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PP

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PP

  1. 1. Pro Forma Financial Statements
  2. 2. Pro Forma Financial Statements • Projected or future financial statements. • Pro forma income statements, balance sheets, and the resulting cash flow statements are the building blocks of financial planning. • They are also vital for any valuation exercises one might do in investment or M&A planning.
  3. 3. 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 (EAT)
  4. 4. Generic Forms: Balance Sheet • Assets • Liabilities + Equity – Cash – Bank Loan – Accounts Receivable – Accounts Payable – Wages Payable – Inventory – Taxes Payable – Marketable Securities – Current Portion – L-T Debt • Total Current Assets • Total Current Liabilities – Gross PP&E – Long-Term Debt – Accumulated Depreciation – Preferred Stock – Net PP&E – Common Stock – Land – Retained Earnings • Total Assets • Total Liabilities + Equity
  5. 5. Generic Forms: Bridge • Clearly we can’t hope to get anywhere if we treat these forecasts as being separate. 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. • One important bridge is: Net Income less Dividends = Change in Retained Earnings – This simple relation and interest expense will tie them together.
  6. 6. 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 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
  7. 7. Overview of the Process • The most common way to proceed is to fill in the income statement first. The standard approach is called “percent of sales forecasting.” – Because you first get the sales or sales growth forecast. • Then, project variables having a stable relation to sales using forecasted sales and estimated ratios. – COGS, Inventory, Operating expenses (may) – D&A, Interest expense (won’t), Taxes (will be predictable from EBT) • Require estimates of the components of expenses that don’t vary directly (and in a stable way) with sales to complete the income statement.
  8. 8. Overview of the Process… • From the completed income statement, determine the change in retained earnings, transfer it to the balance sheet. • Some of the current assets and liabilities (accounts receivable, accounts payable, inventory, wages payable, etc.) can be expected to vary directly with sales. • Cash is usually determined by a policy decision via some inventory (of liquidity) model. • Gross PP&E changes are usually the result of policy decisions as are changes in preferred or common stock or long-term debt. • Often the bank loan or long-term debt is used as a residual to determine the required new financing (make it balance).
  9. 9. Overview of the Process • Interest expense comes from the amount of interest bearing (Long-term) 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. • Thus these two statements are intimately connected.
  10. 10. Circularity 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
  11. 11. 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: 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.
  12. 12. Example Income Statement Net Sales 240000 Firm decides that $20,000 is a minimum Cost of Goods Sold 156000 cash balance that is acceptable. GS&A Expenses 36000 All but cash account and bank loan Interest Expense 8000 "+E22*.10+4500" are assumed to be estimated via ratios. Earnings Before Tax 40000 Tax 16000 "+E6*.4" Net Income 24000 Dividends Paid 12000 "+E8*.5" Additions to Retained Earnings 12000 "+E8-E9" Balance Sheet (end of period) Cash 20000 "=IF(20000+SUM(E14:E17)>E20+E21+SUM(E23:E27),20000," Accounts Receivable 65000 "E20+E21+SUM(E23:E27)-SUM(E14:E17))" Inventory 82000 Net PP&E 150000 Other Assets 25000 Total Assets 342000 Accounts Payable 18000 Tax Accruals 9000 Bank Loan 35000 "=IF(20000+SUM(E14:E17)>E20+E21+SUM(E23:E27)," Equipment Loan 23000 "(20000+SUM(E14:E17))-(E20+E21+SUM(E23:E27)),0)" Miscellaneous Accruals 5000 Long-Term Debt 45000 Common Stock 95000 Retained Earnings 112000 "100000+E10" Firm had $100,000 RE end of last period. Total Liabilities + Equity 342000

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