Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Financial Statement Analysis K R Subramanyam John J Wild

9-2 9 CHAPTER Prospective Analysis

9-3 To forecast financial statements’ items and identify the need for an additional financing fund. –Management: forecasts of financial performance examine the viability of companies’ strategic plans; be active in a financing plan. –Creditors & investors: useful to assess a company’s ability to meet debt service requirements; useful for valuing the firm. Importance

9-4 Forecast Sales Project Income statement Project Balance sheet & the need for extra financing fund Project Statement of cash flows Projection Process

9-5 Forecast sales Sales forecasts are a function of: 1) Historical trends 2) Expected level of macroeconomic activity 3) The competitive landscape 4) New versus old store mix

9-6 Target Corporation Income Statements

9-7 Target Corporation Balance Sheet

9-8 Project Income statement Steps: 1.Project cost of goods sold and gross profit margins using historical averages as a percent of sales 2.Project SG&A expenses using historical averages as a percent of sales 3.Project depreciation expense as an historical average percentage of beginning-of-year depreciable assets 4.Project interest expense as a percent of beginning-of- year interest-bearing debt using existing rates if fixed and projected rates if variable 5.Project tax expense as an average of historical tax expense to pre-tax income

9-9 Project Income Statement

9-10 Target Corporation Projected Income Statement

9-11 Project Balance Sheet Steps: 1.Project current assets other than cash, using projected sales or cost of goods sold and appropriate turnover ratios. 2.Project PP&E increases with capital expenditures estimate derived from historical trends or information obtained in the MD&A section of the annual report. 3.Project current liabilities other than debt, using projected sales or cost of goods sold and appropriate turnover ratios. 4.Obtain current maturities of long-term debt from the long-term debt footnote.

9-12 Project Balance Sheet Notes to Financial Statements 2005: A current portion of long-term debt for 2006 is $751 mil.

9-13 Target Corporation Balance Sheet

9-14 Project Balance Sheet The difference between total projected assets and total projected liabilities & equity will increase in cash balance. If cash balance is too high (in percentage of sales): –Invest excess cash in marketable securities. –Reduce long-term debts. If cash balance is too low: –Increase additional long-term debt and/or common stock.

9-15 Project Statement of Cash Flows Use indirect method Prepared from: –Projected Balance sheet –Projected Income statement

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