274  Forecasting Performance
When forecasting the balance sheet, one of the first issues you face is 
whether to forecast the line items in the balance sheet directly (in stocks) or 
indirectly by forecasting the year-to-year changes in accounts (in flows). For 
example, the stock approach forecasts end-of-year receivables as a function 
of revenues, while the flow approach forecasts the change in receivables as a 
function of the growth in revenues. We favor the stock approach. The relation-
ship between the balance sheet accounts and revenues (or other volume mea-
sures) is more stable than that between balance sheet changes and changes 
in revenues. Consider the example presented in Exhibit 13.9. The ratio of ac-
counts receivable to revenues remains within a tight band between 9.2 percent 
and 10.1 percent, while the ratio of changes in accounts receivable to changes 
in revenues ranges from –1 percent to 16 percent, too volatile to be insightful.
Exhibit 13.10 summarizes forecast drivers and forecast ratios for the most 
common line items on the balance sheet. The three primary operating line items 
are operating working capital, long-term capital such as net PP&E, and intangible 
EXHIBIT 13.9  Stock-versus-Flow Example
Year 1
Year 2
Year 3
Year 4
Revenues, $
1,000
1,100
1,200
1,300
Accounts receivable, $
100
105
121
120
Stock method
Accounts receivable as a % of revenues
10.0
9.5
10.1
9.2
Flow method
Change in accounts receivable as a % of 
change in revenues 
5.0
16.0
(1.0)
EXHIBIT 13.10  Typical Forecast Drivers and Ratios for the Balance Sheet
Line item
Typical forecast driver
Typical forecast ratio
Operating line items
Operating working capital
  Accounts receivable
Revenues
Accounts receivable/revenues
  Inventories
Cost of goods sold
Inventories/COGS
  Accounts payable
Cost of goods sold
Accounts payable/COGS
  Accrued expenses
Revenues
Accrued expenses/revenue
Net PP&E
Revenues or units sold
Net PP&E/revenues
Goodwill and acquired 
intangibles
Acquired revenues
Goodwill and acquired 
intangibles/acquired revenues
Nonoperating line items
Nonoperating assets
None
Growth in nonoperating assets
Pension assets or liabilities
None
Trend toward zero
Deferred taxes
Operating taxes or 
corresponding balance sheet 
item
Change in operating deferred 
taxes/operating taxes, or 
deferred taxes/corresponding 
balance sheet item

Mechanics of Forecasting  275
assets related to acquisitions. Nonoperating line items include nonoperating as-
sets, pensions, and deferred taxes, among others. We discuss each category next.
Operating Working Capital  To start the balance sheet, forecast items within 
operating working capital, such as accounts receivable, inventories, accounts pay-
able, and accrued expenses. Remember, operating working capital excludes any 
nonoperating assets (such as excess cash) and financing items (such as short-term 
debt and dividends payable).
When forecasting operating working capital, estimate most line items as a 
percentage of revenues or in days’ sales.9 Possible exceptions are inventories 
and accounts payable. Since these two accounts are economically tied to input 
prices, estimate them instead as a percentage of cost of goods sold (which is 
also tied to input prices).10 Look for other links between the income statement 
and balance sheet that may exist. For instance, accrued wages can be calcu-
lated as a percent of compensation and benefits.
Exhibit 13.11 presents a partially completed forecast of our hypothetical 
company’s balance sheet, in particular its operating working capital, long-term 
operating assets, and nonoperating assets (investor funds will be detailed later). 
All working-capital items are forecast in days, most of which are computed 
EXHIBIT 13.11  Partial Forecast of the Balance Sheet
Forecast worksheet
Balance sheet
Forecast ratio
2019
Forecast 
2020
$ million
2018
2019
Forecast 
2020
Working capital
Assets
Operating cash, days’ sales
7.6
7.6
Operating cash
5.0
5.0
6.0
Inventory, days’ COGS
182.5
182.5
Excess cash
100.0
60.0
Accounts payable, days’ sales
81.1
81.1
Inventory
35.0
45.0
54.0
Current assets
140.0
110.0
Fixed assets
Net PP&E/revenues, %
104.2
104.2
Net PP&E
200.0
250.0
300.0
Equity investments
100.0
100.0
100.0
Nonoperating assets
Total assets
440.0
460.0
Growth in equity investments, %
0.0
0.0
Liabilities and equity
Accounts payable
15.0
20.0
24.0
Short-term debt
200.0
178.0
Current liabilities
215.0
198.0
Long-term debt
80.0
80.0
Shareholders’ equity
145.0
182.0
Total liabilities and equity
440.0
460.0
9 To compute a ratio in days’ sales, multiply the percent-of-revenue ratio by 365. For instance, if ac-
counts receivable equal 10 percent of revenues, this translates to accounts receivable at 36.5 days’ sales. 
This implies that, on average, the company collects its receivables in 36.5 days.
10 As a practical matter, we sometimes simplify the forecast model by projecting each working-capital item us-
ing revenues. The distinction is material only when price is expected to deviate significantly from cost per unit.