Constructing Pro Forma Statements

Pro forma, or projected, financial statements enable

a firm to estimate its future level of receivables,
inventory, payables, as well as its anticipated profits
and borrowing requirements.
These statements are often required by bankers and
other lenders as a guide for the future.
A systems approach to develop pro forma
statements consists of:
Constructing income statement based on sales
projections and the production plan
Translating it into a cash budget
Assimilating all materials into a pro forma balance sheet
4-1

Development of
Pro Forma Statements

4-2

Pro Forma Income Statement

Provides a projection on the anticipation of
profits over a subsequent period
Four important steps include:
Establishing a sales projection
Determining production schedule and the associated use
of new material, direct labor, and overhead to arrive at
gross profit
Computing other expenses
Determining profit by completing actual pro forma
statement
4-3

Establish a Sales Projection

Let us assume Goldman Corporation has two primary
products: wheels and casters
Table 4-1

4-4

Determine a Production Schedule

and the Gross Profit
Number of units produced will depend on:
Beginning inventory
Sales projections
Desired ending inventory

To determine the production requirements:

Units
+ Projected sales
+ Desired ending inventory
Beginning inventory
= Production requirements
4-5

Stock of Beginning Inventory

Goldman Corporation has in stock the
items shown in the Table below:
Table 4-2

4-6

Production Requirements
for Six Months
Table 4-3

4-7

Unit Costs
Cost to produce each unit:
Table 4-4

4-8

Total Production Costs

Table 4-5

4-9

Cost of Goods Sold

Costs associated with units sold during the
time period
Assumptions for the illustration:
FIFO accounting is used
First allocates the cost of current sales to beginning
inventory
Then to goods manufactured during the period

4-10

Allocation of Manufacturing Cost

and Determination of Gross Profits
Table 4-6

4-11

Value of Ending Inventory

Table 4-7

4-12

Other Expense Items

Must be subtracted from gross profits to
arrive at net profit
Earning before taxes
General and administrative expenses, and interest
expenses are subtracted from gross profit

Aftertax income
Taxes are deducted from the earning before taxes

Contribution to retained earnings

Dividends are deducted from the aftertax income
4-13

Actual Pro Forma Income Statement

Table 4-8

4-14

Cash Budget
Pro forma income statement must be
translated into cash flows
The long-term pro forma is divided into smaller
More precise time frames set to help anticipate
patterns of cash inflows and outflows

4-15

Monthly Sales Pattern

Table 4-9

4-16

Cash Receipts
In the case of Goldman Corporation:
The pro forma income statement is taken for the
first half year:
Sales are divided into monthly projections

A careful analysis of past sales and collection

records show:
20% of sales is collected in the month
80% in the following month

4-17

Monthly Cash Receipts

Table 4-10

4-18

Component Costs
of Manufactured Goods
Table 4-11

4-19

Cash Payments
Monthly costs associated with:
Inventory manufactured during the period
Material
Labor
Overhead

Disbursements for general and administrative

expenses
Interest payments, taxes, and dividends
Cash payments for new plant and equipment
4-20

Cash Payments (contd)

Assumptions for the next two tables:
Costs are incurred on an equal monthly basis
over a six-month period
Maintain production level to ensure maximum
efficiency though sales volume varies from
month to month
Payment for material, once a month after
purchases have been made

4-21

Average Monthly
Manufacturing Costs
Table 4-12

4-22

Summary of All
Monthly Cash Payments
Table 4-13

4-23

Actual Budget
(Monthly Cash Flow)
Difference between monthly receipts and
payments is the net cash flow for the month
Allows the firm to anticipate the need for funding
at the end of each month
Table 4-14

4-24

Cash Budget with Borrowing

and Repayment Provisions
Assumptions:
The firm wishes to maintain minimum cash balance
If the balance goes below the minimum, the firm will borrow
If the balance goes above the minimum, the firm will use the
excess to repay the loan
Table 4-15

4-25

Pro Forma Balance Sheet

Represents the cumulative changes over
time
Important to examine the prior periods balance
sheet
Some accounts will remain unchanged, while
others will take new values
Information is derived from the pro forma income
statement and cash budget

4-26

Development of a
Pro Forma Balance Sheet
Table 4-16

4-27

Development of a
Pro Forma Balance Sheet (contd)

4-28

Pro Forma Balance Sheet

4-29

Explanation of Pro Forma Balance

Sheet

Cash ( $5,000 )minimum cash balance as shown in Table 415

Marketable securities ( $3,200 )remains unchanged from prior
periods value in Table 416
Accounts receivable ( $16,000 )based on June sales of $20,000 in
Table 410 (80% of current month sales become accounts receivables)
Inventory ( $6,200 )ending inventory as shown in Table 47.
Plant and equipment ( $27,740+ $18,000) $45,740
Accounts payable ( $5,732 )based on June purchases in Table 413
Notes payable ( $5,884 )the amount that must be borrowed to
maintain the cash balance of $5,000, as shown in Table 415
Long-term debt ( $15,000 )remains unchanged from prior periods
value in Table 416
Common stock ( $10,500 )remains unchanged from prior periods
value in Table 416
Retained earnings ( $39,024 )initial value plus pro forma income
($20,500 + $18,524)
4-30

Analysis of Pro Forma Statement

The growth ($25,640) was financed by
accounts payable, notes payable, and profit
As reflected by the increase in retained earnings
Total assets (June 30, 2011)$76,140
Total assets (Dec 31, 2010).$50,500
Increase...$25,640

4-31

Percent-of-Sales Method
Based on the assumption that:
Accounts on the balance sheet will maintain a
given percentage relationship to sales
Notes payable, common stock, and retained
earnings do not maintain a direct relationship
with sales volume
Hence percentages are not computed

4-32

Balance Sheet
of Howard Corporation

4-33

Percent-of-Sales Method (contd)

Funds required is ascertained
Financing is planned based on:
Notes payable
Sale of common stock
Use of long-term debt

4-34

Percent-of-Sales Method (contd)

Company operating at full capacity needs to buy new
plant and equipment to produce more goods to sell:
Required new funds:
(RNF) = A (S) L (S) PS2(1 D)
S
S
Where: A/S = Percentage relationship of variable assets to sales;
S = Change in sales; L/S = Percentage relationship of variable
liabilities to sales; P = Profit margin; S 2 = New sales level; D =
Dividend payout ratio
RNF = 60% ($100,000) 25% ($100,000) 6% ($300,000) (1 .50)
= $60,000 - $25000 - $18,000 (.50)
= $35,000 - $9000
= $26,000 required sources of new funds
4-35

Percent-of-Sales Method (contd)

Company not operating at full capacity - needs to add more
current assets to increase sales:
RNF = 35% ($100,000) 25% ($100,000) 6% ($300,000) (1 .50)
= $35,000 - $25,000 - $18,000 (.50)
= $35,000 - $25,000 - $9,000
= $1,000 required sources of new funds

4-36