 Hello and welcome to the session. This is Professor Farhad in which we would look at prospective financial statements which involve financial forecast and financial projections. So what I'm going to do I'm going to I'm going to explain what is financial forecast and what is financial projection. Both terms are very they sound very similar and they both look at the future which is prospective financial statements and usually as accountant we always prepare financial statements based on past data not prospective data. So that's why it's important to differentiate between the two because we need to understand what each one is. Now this topic is covered also in auditing but I will I will explain it from a financial accounting perspective because I do have an auditing section about financial forecast and financial projection what is the auditor is responsible for this is the meaning of them. So what is financial forecast well think about a forecast when do you think about a forecast I hope you know the weather forecast what do the weather forecast do the weather forecast will tell you the weather there's a 40 50 70 chance it's going to rain it's going to be sunny it's going to be windy so on and so forth. Now how would the forecasters know that's going to be the case. What they do is they look at past data and they would say giving the past giving the data that we are seeing now and past data we can predict the next 24 hours that's how they do it literally that's how they do it based on what we saw in the past giving the sets of conditions this is what would happen next and there's a 60 percent chance this is what will happen next so that's how they forecast the weather same thing with financial forecast you will prepare financial statement that presented the best of the knowledge parties responsible for this and believe expected financial data how would they know this expected financial data it's based on past performance so you are saying this is what I expect to happen based on old data so it's more I'm going to put realistic in quote because once I compare it to financial projection I'm going to use a different word so basically I'm looking at old data I see that my sales has been increasing by 10 percent my cost of goods sold increasing by 10 percent for the past three years well what can I do I can make a financial forecast where I can predict in my forecast well let's not use to predict I can forecast that it's going to be the same based on the conditions giving okay so this is what we mean by forecast think of again think of forecasting the weather think of let's assume I want to know what's the busiest time of the day on youtube for my users well I have data and based on this data I would know for example Monday I have 50 users okay and the following Monday I have 52 the third Monday I have 51 then can I predict the fourth Monday yes it's going to be between 50 and 51 giving the data it's going to be around 50 50 51 something like this and this is what forecast is looking at past data to predict to forecast the future now bear in mind that financial forecast again I'm not going to go into the audit concept but maybe you happen to stumble upon this studying for audit it's for general use and we're going to see why it's for general use at the end because it has a certain guidelines well we're going to see general use means you can publish it to the public now a lot of companies avoid doing that avoid doing that and we will talk about why as well in this session you don't review so financial forecasts don't get reviewed and obviously not audited there's nothing to audit and you don't even review now financial projection let's look at financial projection financial projection also prospective financial statements that present to the best knowledge of the responsible party knowledge and believe given one or more hypothetical assumption so simply put you are also preparing financial statements same exact thing futuristic financial statements however those financial statements you know balance sheet net income statement of cash flow they are based on hypothetical assumptions you are making up assumptions if this happened this is what will happen basically something like what if we find the cure for covid if we find the cure for covid this is what's going to happen to our income statement if we did not find the cure for covid this is what's going to happen so here you are making hypothetical assumptions not not forecasting not what you expect to happen you are saying okay i am i am expecting what to happen giving giving this hypothetical assumptions and you can make all sorts of reasonable or crazy hypothetical assumptions because you are making hypothetical assumptions because the hypothetical assumption could be in quote crazy or unrealistic the financial projection are of limited use in other words you cannot publish them to the public you cannot tell the public this is what's going to happen limited use maybe if some a prospective investor is looking into it maybe a loan officer why why they're limited use because they can ask questions tell me a little bit more why if you why if we find the cure for covid your business will change i need to know i need to know a little bit more then you can talk about your hypothetical assumption whatever that hypothetical assumptions happens to be so that's why it's of limited use versus a forecast the forecast because you are kind of a little bit more realistic a little bit more conservative you can publish it to the public general general use versus limited use now you can supplement you can supplement the financial projection with the financial forecast so if you prepare a financial forecast and you prepare it properly you can also prepare a financial projection and make some hypothetical assumptions then use the report publish the report to the general public however it has to be part of a supplemental forecast part of the financial forecast supplement means a part of it it cannot be on its own so if you show them the forecast tell them here's the forecast take a look at it and here's a financial projection based on hypothetical assumptions but you cannot publish the hypothetical assumption on its own and make it for general use before we proceed any further most likely you are a student or a cpa candidate watching please take a look at my website farhat lectures dot com what i provide you with additional resources for your accounting courses lectures multiple choice true false that's gonna cover all your accounting courses all your cpa material i don't replace your cpa review course i don't replace your accounting course i help you please connect with me on social media linkedin youtube twitter facebook reddit and instagram so what is the argument for a forecast and what's the argument against the forecast because remember the forecast is for general use so understanding the argument for and against would help you understand what a forecast is well the people that support their companies should publish a financial forecast what would they say well when you invest in stocks in equity you invest for the future so they're saying well if you're investing for the future why not prepare financial forecast because this is what investors are looking for the other argument well forecasts are informally prepared simply put you are giving everything for someone to prepare a forecast why not regulate this process and let the company prepare a financial forecast this is the people that support this also what they say is future or prospective information is more relevant of course it is then past or old data as the environment changes and they're saying look okay you're giving me the financial statements now that are based on old data that's good but what's more relevant tell me what's gonna look like into the future based on your environment that you know the most now obviously i'm sure you are now you are thinking about i'm gonna know what's the argument against and hopefully you are trying to predict some argument against the first argument against financial forecasting is it could be misleading and wrong as you are predicting the future and it's risky to predict the futures and that's why cpa lot of cpa firms they stare away from financial forecasting what i used to work we did not provide the service and you're gonna see why in a moment company might massage earnings to reach the forecasted target not tagged and not the best interest of the shareholders what what they're saying in this the argument here state that once you have a financial forecast the company will work to achieve that forecast and not beyond that forecast because the company would like to just reach the forecast but that's not in the in the best interest of the shareholders of the owners managers that they're happy with that three and that's why companies cpa avoid this is because could be misleading and wrong there's there could be legal liability and action for incorrect forecast so if you make a forecast okay and that forecast was incorrect you could be subject to litigation and this is what happened with monsanto monsanto projected sales to be not eight to nine eight to nine percent higher but they only realized four to five percent so what did investors do they sue them and what did monsanto did they they defended themselves they said well we did our forecast based on our best believe in good faith and as a result they were off the hook but the key is there's always risk and forecast also some would argue that given a forecast will give too much information to competitors and you don't want to do that now what would what would the cpa do about forecast of course projected financial statements are covered under the aicpa they issued a statement on standard for accounting services on prospective financial information and we're not going to go over detailed of it because this is not again another course but simply put they established certain guidelines for preparing financial forecast and projection what it requires you to provide the significant assumptions that you made in using the in preparing the forecast or the project projection what assumptions that you use it tell us explain to us and tell us how what's are the minimum and they also provide with minimum presentation what you need to show when you are preparing a financial forecast or a financial projection so there are guidelines and the most important one is and this is obviously the most important one is what assumptions did you make about the future because you're going to be looking at the past obviously you're going to use past data and from the past data you're going to predict the future you're going to be making certain assumptions you know the the GDP is going to grow by three percent okay tell us you know how did you come up with this i use the government data i use some statistical analysis services tell us tell us what assumptions that you make to come up to that projection or forecast at the end of this recording i'm going to remind you again to go to farhatlectures.com work mcq's through false that's going to help you do better in your classes your accounting education is important invest in yourself good luck study hard and of course stay safe