Predicting the Near Term Profit and Loss Statement with an Econometric Model: A Feasibility Study

Abstract

Conventional financial statements present a model of key financial stocks and flows in the business firm. For all their problems, monthly and quarterly profit and loss statements remain in widespread use by management for internal control and planning, and by stockholders and lenders as a device to evaluate corporate financial performance. Accordingly, shortterm prediction of the income statement is a continuing planning requirement of corporate management. In addition, a growing interest has been recently displayed among accountants in evaluating the feasibility of including projections of financial statements as part of the annual report. These factors heighten the profession's interest in the usefulness of tools and methods for near-term financial forecasting along three dimensions: (a) to facilitate consideration of the practicability of proposals that financial projections be involved in audited statements; (b) to aid consideration by the management services function of possible client requests for externally prepared short-term income statement projections; and (c) to aid corporate accountants in evaluating available tools for short-term income statement forecasting. At the present time, near-term income statement prediction by corporations is most usually accomplished by basically qualitative methods supplemented in a growing number of cases by exponential or related data smoothing procedures. The results of this approach typically leave ample room for improvement in predictive accuracy. This study is directed at exploring the application of the tools of econometrics to predict the monthly profit and loss statement of a firm. Our