Forecasting Errors in Capital Budgeting: A Multi-Firm Post-Audit Study

Abstract

This is a post-audit study concerning the accuracy of capital budgeting procedures. It is based on the statistical analysis of the deviations occurring between effective and forecasted performance of companies after implementing their projected investments. The forecasts were collected from a large database of applications for investment incentives submitted for consideration to the Portuguese Governmental Agency IAPMEI during the 2nd European Union Framework Programme. The first conclusion of the study is the significance of negative forecasting errors of post-investment sales and their implication in terms of the expected profitability. In contrast, forecasts on future operating costs were quite accurate and errors on investment expenses revealed high volatility. Also interesting is the finding that there seems to be no relationship between the size, industry, region, or investment incentives and the pattern of the errors found.

ACKNOWLEDGMENTS

This research was partially supported by IAPMEI, “Instituto de Apoio às Pequenas e Médias Empresas e ao Investimento,” Portugal (Program “Valor PME”).

Notes

¹ In practice, this follow-up has always been more concerned with controlling the investment expenses than with the subsequent operating cash flows.

²The definitions considered are exclusively based on the number of employees and follow the Portuguese nomenclature that considers the upper limit for medium-sized firms as being 500 employees.

³Corresponding to the global cost of goods sold for merely commercial activities and exclusively to the cost of raw materials when products are manufactured internally.

*Note: For computing the percentages of positive and negative errors, relative errors < 0.01 were considered null.

*Note: For computing the percentages of positive and negative errors, relative errors < 0.01 were considered null.