34 profit planning pro forma statements pro forma

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Unformatted text preview: Whereas cash planning focuses on forecasting cash flows, profit planning relies on accrual concepts to project the firm’s profit and overall financial position. Shareholders, creditors, and the firm’s management pay close attention to the pro forma statements, which are projected, or forecast, income statements and bal- CHAPTER 3 Hint A key point in understanding pro forma statements is that they reflect the goals and objectives of the firm for the planning period. In order for these goals and objectives to be achieved, operational plans will have to be developed. Financial plans can be realized only if the correct actions are implemented. Cash Flow and Financial Planning 119 ance sheets. The basic steps in the short-term financial planning process were shown in the flow diagram of Figure 3.2. Various approaches for estimating the pro forma statements are based on the belief that the financial relationships reflected in the firm’s past financial statements will not change in the coming period. The commonly used simplified approaches are presented in subsequent discussions. Two inputs are required for preparing pro forma statements: (1) financial statements for the preceding year and (2) the sales forecast for the coming year. A variety of assumptions must also be made. The company that we will use to illustrate the simplified approaches to pro forma preparation is Vectra Manufacturing, which manufactures and sells one product. It has two basic product models—X and Y—which are produced by the same process but require different amounts of raw material and labor. Preceding Year’s Financial Statements The income statement for the firm’s 2003 operations is given in Table 3.12. It indicates that Vectra had sales of $100,000, total cost of goods sold of $80,000, net profits before taxes of $9,000, and net profits after taxes of $7,650. The firm paid $4,000 in cash dividends, leaving $3,650 to be transferred to retained earnings. The firm’s balance sheet for 2003 is given in Table 3.13. TABLE 3.12 Vectra Manufacturing’s Income Statement for the Year Ended December 31, 2003 Sales revenue Model X (1,000 units at $20/unit) $20,000 Model Y (2,000 units at $40/unit) 80,000 Total sales $100,000 Less: Cost of goods sold Labor $28,500 Material A 8,000 Material B 5,500 Overhead 38,000 Total cost of goods sold Gross profits Less: Operating expenses Operating profits 10,000 $ 10,000 Less: Interest expense Net profits before taxes Less: Taxes (0.15 80,000 $ 20,000 $9,000) Net profits after taxes Less: Common stock dividends To retained earnings 1,000 $ 9,000 1,350 $ 7,650 4,000 $ 3,650 120 PART 1 Introduction to Managerial Finance TABLE 3.13 Vectra Manufacturing’s Balance Sheet, December 31, 2003 Assets Liabilities and Stockholders’ Equity Cash $ 6,000 Marketable securities Accounts payable $ 7,000 4,000 Total current assets Notes payable 8,300 16,000 Inventories 300 13,000 Accounts receivable Taxes payable Other current liabilities $39,000 Total current liabilities Net fixed assets $51,000 Long-term debt Total assets $90,000 3,400 $19,000 Stockholders’ equity $18,000 Common stock $30,000 Retained earnings $23,000 Total liabilities and stockholders’ equity $90,000 Sales Forecast Just as for the cash budget, the key input for pro forma statements is the sales forecast. Vectra Manufacturing’s sales forecast for the coming year, based on both external and internal data, is presented in Table 3.14. The unit sale prices of the products reflect an increase from $20 to $25 for model X and from $40 to $50 for model Y. These increases are necessary to cover anticipated increases in costs. Review Question 3–13 What is the purpose of pro forma statements? What inputs are required for preparing them using the simplified approaches? TABLE 3.14 2004 Sales Forecast for Vectra Manufacturing Unit sales Model X 1,500 Model Y 1,950 Dollar sales Model X ($25/unit) Model Y ($50/unit) Total $ 37,500 97,500 $135,000 CHAPTER 3 LG5 Cash Flow and Financial Planning 121 3.5 Preparing the Pro Forma Income Statement percent-of-sales method A simple method for developing the pro forma income statement; it forecasts sales and then expresses the various income statement items as percentages of projected sales. A simple method for developing a pro forma income statement is the percent-ofsales method. It forecasts sales and then expresses the various income statement items as percentages of projected sales. The percentages used are likely to be the percentages of sales for those items in the previous year. By using dollar values taken from Vectra’s 2003 income statement (Table 3.12), we find that these percentages are Cost of goods sold Sales $80,000 $100,000 80.0% Operating expenses Sales $10,000 $100,000 10.0% Interest expense Sales $1,000 $100,000 1.0% Applying these percentages to the firm’s forecast sales of $135,000 (developed in Table 3.14), we get the 2004 pro forma income statement shown in Table 3.15. We have assumed that Vectra will pay $4,000 in common stock dividends, so the expected contribution to...
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