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7/28/2019 ProForma Nt
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PRO FORMAFINANCIAL STATEMENTS
7/28/2019 ProForma Nt
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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.
7/28/2019 ProForma Nt
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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)
7/28/2019 ProForma Nt
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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
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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.
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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.
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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
Total Current Assets
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
7/28/2019 ProForma Nt
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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.
7/28/2019 ProForma Nt
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THE PROCESS
How would we describe and estimate the
following:
COGS
Operating expenses
Depreciation & Amortization
Interest expense
Taxes
7/28/2019 ProForma Nt
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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.
7/28/2019 ProForma Nt
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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
7/28/2019 ProForma Nt
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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.
7/28/2019 ProForma Nt
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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.
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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.
7/28/2019 ProForma Nt
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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
Total Current Assets
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
7/28/2019 ProForma Nt
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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.
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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
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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?