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Unformatted text preview: no issues, retirements, or
repurchases of bonds or stocks are planned.
11. Retained earnings will increase from the beginning level of $23,000 (from the
balance sheet dated December 31, 2003, in Table 3.13) to $29,327. The
increase of $6,327 represents the amount of retained earnings calculated in
the year-end 2004 pro forma income statement in Table 3.15.
A 2004 pro forma balance sheet for Vectra Manufacturing based on these
assumptions is presented in Table 3.16. A “plug” figure—called the external fi11. The judgmental approach represents an improved version of the often discussed percent-of-sales approach to pro
forma balance sheet preparation. Because the judgmental approach requires only slightly more information and
should yield better estimates than the somewhat naive percent-of-sales approach, it is presented here. CHAPTER 3 TABLE 3.16 125 Cash Flow and Financial Planning A Pro Forma Balance Sheet, Using the Judgmental Approach,
for Vectra Manufacturing (December 31, 2004) Assets Liabilities and Stockholders’ Equity Cash $ 6,000 Marketable securities Accounts payable $ 8,100 4,000 Taxes payable 455 16,875 Accounts receivable Notes payable 8,300 Inventories Other current liabilities Raw materials $ 4,000 Finished goods Total current liabilities 12,000 Long-term debt
16,000 Total inventory
Total current assets 3,400
$ 18,000 Stockholders’ equity $ 42,875 Common stock $ 30,000 Net fixed assets $ 63,000 Retained earnings $ 29,327 Total assets $105,875 Total $ 97,582 External financing requireda $ 8,293 Total liabilities and
stockholders’ equity $105,875 aThe amount of external financing needed to force the firm’s balance sheet to balance. Because of the nature of the judgmental approach, the balance sheet is not expected to balance without some type of adjustment. nancing required—of $8,293 is needed to bring the statement into balance. This
means that the firm will have to obtain about $8,293 of additional external
financing to support the increased sales level of $135,000 for 2004.
A positive value for “external financing required,” like that shown in Table
3.16, means that to support the forecast level of operation, the firm must raise
funds externally using debt and/or equity financing or by reducing dividends.
Once the form of financing is determined, the pro forma balance sheet is modified
to replace “external financing required” with the planned increases in the debt
and/or equity accounts.
A negative value for “external financing required” indicates that the firm’s
forecast financing is in excess of its needs. In this case, funds are available for use
in repaying debt, repurchasing stock, or increasing dividends. Once the specific
actions are determined, “external financing required” is replaced in the pro
forma balance sheet with the planned reductions in the debt and/or equity
accounts. Obviously, besides being used to prepare the pro forma balance sheet,
the judgmental approach is also frequently used specifically to estimate the firm’s
financing requirements. Review Questions
3–17 Describe the judgmental approach for simplified preparation of the pro
forma balance sheet.
What is the significance of the “plug” figure, external financing required?
Differentiate between strategies associated with positive and with negative values for external financing required. 126 PART 1 Introduction to Managerial Finance LG6 3.7 Evaluation of Pro Forma Statements
It is difficult to forecast the many variables involved in preparing pro forma statements. As a result, investors, lenders, and managers frequently use the techniques
presented in this chapter to make rough estimates of pro forma financial statements. However, it is important to recognize the basic weaknesses of these simplified approaches. The weaknesses lie in two assumptions: (1) that the firm’s
past financial condition is an accurate indicator of its future, and (2) that certain
variables (such as cash, accounts receivable, and inventories) can be forced to
take on certain “desired” values. These assumptions cannot be justified solely on
the basis of their ability to simplify the calculations involved. However, despite
their weaknesses, the simplified approaches to pro forma statement preparation
are likely to remain popular because of their relative simplicity. Eventually, the
use of computers to streamline financial planning will become the norm.
However pro forma statements are prepared, analysts must understand how
to use them to make financial decisions. Both financial managers and lenders can
use pro forma statements to analyze the firm’s inflows and outflows of cash, as
well as its liquidity, activity, debt, profitability, and market value. Various ratios
can be calculated from the pro forma income statement and balance sheet to evaluate performance. Cash inflows and outflows can be evaluated by preparing a
pro forma statement of cash flows. After analyzing the pro forma statements, the
financial manager can take steps to adjust planned...
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