4-0 Financial Planning Model Ingredients 4.2 Sales Forecast – many cash flows depend directly on the level of sales (often estimated using a growth rate in sales) Pro Forma Statements – setting up the financial plan in the form of projected financial statements allows for consistency and ease of interpretation Asset Requirements – how much additional fixed assets will be required to meet sales projections LO3 © 2013 McGraw-Hill Ryerson Limited

4-1 Ingredients Continued Financial Requirements – how much financing will we need to pay for the required assets Plug Variable – management decision about what type of financing will be used (makes the Statement of Financial Position balance) Economic Assumptions – explicit assumptions about the coming economic environment LO3 © 2013 McGraw-Hill Ryerson Limited

4-2 Example 1 – Historical Financial Statements Gourmet Coffee Inc. Statement of Financial Position December 31, 2011 Assets1000Debt400 Equity600 Total1000Total1000 LO3 © 2013 McGraw-Hill Ryerson Limited

4-3 Example 1 continued – Historical Statement of Comprehensive Income Gourmet Coffee Inc. Statement of Comprehensive Income For Year Ended December 31, 2011 Revenues2000 Costs1600 Net Income400 LO3 © 2013 McGraw-Hill Ryerson Limited

4-4 Example 1 continued - Pro Forma Statement of Comp. Income Initial Assumptions Revenues will grow at 15% (2000*1.15) All items are tied directly to sales and the current relationships are optimal Consequently, all other items will also grow at 15% Gourmet Coffee Inc. Pro Forma Statement of Comprehensive Income For Year Ended 2012 Revenues2,300 Costs1,840 Net Income460 LO3 © 2013 McGraw-Hill Ryerson Limited

4-5 Example 1 continued - Pro Forma Statement of Financial Position Case I Dividends are the plug variable, so debt and equity increase at 15% Dividends = 460 NI – 90 increase in equity = 370 Gourmet Coffee Inc. Pro Forma Stmt. of Fin. Position Case 1 Assets1,150Debt460 Equity690 Total1,150Total1,150 LO3 © 2013 McGraw-Hill Ryerson Limited

4-6 Example 1 continued - Pro Forma Statement of Financial Position Case II Debt is the plug variable and no dividends are paid Debt = 1,150 – ( ) = 90 Repay 400 – 90 = 310 in debt Gourmet Coffee Inc. Pro Forma Stmt. of Fin. Position Case 1 Assets1,150Debt90 Equity1,060 Total1,150Total1,150 LO3 © 2013 McGraw-Hill Ryerson Limited

4-7 Percent of Sales Approach 4.3 Some items tend to vary directly with sales, while others do not Statement of Comprehensive Income Costs may vary directly with sales If this is the case, then the profit margin is constant Dividends are a management decision and generally do not vary directly with sales – this affects the retained earnings that go on the Statement of Financial Position LO3 © 2013 McGraw-Hill Ryerson Limited

4-8 Percentage of Sales Approach Continued Statement of Financial Position Initially assume that all assets, including fixed, vary directly with sales Accounts payable will also normally vary directly with sales Notes payable, long-term debt and equity generally do not vary with sales because they depend on management decisions about capital structure The change in the retained earnings portion of equity will come from the dividend decision LO3 © 2013 McGraw-Hill Ryerson Limited

4-9 Example 2 – Percentage of Sales Method Tasha’s Toy Emporium Statement of Comp. Income, 2011 % of Sales Sales5,000 Costs3,00060% EBT2,00040% Taxes (40%) 80016% Net Income1,20024% Dividends600 Add. To RE600 Tasha’s Toy Emporium Pro Forma Statement of Comp. Income, 2012 Sales5,500 Costs3,300 EBT2,200 Taxes880 Net Income1,320 Dividends660 Add. To RE660 Assume Sales grow at 10% Dividend Payout Rate = 50% LO3 © 2013 McGraw-Hill Ryerson Limited

4-10 Example 2 – Percentage of Sales Method continued Tasha’s Toy Emporium – Statement of Financial Position Current% of Sales Pro Forma Current% of Sales Pro Forma ASSETSLIABILITIES & OWNERS’ EQUITY Current AssetsCurrent Liabilities Cash$50010%$550 A/P$90018%$990 A/R2,000402,200N/P2,500n/a2,500 Inventory3,000603,300 Total3,400n/a3,490 Total5, ,050LT Debt2,000n/a2,000 Fixed AssetsOwners’ Equity Net PP&E4,000804,400 C Shares2,000n/a2,000 Total Assets9, ,450 RE2,100n/a2,760 Total4,100n/a4,760 Total L & OE9,50010,250 LO3 © 2013 McGraw-Hill Ryerson Limited