1. Pro Forma Financial Statements
Dr. Nancy Mangold
California State University, East Bay

2. Preparing Pro Forma Financial Statements – Step 1
Project Operating Revenue
Sales revenue
Other revenue

3. Preparing Pro Forma Financial Statements – Step 2
Projecting Operating Expenses
Cost of Goods Sold
Selling and Administrative Expenses
Net Income Before Interest and Taxes

4. Preparing Pro Forma Financial Statements – Step 3
Project Assets
Cash
Accounts Receivable
Inventories
Other Current Assets
Investments
Fixed Assets
Other Assets

5. 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

6. Preparing Pro Forma Financial Statements – Step 5
Project Retained Earnings
Retained Earnings

7. 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

8. 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

9. 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

10. 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

11. Projecting Other Revenues
Use historical percentage of sales

12. 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

13. 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

15. 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

16. Project the Assets on the Balance Sheet
Projected Total Assets Approach
Use historical growth rate in assets
compound annual growth rate over five years

18. 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

20. Project Assets on Balance Sheet
May create sawtooth problem

21. Illustration of Difficulty Sometimes Encountered When Projecting Total Assets Using Assets Turnover
Sales
Assets
Dollars 1 2 3 4
Year

22. 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)

24. 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

26. Project Assets on Balance Sheet
Use common size balance sheet percentages to allocate the total assets to individual assets

28. 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

29. 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

30. 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

33. 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

36. 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

37. 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

38. 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

39. 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

40. 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

41. 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

42. 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

43. 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

44. Project Income Tax Expense
Income Taxes
use effective tax rate

45. Project Retained Earnings
Dividends
use compound annual dividend growth rate
Change in Retained Earnings
Beginning R/E + Net income - Dividends = Ending Retained Earnings

46. 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

47. 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

48. 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

50. 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