Chapter 7 lays out a comprehensive financial statement analysis to uncover the drivers of value generation, the drivers of residual operating income. It then forecasts those drivers for the future to assess the prospects of adding value. In the short-cut formula for non-financial firms, those are forecasts of sales, operating profit margins, and asset turnovers.
Prospective financial statements give the analyst a better handle on the forecasting. They are simply (!) the full financial statements estimated for the future, displaying the forecasted evolution of the statements from the current financial statements. Subject to the same chapter 7 financial statement analysis of current and past financial statements, they yield a more detailed analysis of drivers. So, for example, the future operating liability leverage, the gross profit margin, the inventory turnover, the R&D-to-Sales ratio are explicitly modeled. The prospective financial statement modeling also reveals to the investor his uncertainty: What prospective driver do I have difficulty in getting a hold on? That bears on his assessment of risk in chapter 8.
The investor maintains these prospective financial statements, updating them as more information arrives and consequently her buy or sell decision. One such piece of information is new financial statements published. The investor not only revises the prospective financial statements based on actual realization of the line items but also observes the variance of actual versus estimate: Where did I go wrong? Learning over time.