Pro Forma Income Statement PRO FORMA FINANCIAL STATEMENTS PRO FORMA FINANCIAL by qle76866

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									PRO FORMA FINANCIAL STATEMENTS
PRO FORMA FINANCIAL STATEMENTS
   Projected or “future” financial statements.
       The idea is to write down a sequence of financial
        statements that represent expectations of what the
        results of actions and policies will be on the future
        financial status of the firm.
 Pro forma income statements, balance sheets,
  and the resulting statements of cash flow are the
  building blocks of financial planning.
 They are also vital for any valuation exercises
  one might do in investment analysis or M&A
  planning. Remember, it’s future cash flow that
  determines value.
 Financial modeling skills such as these are also
  one of the most important skills (for those of you
  interested in finance or marketing) to develop.
GENERIC FORMS: INCOME
STATEMENT
 Sales (or Revenue)
 Less Cost of Goods Sold
 Equals Gross Income (or Gross Earnings)
 Less Operating Expenses
 Equals Operating Income
 Less Depreciation
 Equals EBIT
 Less Interest Expense
 Equals EBT
 Less Taxes
 Equals Net Income (Net Earnings, EAT, Profits)
GENERIC FORMS: BALANCE SHEET
   Assets                            Liabilities + O’s Equity
       Cash                              Bank Loan
       Accounts Receivable               Accounts Payable
       Inventory                         Wages Payable
       Prepaid Taxes                     Taxes Payable
       Marketable Securities             Current Portion – L-T
           Total Current Assets           Debt
     Gross PP&E                              Total Current Liabilities
     Accumulated                       Long-Term Debt
      Depreciation                      Preferred Stock
     Net PP&E                          Common Stock
     Land                              Retained Earnings
           Total Assets                      Total Liabilities + Equity
GENERIC FORMS: BRIDGE
 Clearly we can’t hope to get anywhere if we
  develop separate forecasts of the different
  statements.
 The income statement records the effect of a
  given year while the balance sheets show the
  situation at the beginning of and after that
  year.
 Furthermore the balance sheet must balance.

 The two statements must therefore be
  intimately linked. There must be a “bridge”
  between them.
GENERIC FORMS: BRIDGE
 One important bridge is:
  Net Income – Dividends = Change in Retained Earnings
  An income statement amount less dividends equals a
  balance sheet amount.
 Another is:
  Interest Expense = Interest Rate  Interest Bearing Debt
  An income statement amount equals a balance sheet
  amount times a cost figure.
 These simple relations, plus requiring the
  balance sheet to balance, tie the income
  statement directly to the balance sheet
  and vice versa.
BRIDGE
Income Statement                     Balance Sheet
Sales (or revenue)     Assets                  Liabilities + Owner’s E
Less COGS              Cash                    Bank Loan
Equals Gross Income    Accts Rec               Accts Pay
Less Operating Exp     Inventory               Wages Pay
Less Depr              Prepaid Taxes           Taxes Pay
Equals EBIT             Total Current Assets    Total Current Liab
Less Interest Exp      Gross PP&E              L-T Debt
Equals EBT             Accumulated Depr.       Common Stock
Less Taxes             Net PP&E                Retained Earnings
Equals Net Inc (EAT)   Land                     Total Liab + OE
Less Dividends           Total Assets
Change in Retained E
THE FORECASTING PROCESS
  The most common way to proceed is to fill in the
   income statement first. The standard approach is
   called “percent of sales forecasting.”
  Why?: You first get the sales (or sales growth)
   forecast.
  Then, you project variables having a stable relation
   to sales using forecasted sales and the estimated
   relations.
  Then there is the rest.
THE PROCESS…
   How would we describe and estimate the
    following:
       COGS
       Operating expenses
       Depreciation & Amortization
       Interest expense
       Taxes
THE PROCESS…
 COGS  will generally vary directly with
 sales. If not, it is likely that something
 has gone (or is going) very wrong.
     Calculate the COGS/Sales ratio for the last
      few years. Multiply a forecast for this ratio
      times the forecast for sales to find a forecast
      for COGS.
     How do we forecast the COGS/Sales ratio?
     that there may also be a fixed
 Note
 component for some of these relations.
 How do you adjust?
     Operating expenses is a good example.
THE PROCESS…
 We then require estimates of the
 components of expenses that don’t vary
 directly (and in a stable way) with sales to
 complete the income statement.
  Other Expenses
  Other Income
  Depreciation
  Taxes
  Net Income
  Dividends
THE PROCESS…
 From  the completed income statement,
  determine the change in retained
  earnings, transfer it to the balance sheet.
 Now we have to fill out the rest of the
  balance sheet.
     Many of the current assets and liabilities
      (accounts receivable, accounts payable,
      inventory, wages payable, etc.) can be expected
      to vary directly with sales.
     Forecast these as we just described.
THE PROCESS…
 The cash balance is usually determined by
 a policy decision via some inventory (of
 liquidity) model.
     Alternatively this account may be used as a
      “plug.”
 Changes   in Gross PP&E are also the
  result of policy decisions as are changes in
  preferred or common stock.
 Often short-term (bank loan or line of
  credit) or long-term debt is used as a
  residual to determine the required new
  financing (a plug to make it balance).
     But don’t forget that these can’t be chosen in
      isolation.
THE PROCESS…
 Interest expense comes from the amount
  of interest bearing debt.
 Interest expense effects net income,

 Which effects changes in retained
  earnings,
 Which, through the equality requirement
  for the balance sheet, effects the amount
  of interest bearing debt that is necessary.
 The two statements are intimately
  connected.
   A CIRCULARITY RATHER THAN A
   BRIDGE
Sales (or revenue)      Assets                  Liabilities + Owner’s E
Less COGS               Cash                    Bank Loan
Equals Gross Income     Accts Rec               Accts Pay
Less Operating Exp      Inventory               Wages Pay
Less Depr                Total Current Assets   Taxes Pay
Equals EBIT             Gross PP&E               Total Current Liab
Less Interest Exp       Accumulated Depr.       L-T Debt
Equals EBT              Net PP&E                Common Stock
Less Taxes              Land                    Retained Earnings
Equals Net Inc (EAT)      Total Assets           Total Liab + OE
Less Dividends
Changes in Retained E
INTERACTIONS…
    The income statement “equation” can be written:
     [Rev – Operating Exp – Depr&Amort
     - (Int Bearing Debt)(Int Rate)](1- Tax Rate)
     - Dividends = Change in retained earnings
    The balance sheet “equation” is written:
     Total Assets = Accts Pay + Wages Pay + Taxes Pay
     + Int Bearing Debt + Common Stock + Change in retained
     earnings
    Interest bearing debt is the unknown in each equation.
    If we just substitute the LHS of the income statement equation
     for the last term of the balance sheet equation we can “solve
     them simultaneously” to find the external debt financing
     required.
    This is made easy by spread sheets and should be easier to
     understand by looking at the following example.
        EXAMPLE
Income Statement
Net Sales                        $240,000.00                     Firm decides that $20,000 is a minimum
Cost of Goods Sold               $156,000.00   65% of sales      cash balance that is acceptable.
GS&A Expenses                     $36,000.00   15% of sales      All but cash account and bank loan
Interest Expense                   $8,000.00   "+E22*.10+4500"   are assumed to be estimated via ratios.
Earnings Before Tax               $40,000.00
Tax                               $16,000.00   "+E6*.4"          Interest on existing LT Debt is $4,500
Net Income                        $24,000.00
Dividends Paid                    $12,000.00   "+E8*.5"
Additions to Retained Earnings    $12,000.00   "+E8-E9"

Balance Sheet (end of period)
Cash                              $20,000.00 "=IF(20000+SUM(E14:E17)>E20+E21+SUM(E23:E27),20000,"
Accounts Receivable               $65,000.00 "E20+E21+SUM(E23:E27)-SUM(E14:E17))"
Inventory                         $82,000.00
Net PP&E                         $150,000.00
Other Assets                      $25,000.00
Total Assets                     $342,000.00

Accounts Payable                  $18,000.00
Tax Accruals                       $9,000.00
Bank Loan                         $35,000.00 "=IF(20000+SUM(E14:E17)>E20+E21+SUM(E23:E27),"
Equipment Loan                    $23,000.00 "(20000+SUM(E14:E17))-(E20+E21+SUM(E23:E27)),0)"
Miscellaneous Accruals             $5,000.00
Long-Term Debt                    $45,000.00
Common Stock                      $95,000.00
Retained Earnings                $112,000.00 "100000+E10"      Firm had $100,000 RE end of last period.
Total Liabilities + Equity       $342,000.00
THE PROCESS…
 Many will not go to all the trouble and simply use
  one balance sheet account as a residual account
  (often “cash”) that makes the balance sheet
  balance.
 In this way you don’t change the interest bearing
  debt directly (so interest expense is fixed but
  “wrong”) and equity changes only through
  retained earnings.
 This allows you to see what you have to do with
  financing to keep things on track. If cash gets big
  or very negative you can plan on having to take
  actions.
 This method is not very useful for FAP and
  makes you think about what is going on before
  you do any valuation.
 Why be sloppy when doing it right is now so
  easy?

								
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