1 of 38 ©2012 McGraw-Hill Ryerson Limited

Learning Objectives

1. Explain why financial forecasting is essential for the healthy growth of the firm. (LO1)

2. Prepare the four financial statements for forecasting. (LO2)

i. The pro forma income statementii. The pro forma statement of retained earningsiii. The cash budgetiv. The pro forma balance sheet

3. Perform the specific accounts method and the percent-of-sales method for forecasting on a less precise basis. (LO3)

2 of 38 ©2012 McGraw-Hill Ryerson Limited

Pro Forma Income Statement

• Provides a projection of how much profit the firm anticipates making over the ensuing time period

• Involves the following 4 steps:1. establishing a sales projection2. determining a production (or purchase)

schedule and the associated use of new material, direct labor and overhead to arrive at gross profit

3. computing other expenses4. determining the profit

LO3

3 of 38 ©2012 McGraw-Hill Ryerson Limited

Basis for Sales Projections

External Factors• Recession or boom?• Export sales?• Consumer spending?• Competition?• New technology?• etc.

Internal Factors• New product lines?• Turnover in people?• Profit targets?• Employee training?• Price changes?• etc.

LO3

4 of 38 ©2012 McGraw-Hill Ryerson Limited

Table 4-1Projected wheel and caster sales (first six months, 2012)

LO3

5 of 38 ©2012 McGraw-Hill Ryerson Limited

Table 4-2Stock of beginning inventory

LO3

6 of 38 ©2012 McGraw-Hill Ryerson Limited

Production (or Purchases) Schedule

Projected sales (in Units or $)

PLUS

Desired ending inventory

MINUS

Beginning inventory

EQUALS

Production (or Purchases)

LO3

7 of 38 ©2012 McGraw-Hill Ryerson Limited

Table 4-3Productionrequirements for sixmonths

LO3

8 of 38 ©2012 McGraw-Hill Ryerson Limited

Table 4-4Unit costs

LO3

9 of 38 ©2012 McGraw-Hill Ryerson Limited

Table 4-5Total production costs

LO3

10 of 38 ©2012 McGraw-Hill Ryerson Limited

Table 4-6Allocation of manufacturing costand determination of gross profits

LO3

11 of 38 ©2012 McGraw-Hill Ryerson Limited

Table 4-7Value of endinginventory

LO3

12 of 38 ©2012 McGraw-Hill Ryerson Limited

Pro Forma Balance Sheet

• Shows the anticipated cumulative changes in a firm’s asset holdings and liabilities and equity account over the next time period

• Is constructed from the prior period’s balance sheet and pro forma income statement and the cash budget

LO3

13 of 38 ©2012 McGraw-Hill Ryerson Limited

Figure 4-2Development of a pro formabalance sheet

LO3

14 of 38 ©2012 McGraw-Hill Ryerson Limited

Table 4-17Pro Forma Balance Sheet (ASPE format)

Pro Forma Balance SheetJune 30, 2013

AssetsCurrent assets:

1. Cash . . . . . . . . . . . . $ 5,0002. Marketable securities . . . . . . .3,2003. Accounts receivable. . . . . . . .16,0004. Inventory . . . . . . . . . . .6,200Total current assets . . . . . .30,400

5. Plant and equipment . . . . . . .45,740Total assets . . . . . . . . . . .$76,140

Liabilities and Shareholders' Equity6. Accounts payable . . . . . . . .$ 5,7327. Notes payable . . . . . . . . .5,8848. Long-term debt . . . . . . . . .15,0009. Common stock . . . . . . . . .10,50010. Retained earnings . . . . . . . .39,024

Total liabilities and shareholders' equity . .$76,140

LO3

15 of 38 ©2012 McGraw-Hill Ryerson Limited

Percent-of-Sales Method

• A short-cut, less exact, easier method of determining financing needs (The “quick and dirty” approach)

• Assumes that B/S accounts will maintain a constant percentage relationship to sales

• More sales will mean more assets which will require more financing

• Can be summarized by using the Required New Funding formula

LO3

16 of 38 ©2012 McGraw-Hill Ryerson Limited

Table 4-18 Percent –of-sales table

LO3