Example: Pro Forma Income Statement

2011

Forecast
Revenue Growth Rate (Sales Growth)
Total Operating Cost /Sales
Depreciation / Net PPE
Cash /Sales
Total Receivables, Net / Sales
Inventories/Sales
Net PPE /Sales
Acct. Pay. / Sales
Accrued Expenses /Sales
Tax rate
Weighted average cost of capital (WACC)

2012
10.72%
38.83%
13.05%
27.37%
10.52%
6.61%
31.94%
4.64%
2.25%
24.56%
5.25%

38.83%
13.05%
27.37%
10.52%
6.61%
31.94%
4.64%
2.25%
24.56%
5.25%

2013
10.72%
38.83%
13.05%
27.37%
10.52%
6.61%
31.94%
4.64%
2.25%
24.56%
5.25%

2014
10.72%
38.83%
13.05%
27.37%
10.52%
6.61%
31.94%
4.64%
2.25%
24.56%
5.25%

2015
10.72%
38.83%
13.05%
27.37%
10.52%
6.61%
31.94%
4.64%
2.25%
24.56%
5.25%

Partial Income Statement

Sales/Revenue
COGS excluding D&A
Depreciation & Amortization Expense
Total operating costs
Operating Income

$
$
$
$
$

Actual
2011
46.77
16.21
1.95
18.16
28.61

Projected Sales 2012 = 46.77 x (1+0.1072)

Projected COGS 2012 = 46.77 x 0.3883
Projected Depreciation = 46.77 x 0.1305

$
$
$
$
$

Projected
2012
51.8
20.1
2.2
22.3
29.5

Projected
2013
$
57.3
$
22.3
$
2.4
$
24.7
$
32.7

Projected
2014
$
63.5
$
24.6
$
2.6
$
27.3
$
36.2

Projected
2015
$
70.3
$
27.3
$
2.9
$
30.2
$
40.1

Numerical Example: Forecasting

Betty Simmons, the new financial manager of Southeast

Chemicals (SEC), a Georgia producer of specialized
chemicals for use in fruit orchards, must prepare a
financial forecast for 2011.
SEC's 2010 sales were $2 billion, and the marketing
department is forecasting a 25 percent increase for
2011.
Simmons thinks the company was operating at full
capacity in 2010, but she is not sure about this.
Assume that you were recently hired as Simmons'
assistant, and your first major task is to help her develop
the forecast.
The 2010 financial statements, plus some other data, are
as follows.

2010 Balance Sheet in millions of dollars

% of sales

Cash &
Securities

$ 20

1%

Accounts
Receivable
Inventory

240

12

240

12

Total Current
Assets
Net Fixed
Assets

Total Assets

$ 500
500

$1,000

25

% of sales
Accounts
Payable And
Accruals
Notes Payable

$ 100

Total Current
Liabilities
Long-Term
Debt
Common
Stock
Retained
Earnings
Total Liabilities
And Equity

$ 200

100

100
500
200
$1,000

5%

2010 Income Statement in millions of dollars

% of sales

Sales
Cost Of Goods Sold (COGS)
Sales, General, And
Administrative Costs
Earnings Before Interest
And Taxes
Interest
Earnings Before Taxes
Taxes
Net income
Dividends (40%)
Addition to Retained
Earnings

$2,000.00
1,200.00

60%

700.00

35%

$ 100.00

$
$

10.00
90.00
36.00
54.00
21.60

32.40

Key Ratios
SEC
Profit Margin
Return on Equity
Days Sales Outstanding
(365 days)
Inventory Turnover
Fixed Assets Turnover
Debt/Assets
Times Interest Earned
Current Ratio
Return on Investment
Capital
(NOPAT/Operating Capital)

2.70
7.71

Industry
4.00
15.60

43.80 Days

32.00 Days

8.33x
4.00
30.00%
10.00x
2.50

11.00x
5.00
36.00%
9.40x
3.00

6.67%

14.00%

Calculation of AFN

Assume

SEC was operating at full capacity in 2010 with respect to all

assets,
All assets must grow proportionally with sales,
Accounts payable and accruals will also grow in proportion to
sales, and
The 2010 profit margin and dividend payout will be maintained.

Under these conditions, what will the company's financial

requirements be for the coming year? Use the AFN equation
to answer this question.
=

0
0

1 1
0
0

Forecasted Income Statement

Estimate the 2011 financial requirements using the

forecasted financial statement approach.
Assume

Each type of asset, as well as payables, accruals, and fixed and

variable costs, will be the same percent of sales in 2011 as in
2010;
That the payout ratio is held constant at 40 percent;
External funds needed are financed 50 percent by notes
payable and 50 percent by long-term debt (no new common
stock will be issued);
All debt carries an interest rate of 10 percent; and
Interest expenses should be based on the balance of debt at the
beginning of the year.

Income Statement

(In Millions Of Dollars)

Actual

Sales
COGS

2010
$ 2,000.0
$ 1,200.0

SGA Expenses
EBIT

$
$

700.0
100.0

Less Interest
EBT

$
$

10.0
90.0

Taxes (40%)

Net Income
Dividends (40% of NI)
Add. To Retained
Earnings

Forecast
Forecast
Basis
% Of Sales

1.25
60.00%

% Of Sales

35.00%

Growth

2011
$ 2,500.0
$ 1,500.0
$
$

875.0
125.0
$

20.0
105.0

36.0

42.0

54.0

63.0

21.6

25.2

32.4

37.8

Interest Rate X Debt10

Balance Sheet
(In Millions Of Dollars)
2010 Forecast Basis
Cash

2011
Forecast

2011
Forecast

Without
AFN

With
AFN

AFN

Assets

$ 20.0 with
% Of Sales
$ 25.0
Balance Sheet Forecast
AFN 1.00%
and without
AFN$ 25.0

Accounts Receivable
Inventories
Total Current Assets

$240.0
$240.0
$500.0

% Of Sales
% Of Sales

12.00%
12.00%

$300.0
$300.0
$625.0

$300.0
$300.0
$625.0

Net Plant and Equipment

Total Assets
Liabilities and Equity

$500.0
$ 1,000.0

% Of Sales

25.00%

$625.0
$1,250.0

$625.0
$1,250.0

Accounts Payable & Accruals

Notes Payable

$100.0
$100.0

% Of Sales
Carry-Over

5.00%

Total Current Liabilities

Long-Term Bonds
Total Liabilities
Common Stock
Retained Earnings
Total Common Equity
Total Liabilities And Equity

$125.0
$100.0 $92.3

$125.0
$192.25

$200.0
$100.0 Carry-Over
$300.0
$500.0 Carry-Over
$200.0 RE10 + RE11

$225.0
$100.0 $92.3
$325.0
$500.0
$237.8

$317.25
$192.25
$509.55
$500.0
$237.8

$700.0

$737.8

$737.8

$1,000.0

$1,062.8

$1,247.3

Required Assets =

$1,247.3

Specified Sources of Financing =

$1,062.8

Additional Funds Needed (AFN)

$184.50

Forecasted ratios, FCF and ROIC

Calculate SEC's forecasted ratios, and compare them

with the company's 2010 ratios and with the industry
averages.
Calculate SEC's forecasted free cash flow and return on
invested capital (ROIC).

Formula

Actual Forecast
2010
2011 Industry

Net Income/Sales
Net Income/Beginning
Equity
Accounts Receivable /
(Annual Sales / 365
days)
Sales/Total Assets

2.70%

2.52%

4.00%

7.71%

8.54%

15.60%

43.80

43.80

32.00

8.33

8.33

11.00

Key Ratios
Profit Margin
ROE
DSO
Inventory Turnover
Fixed Asset Turnover
Debt/Assets
TIE
Current Ratio

Net Sales/Fixed
Assets

EBIT/Interest
Current Asset/Current
Liabilities

4.00
4.00
5.00
30.00% 40.98% 36.00%
10.00
6.25
9.40
2.50

1.96

3.00

FCF = NOPAT (Operating Capital2011 Operating

Capital2010)

Note

Operating Capital = Net Operating Working Capital + Net Fixed

Assets.
A negative free cash flow is not bad in itself.

If free cash flow is negative, it could be a sign that a company is

making large investments.
If these investments earn a high return, the strategy has the
potential to pay off in the long run.

The company's ROIC would then be:

ROIC = NOPAT / Capital