Financial Forecasting and Pro-Forma Statements

 

These pages are designed for students in Intro to Finance and other elementary Finance courses.

 

These pages are not meant to replace your textbook. They are provided as an adjunct to help you with practical problems and assignments.

The format of the balance sheet and income statement can be used as a format for planning the next period. This form of planning is called Pro-Forma financial statements. It can be as simple or complex as the situation and time warrants. The simplest format is the best to start the analysis. More omplications can be added later to better simulate the real situation.

The Percent of sales method

This method simply takes the last available year and uses the balance sheet and income statement to forecast next year by assuming that most items on the statements will have to go up if sales go up.

Big assumption! The company is efficiently run and has just the ideal amount of assets and liabilities for the existing situation. This assumption will have to be faced later. Keep it in mind for now.

Some liability and equity accounts can be tapped by the financial manager for any external financing needed. This is called negotiated sources. It is the amount that you plug in somewhere to make the balancesheet balance. The accounts that will go up with sales are called spontaneous.

The % of sales column is calculated based on 1996 account proportions to sales. Multiply the Percentage by the forecasted 1997 sales.

The 1997 Sales = 1 + the sales growth rate times 1996 Sales.

External Financing Needed

External financing needed is equal to the amount of extra money needed because assets increase minus the money provided by increased liabilities and minus the amount of increase in retained earnings for 1997 minus less any dividends paid.

EFN= (SalesInc X Asset%) -( SalesInc X Liability%) -( Net Profit -Dividends)

EFN= (5011766 X .08) X .93)) - (5011766 X .08) X .17) - (5412707 X .02 X .5)= 252060

Using the values in the table below may differ a little because of rounding in the % of Sales shown.

Balance Sheet
	12-31-96	%of Sales	1997 Forecast
ASSETS
Cash	175500	4	189540
Accounts Receivable	1875250	37	2025270
Inventory	146890	29	1573441
Plant and Equipment	1155250	23	1247670
Total Assets	4662890		5035921
Liabilities & Capital
Accruals	275000	5	297000
Accounts Payable	560550	11	605394
Notes Payable [current]	800000	negotiated	1052060
Mortgage Bonds	1000000	negotiated	1000000
Preferred Stock	225000	negotiated	225000
Common Stock	300000	negotiated	300000
Retained Earnings	1502340	from income statement	1556467
Total Lia. & capital	4662890		5035921

Other Data for Planning
Net profit margin on sales	.02
Rate of growth in Sales	.08
Dividend Payout ratio	.50
1996 Sales	5011766
Assume all external financing needed is secured by new notes payable

Notice that the retained earnings go up by the amount of profit minus dividends and that the EFN was added to the Notes Payable ,plugged. The balance sheet balances !

If the Financial manager is unable to get this full amount of financing somewhere the company will run out of money or inventory and be unable to make the projected sales growth.

Once this simple method is used to forecast each balance sheet item the same process can be used for the income statement. More realistic estimates will probably have to be substituted for Plant and Equipment increases as they tend to be lumpy and not really just a percentage of sales. For example, if there is excess manufacturing capacity, no increase in Plant and Equipment may be necessary and this would substantially reduce the EFN requirement.

from:http://academic.uofs.edu