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7/28/2019 ProForma Nt

1/18

PRO FORMAFINANCIAL STATEMENTS


2/18

PRO FORMAFINANCIAL STATEMENTS

Projected or future financial statements. The idea is to write down a sequence of financial

statements that represent expectations of what theresults of actions and policies will be on the futurefinancial status of the firm.

Pro forma income statements, balance sheets,and the resulting statements of cash flow are thebuilding blocks of financial planning.

They are also vital for any valuation exercisesone might do in investment analysis or M&A

planning. Remember, itsfuture cash flow thatdetermines value.

Financial modeling skills such as these are alsoone of the most important skills (for those of youinterested in finance or marketing) to develop.


3/18

GENERIC FORMS: INCOME

STATEMENT

Sales (or Revenue)

Less Cost of Goods Sold

Equals Gross Income (or Gross Earnings)

Less Operating ExpensesEquals Operating Income

Less Depreciation

Equals EBIT

Less Interest ExpenseEquals EBT

Less Taxes

Equals Net Income (Net Earnings, EAT, Profits)


4/18

GENERIC FORMS: BALANCE SHEET

Assets

Cash

Accounts Receivable

Inventory

Prepaid Taxes Marketable Securities

Total Current Assets

Gross PP&E

AccumulatedDepreciation

Net PP&E

Land

Total Assets

Liabilities + Os Equity

Bank Loan

Accounts Payable

Wages Payable

Taxes Payable Current PortionL-T

Debt

Total Current Liabilities

Long-Term Debt

Preferred Stock

Common Stock

Retained Earnings

Total Liabilities + Equity


5/18

GENERIC FORMS: BRIDGE

Clearly we cant hope to get anywhere if wedevelop separate forecasts of the different

statements.

The income statement records the effect of agiven 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.


6/18

GENERIC FORMS: BRIDGE

One important bridge is:Net IncomeDividends = Change in Retained Earnings

An income statement amount less dividends equals abalance sheet amount.

Another is:Interest Expense = Interest Rate Interest Bearing Debt

An income statement amount equals a balance sheetamount times a cost figure.

These simple relations, plus requiring thebalance sheet to balance, tie the incomestatement directly to the balance sheetand vice versa.


7/18

BRIDGE

Sales (or revenue)

Less COGS

Equals Gross Income

Less Operating Exp

Less Depr

Equals EBIT

Less Interest Exp

Equals EBTLess Taxes

Equals Net Inc (EAT)

Less Dividends

Change in Retained E

Assets

Cash

Accts Rec

Inventory

Prepaid Taxes


Gross PP&E

Accumulated Depr.Net PP&E

Land

Total Assets

Liabilities + Owners E

Bank Loan

Accts Pay

Wages Pay

Taxes Pay

Total Current Liab

L-T Debt

Common StockRetained Earnings

Total Liab + OE

Income Statement Balance Sheet


8/18

THE FORECASTING PROCESS

The most common way to proceed is to fill in theincome statement first. The standard approach iscalled 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 estimatedrelations.

Then there is the rest.


9/18

THE PROCESS

How would we describe and estimate the

following:

COGS

Operating expenses

Depreciation & Amortization

Interest expense

Taxes


10/18

THE PROCESS

COGS will generally vary directly withsales. If not, it is likely that somethinghas gone (or is going) very wrong. Calculate the COGS/Sales ratio for the last

few years. Multiply a forecast for this ratiotimes the forecast for sales to find a forecastfor COGS.

How do we forecast the COGS/Sales ratio?

Note that there may also be a fixedcomponent for some of these relations.How do you adjust? Operating expenses is a good example.


11/18

THE PROCESS

We then require estimates of the

components of expenses that dont vary

directly (and in a stable way) with sales to

complete the income statement. Other Expenses

Other Income

Depreciation

Taxes

Net Income

Dividends


12/18

THE PROCESS

From the completed income statement,determine the change in retainedearnings, transfer it to the balance sheet.

Now we have to fill out the rest of thebalance 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.


13/18

THE PROCESS

The cash balance is usually determined bya policy decision via some inventory (ofliquidity) model. Alternatively this account may be used as a

plug.

Changes in Gross PP&E are also theresult of policy decisions as are changes inpreferred or common stock.

Often short-term (bank loan or line ofcredit) or long-term debt is used as aresidual to determine the required newfinancing (a plug to make it balance). But dont forget that these cant be chosen in

isolation.


14/18

THE PROCESS

Interest expense comes from the amount

of interest bearing debt.

Interest expense effects net income,

Which effects changes in retainedearnings,

Which, through the equality requirement

for the balance sheet, effects the amountof interest bearing debt that is necessary.

The two statements are intimately

connected.


15/18

A CIRCULARITYRATHER THAN A

BRIDGESales (or revenue)

Less COGS

Equals Gross Income

Less Operating Exp

Less Depr

Equals EBIT

Less Interest Exp

Equals EBTLess Taxes

Equals Net Inc (EAT)

Less Dividends

Changes in Retained E

Assets

Cash

Accts Rec

Inventory


Gross PP&E

Accumulated Depr.

Net PP&ELand

Total Assets

Liabilities + Owners E

Bank Loan

Accts Pay

Wages Pay

Taxes Pay

Total Current Liab

L-T Debt

Common StockRetained Earnings

Total Liab + OE


16/18

INTERACTIONS

The income statement equation can be written:[RevOperating ExpDepr&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 retainedearnings

Interest bearing debt is the unknown in each equation.

If we just substitute the LHS of the income statement equationfor the last term of the balance sheet equation we can solvethem simultaneously to find the external debt financingrequired.

This is made easy by spread sheets and should be easier tounderstand by looking at the following example.


17/18

EXAMPLEIncome 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 loanInterest 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


18/18

THE PROCESS

Many will not go to all the trouble and simply useone balance sheet account as a residual account(often cash) that makes the balance sheetbalance.

In this way you dont change the interest bearing

debt directly (so interest expense is fixed butwrong) and equity changes only throughretained earnings.

This allows you to see what you have to do withfinancing to keep things on track. If cash gets bigor very negative you can plan on having to take

actions. This method is not very useful for FAP andmakes you think about what is going on beforeyou do any valuation.

Why be sloppy when doing it right is now soeasy?

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