Businesses generally engage accountants to report on past performance. You want a record, that is a history, of how your company has performed. This gives you a fairly clear picture of your strengths and weaknesses, so you can make adjustments going forward. But there are also occasions when you might want an accountant to predict how your company might perform in the future. You could be considering whether to take on debt or pay it down, whether to stand pat or acquire an asset. Naturally, this kind of prognostication is less concrete. It’s an extrapolation based on various assumptions, which may or may not be valid. To interpret the report, you have to understand how it was compiled.

Here are the three types of reports you’d could ask an accountant to prepare to give you insight into probable (possible?) future performance:

• Forecasts — This type of prospective statement presents your company’s expected financial position, results of operations and cash flows. Forecasts are based on assumptions about expected conditions and courses of action.
• Projections — Similarly, a projection is based on assumptions about expected conditions and the company’s expected course of action, given one or more hypothetical assumptions. Financial projections may test investment proposals or demonstrate a best-case/worst-case scenario.
• Budgets — Operating budgets are prepared in-house for internal purposes. Budget allocate resources for particular purposes over specified periods. Budgets are generally based on expected revenues and costs of operations.

Although some professionals use these terms interchangeably, the American Institute of Certified Public Accountants (AICPA) has identified important distinctions under AICPA attestation standards.

Whichever method you use, it’s important not simply to take an historical financial statement and draw a straight-line extrapolation into the future. Accurate predictions require incisive and insightful work. For example, your business may be in the midst of a growth spurt that is simply not sustainable. The market might not have sufficient demand, and your facilities might not have the capacity, to keep up with steady growth at the same high rate. In that case, you might have to add assets that would change your expenses considerably.

And speaking of expenses, what happens if you previously took full advantage of the expanded Section 179 and bonus depreciation deductions. Thus, you did immediate expensing when you purchased your qualifying fixed assets. That means your historical depreciation is inflated vis a vis the depreciation going forward. Therefore, your past performance cannot be repeated.

You also have to make allowances for various external factors, including changes in your competition, product obsolescence and global economic conditions. There might also be events within your company that could have an impact one way or the other. For example, you might have ongoing litigation that should be resolved. Win, lose or settle, the outcome of the case may radically change your projections.