What it means
Most accounting is backward-looking. The income statement, balance sheet and cash flow statement record what actually took place in a past period, using transactions that can be checked against invoices and bank statements.
Forward-looking information moves in the other direction by describing what management expects to happen next. Examples include sales forecasts, budgets, capital expenditure plans, earnings guidance and valuations that rely on expected cash flows.
These items are valuable because decisions are made about the future, not the past. A lender asking whether a business can repay a loan is much more interested in next year's cash flow than in last year's profit.
The weakness is uncertainty. Because forward-looking figures depend on assumptions about prices, volumes, costs and the economy, they can be wrong, and the further ahead they look the less reliable they are.
Good practice is to show the assumptions, give a range of outcomes and compare earlier forecasts with what actually happened. Companies that publish forward-looking statements, such as listed firms, normally add a cautionary note.
This tells readers that the statements are not guarantees and that actual results may differ. In many jurisdictions such wording gives some legal protection if the forecast later proves to be wrong, provided it was made in good faith and with reasonable basis.
Forward-looking measures are now common in everyday finance. Forward P/E, projected cash flow, expected credit losses and order books are all examples.
A manager who learns to ask whether a number is historic or expected will avoid the common error of treating estimates as facts. Accounting standards increasingly require forward-looking judgements inside the historic accounts themselves.
Estimates of future bad debts, the useful life of equipment and the expected value of goodwill all rely on management's view of what comes next. This means even a set of audited statements contains forward-looking elements, and readers should look at the notes to see how much judgement was involved.
In practice
Real-world examples.
Example
A retailer's chief financial officer presents next year's budget to the board. It assumes a 6% rise in sales and a 1 percentage point fall in gross margin. The board treats the budget as a forward-looking plan and asks how it would cope if sales rose by only 2%. The chief financial officer shows that profit would fall by around a third in that case, and the board agrees a cost-saving plan to apply if sales growth slips.
Example
A software company publishes a quarterly earnings release with guidance for the following year and a paragraph noting that the guidance is forward-looking. Investors use the guidance to update their models. The paragraph warns that actual results may differ. A week later, the company's lawyers remind the finance team that every forward-looking claim in the presentation should be supported by documented assumptions.
Example
A bank assesses a loan application from a manufacturer. The credit analyst builds a forecast of cash flows for the next three years under three scenarios and tests whether the company can meet the interest payments in each of them. In the weakest scenario the cover falls below the lender's minimum, so she proposes a smaller loan with a longer repayment period.
Case study
Seen in the real world.
Sunvale Solar is a fictional installer of solar panels that reported record profit of $4,000,000 for the year just ended. The management team was pleased, but the finance director, Amira, insisted that the board also look at forward-looking indicators before approving a dividend.
She pointed out that new orders had fallen by 25% in the last quarter and that a government subsidy would end in six months. A forecast built on those facts predicted profit falling to about $1,800,000 the following year.
In this illustrative example the board reduced the planned dividend, kept more cash in the business and cut back on hiring. When profit did fall, the company had the cash to cope, which shows why forward-looking analysis is as important as the historic accounts. Amira also began to report the gap between each forecast and the actual result every quarter. Over two years the average forecast error fell from 15% to 6%, and in this illustrative example the board came to trust the forward-looking figures enough to use them for planning.
Watch out
Common mistakes.
- Treating a forecast or budget as a commitment, when it is an estimate based on assumptions that can change.
- Relying only on historic results when making decisions that depend on future conditions.
- Presenting a single forecast with no range or stated assumptions, which hides the uncertainty.
Questions
People also ask.
What is a forward-looking statement?
It is any statement about expected future results, plans or events, rather than a description of something that has already happened.
Why do companies add warnings to forward-looking statements?
The warnings make clear that the statements are not guarantees, which helps protect the company and informs readers of the risk.
How is forward-looking different from backward-looking?
Backward-looking information reports past results from actual transactions, while forward-looking information is an estimate of what is expected to happen.
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