Pro Forma Financial Statements

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Pro Forma Financial Statements

• Dr. Nancy Mangold
• California State University, East Bay

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Preparing Pro Forma Financial Statements Step 1

• Project Operating Revenue
• Sales revenue
• Other revenue

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Preparing Pro Forma Financial Statements Step 2

• Projecting Operating Expenses
• Cost of Goods Sold
• Selling and Administrative Expenses
• Net Income Before Interest and Taxes

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Preparing Pro Forma Financial Statements Step 3

• Project Assets
• Cash
• Accounts Receivable
• Inventories
• Other Current Assets
• Investments
• Fixed Assets
• Other Assets

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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

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Preparing Pro Forma Financial Statements Step 5

• Project Retained Earnings
• Retained Earnings

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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

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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

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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

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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

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Projecting Other Revenues

• Use historical percentage of sales

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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

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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

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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

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Project the Assets on the Balance Sheet

• Projected Total Assets Approach
• Use historical growth rate in assets
• compound annual growth rate over five years

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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

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Project Assets on Balance Sheet

• May create sawtooth problem

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Illustration of Difficulty Sometimes
EncounteredWhen Projecting Total Assets Using
Assets Turnover

Sales
Assets
Dollars
4
3
2
1
Year
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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)

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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

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Project Assets on Balance Sheet

• Use common size balance sheet percentages to
  allocate the total assets to individual assets

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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

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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

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Projected Individual Asset Approach

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

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Projected Individual Asset Approach

• Inventories
• use inventory turnover
• Sales/Inventory turnover Ave. inventories
• 2Ave. Inv - Beg. Inv. Ending Inv
• Smooth the sawtooth problem using compound growth
  
• (Ending Inv/Beg. Inv) 1/5

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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

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Projected Individual Asset Approach

• If common size Financial Statement indicate
• Cash and Marketable Securities
• 10 of Assets
• (ARInvOther current assetsPPEother
  assets)/90 Total assets
• Total assets percentage cash cash
• Total assets percentage marketable securities
  marketable securities

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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

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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

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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

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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

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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

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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

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Project Income Tax Expense

• Income Taxes
• use effective tax rate

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Project Retained Earnings

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

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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

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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

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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

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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