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 ASSETS Cash Inventory 175500 146890 4 37 29 23 189540 2025270 1573441 1247670 5035921 5 11 negotiated negotiated negotiated negotiated 297000 605394 1052060 1000000 225000 300000 1556467 5035921 .02 .08 .50 5011766 Accounts Receivable 1875250 Plant and Equipment 1155250 Total Assets 4662890 Liabilities & Capital Accruals Accounts Payable Notes Payable [current] Preferred Stock Common Stock 275000 560550 800000 225000 300000 %of Sales 1997 Forecast

Mortgage Bonds 1000000

Retained Earnings 1502340 from income statement Total Lia. & capital 4662890 Other Data for Planning Net profit margin on sales Rate of growth in Sales Dividend Payout ratio 1996 Sales

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.