

Strategic assumptions are those critical factors that, if invalid, would cause termination or
significant changes to the initiative. For contrast, compare them to estimating assumptions
are those factors that are the basis of assumptions for cost, time duration, or resource
commitments.

Here are four examples of strategic assumptions:

• We assume that the market will respond favorably to our new product, and we will
steal 10% market share from our competitors.

• We assume that the organization will not be acquired by another organization during
the next 12 months.

• We assume that the development engineers can solve the compatibility and
integration issues.

• We assume that there will be no new significant legislation or regulation of our

industry in the next 12 months.

What makes them strategic?  It is that if they are invalid, there would be good reason to
cancel the initiative or redirect it in a major way in order to achieve the pre-determined
definition of success.

Preparing a set of Strategic Assumptions

• The identification and discussion of the key issues are not intended to generate right
or wrong “answers;” rather, they represent choices and shared points-of-view about
what the team believes will happen. Together, they form a set of approximately 12-15
strategic assumptions upon which management intends to build its strategic plan and
business.

• There is no universal set of strategic assumptions that must absolutely be generated

and covered in every organization’s strategic plan. There are, however, generic
areas where strategic assumptions generally must be made and which stakeholders
should realistically expect management to disclose:
INCOME STATEMENT FORECAST

 The income statement forecast, sometimes called the profit and loss forecast, is one
of the three main statements for business plan financials. The income statement
forecast shows a business’s financial performance over an accounting period. The
accounting period can be any length but is usually a month or a year.

 There are many income statement forms, the layout below acts as a quick reference,
and sets out the most commonly encountered accounting terms when dealing with
a business plan income statement forecast.

What should an Income Statement Forecast look like?

 A typical and useful income statement format for management is shown in the
example below. The level of detail for each item will depend on your business, and
who is using the information. For example, revenue could be broken down by
product category, or operating expenses could be broken down into multiple lines
such as rent, wages, light & heat etc.
The Need to Understand the Income Statement

The forecast income statement is important for many reasons:

 Management should use the income statement forecast to identify whether the
business made a profit for the period. The important figure is the bottom line net
income. It should also use it to establish % relationships between expenses and
revenue, to spot trends in operating profit ratios, and for comparison of actual
results against a projection.

 They are used by Suppliers to decide on whether credit is given as they identify
the profitability of your business.

 Bank Managers utilise the income statement forecast as they base their lending
ratios on certain aspects of it, for example interest cover = earnings before interest
and tax / interest paid is used to determine whether the profit the business is
making is sufficient to cover the interest payments on their loan.

 The income statement forecast is used by investors to decide whether to invest or

not and at what price. For example they will look at the income before tax to
establish their likely return on investment.

Finance/Accounting

Financial condition is often considered the single best measure of a firm’s competitive
position and overall attractiveness to investors. Determining an organization’s financial
strength and weaknesses is essential to formulating strategies effectively. A firm’s liquidity,
leverage, working capital, profitability, assets utilization, cash flow, and equity eliminate
some strategies as being feasible alternatives. Financial factors often alter existing
strategies and change implementing plans.

Steps in the Analysis of Financial Statements

1. Identify the industry economic characteristic

First, determine a value chain analysis for the industry – the chain of activities
involved in the creation, manufacture and distribution of the firm’s products and/or services.
Techniques such as Porter’s Five Forces or analysis of economic attributes are typically
used in this step.

2. Identify company strategies.

Next, look at the nature of the product/service being offered by the firm, including the
uniqueness of product, level of profit margins, creation of brand loyalty and control of costs.
Additionally, factors such as supply chain integration, geographic diversification and industry
diversification should be considered.

Porter’s Five Forces

Porter's Five Forces Framework is a tool for analyzing competition of a business. It draws
from industrial organization (IO) economics to derive five forces that determine the
competitive intensity and, therefore, the attractiveness (or lack of it) of an industry in terms of
its profitability.

3. Assess the quality of the firm’s financial statements.

Review the key financial statements within the context of the relevant accounting
standards. In examining balance sheet accounts, issues such as recognition, valuation and
classification are keys to proper evaluation. The main question should be whether this
balance sheet is a complete representation of the firm’s economic position.
 When evaluating the income statement, the main point is to properly assess the
quality of earnings as a complete representation of the firm’s economic performance.
Evaluation of the statement of cash flows helps in understanding the impact of the firm’s
liquidity position from its operations, investments and financial activities over the period – in
essence, where funds came from, where they went, and how the overall liquidity of the firm
was affected.

4. Analyze current profitability and risk.

This is the step where financial professionals can really add value in the evaluation of
the firm and its financial statements. The most common analysis tools are key financial
statement ratios relating to liquidity, asset management, profitability, debt
management/coverage and risk/market valuation. With respect to profitability, there are two
broad questions to be asked: how profitable are the operations of the firm relative to its
assets – independent of how the firm finances those assets – and how profitable is the firm
from the perspective of the equity shareholders. It is also important to learn how to
disaggregate return measures into primary impact factors. Lastly, it is critical to analyze any
financial statement ratios in a comparative manner, looking at the current ratios in relation to
those from earlier periods or relative to other firms or industry averages.

5. Prepare forecasted financial statement.

Although often challenging, financial professionals must make reasonable

assumptions about the future of the firm (and its industry) and determine how these
assumptions will impact both the cash flows and the funding. This often takes the form of
pro-forma financial statements, based on techniques such as the percent of sales approach.

The percentage of sales method is used to calculate how much financing is needed
to increase sales. The method allows for the creation of a balance sheet and an income
statement. The equation to calculate the forecasted net income is: Forecasted Sales =
Current Sales x (1 + Growth Rate/100).

6. Value the firm.

While there are many valuation approaches, the most common is a type of
discounted cash flow methodology. These cash flows could be in the form of projected
dividends, or more detailed techniques such as free cash flows to either the equity holders or
on enterprise basis. Other approaches may include using relative valuation or accounting-
based measures such as economic value added.

The Next Step:

Once the analysis of the firm and its financial statements are completed, there are
further questions that must be answered. One of the most critical is: “Can we really trust the
numbers that are being provided?” There are many reported instances of accounting
irregularities. Whether it is called aggressive accounting, earnings management, or outright
fraudulent financial reporting, it is important for the financial professional to understand how
these types of manipulations are perpetrated and more importantly, how to detect them.
ABC Company
Income Statement Forecast (In Million $)
  Prior Year Projected Year Assumptions

  2017 2018
Sales 100 150 50% Increase

Cost of Goods Sold -70 -105 70% of sales

Gross Profit 30 45  

Selling Expense -10 -15 10% of sales

Admisitrative Expense -5 -7.5 5% of sales

Earnings Before Interest and Taxes 15 22.5  

Interest -3 -3  

Earnings Before Taxes 12 19.5  

Taxes -6 -9.75 50% rate

Net Income 6 9.75  

Dividends -2 -5  

Retained Earnings 4 4.75  

Resources: Fred David, Strategic Management: Concepts and Cases, 13th Edition

https://leadingstrategicinitiatives.com/2012/04/26/how-to-identify-strategic-assumptions/

https://iveybusinessjournal.com/publication/strategic-assumptions-the-essential-and-missing-element-of-your-
strategic-plan/