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Pro Forma Financial Statements

Pro Forma Financial Statements. Dr. Nancy Mangold California State University, East Bay. Preparing Pro Forma Financial Statements – Step 1. Project Operating Revenue Sales revenue Other revenue. Preparing Pro Forma Financial Statements – Step 2. Projecting Operating Expenses

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Pro Forma Financial Statements

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  1. Pro Forma Financial Statements Dr. Nancy Mangold California State University, East Bay

  2. Preparing Pro Forma Financial Statements – Step 1 • Project Operating Revenue • Sales revenue • Other revenue

  3. Preparing Pro Forma Financial Statements – Step 2 • Projecting Operating Expenses • Cost of Goods Sold • Selling and Administrative Expenses • Net Income Before Interest and Taxes

  4. Preparing Pro Forma Financial Statements – Step 3 • Project Assets • Cash • Accounts Receivable • Inventories • Other Current Assets • Investments • Fixed Assets • Other Assets

  5. Preparing Pro Forma Financial Statements – Step 4 • Project Liabilities and Contributed Capital • Accounts Payable • Notes Payable • Other Current Liabilities • Long-Term Debt • Other Liabilities • Contributed Capital

  6. Preparing Pro Forma Financial Statements – Step 5 • Project Retained Earnings • Retained Earnings

  7. Preparing Pro Forma Financial Statements – Step 5 • Project Cost of Financing, Income Tax Expense and the Change in Retained Earnings • Interest Expense • Income Tax Expense • Net Income • Dividends • Change in Retained Earnings

  8. Preparing Pro Forma Financial Statements – Step 6 • Project the Statement of Cash Flows • Investing • Acquisition of Fixed Assets • Sale of investments • Acquisition of Investments • Other Investing Transactions • Cash Flow from Investing

  9. Project Sales and Other Revenues • Price: Consider • general price inflation • specific industry factor affecting demand • excess capacity • shortages of raw materials • prices of substitute products • Volume: Consider • growth rate in the general population

  10. Project Sales and Other Revenues • Use historical growth rate • adjust for major acquisition or sale • cyclical sales pattern • use varying growth rate • International sales • Consider • international competition • value of dollars

  11. Projecting Other Revenues • Use historical percentage of sales

  12. Project Operating Expenses • Projection depends on the behavior of the cost items • Variable cost • use common size income statement percentages multiplied by projected sales • High fixed costs • estimate the VC and FC of the firm • use historical growth rates for individual items

  13. Project Operating Expenses • Cost of Goods Sold • VC • use projected cost of goods sold percentage of sales • Selling and Administrative Expenses • use projected S & A percentage of sales

  14. Project the Assets on the Balance Sheet • Project total Assets • use common size balance sheet percentages to allocate the total assets among individual asset items • Project Individual assets • sum up individual asset amounts to obtain total assets

  15. Project the Assets on the Balance Sheet • Projected Total Assets Approach • Use historical growth rate in assets • compound annual growth rate over five years

  16. Project the Assets on the Balance Sheet • Alternative Approach • Use Total Assets Turnover Ratio Projected Sales = Ave. total assets Projected Total Assets Turnover • 2 x Ave. Total Assets - Beg. Assets = ending assets

  17. Project Assets on Balance Sheet • May create sawtooth problem

  18. Illustration of Difficulty Sometimes EncounteredWhen Projecting Total Assets Using Assets Turnover Sales Assets Dollars 1 3 4 2 Year

  19. Project Assets on Balance Sheet • use compound annual rate to smooth the rate of increase in assets (Projected Ending Assets(yr 5)/ Beg. Assets (yr 0)) ^(1/5) • ($21,030/$16,161)^(1/5)

  20. Project Assets on Balance Sheet • Another Alternative • Based the asset turnover on the ending balance instead of the average balance • Sales/ending total assets = projected total asset turnover • Projected sales/ projected total asset turnover = Year-end assets

  21. Project Assets on Balance Sheet • Use common size balance sheet percentages to allocate the total assets to individual assets

  22. Projected Individual Asset Approach • Use historical growth rate for individual assets • Assets linked to operations tie to growth in sales • Accounts receivable • Inventories • Fixed assets • Use asset turnovers

  23. Projected Individual Asset Approach • Cash & Marketable Securities • plug in figure • Change in cash on the balance sheet must agree to change in cash on the projected statement of cash flows • If cash is too high, assume the firm will invest the excess in marketable securities or pay down borrowings • If negative, the firm uses short-term borrowings to bring about a desired level of cash

  24. Projected Individual Asset Approach • Accounts Receivable • Use receivables turnover • Sales/Receivables turnover = Ave. accounts receivable • 2*Ave. AR - beg. AR = ending AR • smooth the Sawtooth problem using compound growth rate (Ending AR/Beg. AR) ** 1/5

  25. Projected Individual Asset Approach • Inventories • use inventory turnover • Sales/Inventory turnover = Ave. inventories • 2*Ave. Inv - Beg. Inv. = Ending Inv • Smooth the sawtooth problem using compound growth • (Ending Inv/Beg. Inv) ** 1/5

  26. Projected Individual Asset Approach • Other Current Assets • use growth rate in sales • Investments in Securities • use compound annual growth rate • Property, Plant and Equipment • use fixed assets turnover (follow AR, Inv) • Other Assets • use growth in sales

  27. Projected Individual Asset Approach • If common size Financial Statement indicate • Cash and Marketable Securities • 10% of Assets • (AR+Inv+Other current assets+PPE+other assets)/90% = Total assets • Total assets * percentage cash = cash • Total assets * percentage marketable securities = marketable securities

  28. Project Liabilities and Shareholders’ Equity • Projected total asset approach • Use common size balance sheet percentages to project • Individual liabilities • Shareholders’ equity • Project individual liabilities and shareholders’ equity accounts • use historical growth rates • use turnover ratios

  29. Project Liabilities and Shareholders’ Equity • Accounts Payable • use AP turnover • COGS + End Inv - Beg Inv = Purchases • Purchases/ AP turnover = Ave AP • Ave AP * 2 - Beg AP = Ending AP balance • Use compound annual AP growth rate to smooth AP • (Proj end AP/ beg AP ) **1/5

  30. Project Liabilities and Shareholders’ Equity • Notes Payable • plug (projected assets - projected liab and equity) • Current Maturities of LT Debt • use disclosed amount • Other Current Liabilities • use growth rate in sales

  31. Project Liabilities and Shareholders’ Equity • Long Term Debt • use percentage of LT debt to total assets • Deferred Income Taxes • relate to operating items (employee benefits, PPE, equity investment, intangible assets) • use growth rate in sales • Other Noncurrent liabilities • use growth rate in sales

  32. Project Liabilities and Shareholders’ Equity • Contributed Capital- Year-end Common Stock • use compound annual growth rate • Other Equity Adjustments • Foreign currency translation adjustment • Unrealized gains on securities for sale • use growth rate in sales • Treasury stock • use projected compound growth rate

  33. Project the Cost of Financing • Interest Expense • Short term borrowing • Ave notes Payable * proj. interest rate • Long term borrowing • Ave long term debt * proj. Interest rate

  34. Project Income Tax Expense • Income Taxes • use effective tax rate

  35. Project Retained Earnings • Dividends • use compound annual dividend growth rate • Change in Retained Earnings • Beginning R/E + Net income - Dividends = Ending Retained Earnings

  36. Project the Statement of Cash Flows • Net income • Pro forma income statement • Depreciation • Change in accumulated depreciation • Other addbacks • increase in deferred income taxes • other noncurrent liabilities

  37. Project the Statement of Cash Flows • Changes in operating current asset and current liability - pro forma balance sheet • Acquisition of PPE • Change in PPE from pro forma B/S • Other Investing Transactions • change in other assets • Increases in borrowing • increase in Notes Payable and LT Debt

  38. Project the Statement of Cash Flows • Changes in Common Stock • Changes in common stock, paid-in capital, and treasury stock • Dividends • Projected amount each year • Change in Cash • Net to the change in cash on the comparative balance sheet

  39. Analyzing Pro Forma Financial Statements • Serves as a base case that an analyst can use to asses the impact of various changes for a company • Changes in various assumptions will have different effects • Use spreadsheet to observe the effect on the financial statement ratios

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