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Pro Forma Financial Statements

Dr. Nancy Mangold


California State University, East Bay

Preparing Pro Forma Financial


Statements Step 1
Project Operating Revenue

Sales revenue
Other revenue

Preparing Pro Forma Financial


Statements Step 2
Projecting Operating Expenses

Cost of Goods Sold


Selling and Administrative Expenses
Net Income Before Interest and Taxes

Preparing Pro Forma Financial


Statements Step 3
Project Assets

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

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

Preparing Pro Forma Financial


Statements Step 5
Project Retained Earnings

Retained Earnings

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

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

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

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

Projecting Other Revenues


Use historical percentage of sales

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

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

EXHIBIT 10.2
Pro Forma Statement of Income and Retained Earnings for Coke
(amounts in millions)
Year 8
Year 9
Year 10 Year 11 Year 12
Projected Projected Projected Projected Projected
Sales
$19, 659 $20, 839 $22, 089 $23, 414 $24, 819
Other Revenues
590
625
663
702
745
Cost of Goods Sold
(7, 077)
(7, 502) (7, 952)
(8, 429) (8, 935)
Selling and Administrative
(7, 864)
(8, 335) (8, 836)
(9, 366) (9, 928)
Interest Expense
(325)
(403)
(494)
(599)
(716)
Net Income before Income Taxes
$4, 983
$5, 223 $5, 470
$5, 723 $5, 985
Income Tax Expense
1, 545
1, 619
1, 696
1, 774
1, 855
Net Income
$3, 438
$3, 604 $3, 774
$3, 949 $4, 130
Dividends
(1, 397)
(1, 564) (1, 752)
(1, 962) (2, 198)
Change in Retained Earnings
$2, 041
$2, 040 $2, 022
$1, 987 $1, 932

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

Project the Assets on the Balance


Sheet
Projected Total Assets Approach
Use historical growth rate in assets

compound annual growth rate over five years

Year 7 Actual Assets


Year 8 Projected Assets
Year 9 Projected Assets
Year 10 Projected Assets
Year 11 Projected Assets
Year 12 Projected Assets

Amount
$16,161
$17,729
$19,448
$21,335
$23,404
$25,674

Percentage Change

9.7%
9.7%
9.7%
9.7%
9.7%

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

Total Assets

Sales

Year 8 Projected Assets


Year 9 Projected Assets
Year 10 Projected Assets
Year 11 Projected Assets
Year 12 Projected Assets

$19, 659
$20, 839
$22, 089
$23, 414
$24, 819

Total Average
Assets Total Beginning End of
Turnover Assets of Year Year

1. 2
1. 2
1. 2
1. 2
1. 2

$16,383
$17,365
$18,407
$19,512
$20,683

$16,161
$16,604
$18,216
$18,689
$20,334

$16,604
$18,216
$18,689
$20,334
$21,031

Project Assets on Balance Sheet


May create sawtooth problem

Illustration of Difficulty Sometimes Encountered


When Projecting Total Assets Using Assets Turnover
Sales

Dollars

Assets

Year

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)

Year 7
Year 8
Year 9
Year 10
Year 11
Year 12

Year-End Percentage Year-End Percentage


Assets Increase Assets Increase
$16,161 7.40% $16,161
$16,604 2.70% $17,035 5.41%
$18,216 9.20% $17,957 5.41%
$18,689 3.10% $18,928 5.41%
$20,334 8.80% $19,952 5.41%
$21,031 3.40% $21,031 5.41%

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

Year 7 Actual
Year 8 Projected
Year 9 Projected
Year 10 Projected
Year 11 Projected
Year 12 Projected

Sales
$18,546
$19,659
$20,839
$22,089
$23,414
$24,819

Total
Assets
1.15
1.15
1.15
1.15
1.15
1.15

Year-End Percentage
Assets Increase
$16,161
$17,095
6%
$18,120
6%
$19,208
6%
$20,360
6%
$21,582
6%

Project Assets on Balance Sheet


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

Pro Forma Balance Sheet for Coke


(amounts in millions)
Year 8
Year 9
Year 10
Projected
Projected Projected
Assets
Cash
Marketable Securities
Accounts Receivable
Inventories
Other Current Assets
Total Current Assets
Investments
Property, Plant, and Equipment (cost)
Accumulated Depreciation
Other Assets
Total Assets
Liabilities and Shareholders' Equity
Accounts Payable
Notes Payable
Current Maturities of Long-Term Debt
Other Current Liabilities
Total Current Liabilities
Long-term Debt
Deferred Income Taxes
Other Noncurrent Liabilities
Total Liabilities
Common Stock
Retained Earnings
Other Equity Adjustments
Treasury Stock
Total Shareholders' Equity
Total Liabilities and Shareholders' Equity

Year 11
Projected

Year 12
Projected

$1, 585
176
1, 768
1, 045
1, 759
$6, 333
6, 543
6, 188
( 2, 252)
798
$17, 610

$1, 732
192
1, 904
1, 148
1, 865
$6, 841
7, 197
6, 859
( 2, 496)
846
$19, 247

$1, 894
210
2, 051
1, 261
1, 976
$7, 392
7, 917
7, 604
( 2, 767)
897
$21, 043

$2, 071
230
2, 210
1, 384
2, 095
$7, 990
8, 708
8, 430
( 3, 068)
951
$23, 011

$2, 265
252
2, 380
1, 520
2, 220
$8, 637
9, 579
9, 346
( 3, 401)
1, 008
$25, 169

$3, 125
4, 288
9
1, 099
8, 521
1, 233
319
1, 253

$3, 285
5, 115
422
1, 165
9, 987
1, 347
338
1, 329

$3, 454
7, 015
16
1, 235
11, 720
1, 473
358
1, 408

$3, 632
8, 470
257
1, 310
13, 669
1, 611
380
1, 492

$3, 819
10, 563
2
1, 387
15, 771
1, 762
403
1, 582

$11, 326
$2, 203
17, 169
( 601)
( 12, 487)
$6, 284
$17, 610

$13, 001
$2, 534
19, 209
( 637)
( 14, 860)
$6, 246
$19, 247

$14, 959
$2, 914
21, 231
( 675)
( 17, 386)
$6, 084
$21, 043

$17, 152
$3, 351
23, 218
( 716)
( 19, 994)
$5, 859
$23, 011

$19, 518
$3, 854
25, 149
( 759)
( 22, 593)
$5, 651
$25, 169

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

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

Projected Individual Asset


Approach
Accounts Receivable

Use receivables turnover


Sales/Receivables turnover = Ave. accounts
receivable
2*Ave. AR - beg. AR = ending AR
smooth the Sawtooth problem using compound
growth rate
(Ending AR/Beg. AR) ** 1/5

Accounts
Year 8 Projected
Year 9 Projected
Year 10 Projected
Year 11 Projected
Year 12 Projected

Sales
$19,659
$20,839
$22,089
$23,414
$24,819

Average
Receivable Accounts
Turnover Receivable
11.1 $1,771
11.1 $1,877
11.1 $1,990
11.1 $2,109
11.1 $2,236

Accounts Receivable
Beginning End of
of Year Year
$1,641 $1,901
$1,901 $1,854
$1,854 $2,126
$2,126 $2,092
$2,092 $2,380

Year-End Accounts Receivable Percentage Increase


Year 7 Actual
Year 8 Projected
Year 9 Projected
Year 10 Projected
Year 11 Projected
Year 12 Projected

$1,641
$1,768
$1,904
$2,051
$2,210
$2,380

7.72%
7.72%
7.72%
7.72%
7.72%

Projected Individual Asset


Approach
Inventories

use inventory turnover


Sales/Inventory turnover = Ave. inventories
2*Ave. Inv - Beg. Inv. = Ending Inv
Smooth the sawtooth problem using compound
growth
(Ending Inv/Beg. Inv) ** 1/5

Year 8 Projected
Year 9 Projected
Year 10 Projected
Year 11 Projected
Year 12 Projected

Cost of Inventory Average Beginning End of


Goods Sold Turnover Inventories of Year Year
$7,077
6.5 $1,089 $952 $1,226
$7,502
$7,952
$8,429
$8,935

6.5
6.5
6.5
6.5

$1,154
$1,223
$1,297
$1,375

$1,226
$1,082
$1,365
$1,229

$1,082
$1,365
$1,229
$1,520

Year 7 Actual

Year-End Inventories
$952

Percentage Increase

Year 8 Projected

$1,045

9.81%

Year 9 Projected
Year 10 Projected
Year 11 Projected
Year 12 Projected

$1,148
$1,261
$1,384
$1,520

9.81%
9.81%
9.81%
9.81%

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

Projected Individual Asset


Approach
If common size Financial Statement indicate
Cash and Marketable Securities

10% of Assets

(AR+Inv+Other current assets+PPE+other


assets)/90% = Total assets
Total assets * percentage cash = cash
Total assets * percentage marketable securities =
marketable securities

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

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

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

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

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

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

Project Income Tax Expense


Income Taxes

use effective tax rate

Project Retained Earnings


Dividends

use compound annual dividend growth rate

Change in Retained Earnings

Beginning R/E + Net income - Dividends =


Ending Retained Earnings

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

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

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

EXHIBIT 10.5
Pro Forma Statement of Cash Flows for Coke
(amounts in millions)
Year 8
Year 9
Year 10 Year 11 Year 12
Projected Projected Projected Projected Projected
Operations
(1) Net Income
$3, 438
$3, 604
$3, 774
$3, 949
$4, 130
(2) Depreciation
221
244
271
300
334
(3) Other Addbacks (net)
55
58
62
65
69
(4) (Increase) in Accounts Receivable
( 127)
( 136)
( 147)
( 159)
( 170)
(5) (Increase) in Inventories
( 93)
( 103)
( 113)
( 123)
( 136)
(6) (Increase) in Prepayments
( 100)
( 106)
( 112)
( 119)
( 126)
(7) Increase in Accounts Payable
153
160
169
178
187
(8) Increase in Other Current Liabilities
63
67
70
75
78
Cash Flow from Operations
$3, 610
$3, 788
$3, 974
$4, 166
$4, 366
Investing
(9) Acquisition of Marketable Securities and Investments
(net) ( $671)
( $546)
( $738)
( $811)
( $892)
(10) Acquisition of Property, Plant, and Equipment ( 607)
( 671)
( 745)
( 825)
( 917)
(11) Other Investing Transactions
( 45)
( 48)
( 51)
( 55)
( 57)
Cash Flow from Investing
( $1, 198) ( $1, 390) ( $1, 534) ( $1, 691) ( $1, 866)
Financing
(12) Increase (Decrease) in Short-term Borrowing $900
$827
$1, 899
$1, 456
$2, 092
(13) Increase in Long-term Debt
117
528
( 280)
379
( 104)
(14) Increase in Common Stock
287
331
380
437
503
(15) Dividends
( 1, 397) ( 1, 564) ( 1, 752) ( 1, 962) ( 2, 198)
(16) Acquisition of Common Stock
( 2, 167) ( 2, 373) ( 2, 526) ( 2, 608) ( 2, 599)
Cash Flow from Financing
( $2, 260) ( $2, 251) ( $2, 279) ( $2, 298) ( $2, 306)
(17) Change in Cash
152
147
161
177
194
Cash-Beginning of Year
1, 433
1, 585
1, 732
1, 894
2, 071
Cash-End of Year
$1, 585
$1, 732
$1, 893
$2, 071
$2, 265

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