Chapter 6 Essentials Flashcards
Focus of chapter 6
Projecting financial growth
How much a firm will generate in profits and how much financing the firm will require are projected on what
Pro Forma Financial Statements
External Funding Required =
Assets - Liabilities - Equity
Key variables in the pro forma income statements
Sales, COGS, Org. Costs, Depreciation expense, interest expense, taxes, dividends, change in RE
Common assumptions about sales in pro forma income statements
Management forecast growth rate applied
Common assumptions about COGS on pro forma income statement
Percentage of sales
Common assumption about organizational costs on pro forma income statement
Percentage of sales
Common assumption about depreciation expense on pro forma income statement
Percentage of fixed assets
Common assumption about interest expense on the pro forma income statement
Interest rate applied to interest bearing debt
Common assumption about taxes on the pro forma income statement
Tax rate applied to earnings before taxes
Common assumption made about dividends on pro forma income statement
Policy or payout rate
Common assumption about retained earnings made on the pro forma income statement
Pro forma net earnings les dividends
Calculating gross profit on a pro forma income statement =
Pro forma sales x gross margin percentage
For the pro forma income statement either COGS is given or it =
Beg. Inventory + Purchases - End Inventory
The typical expenses included on the pro forma income statement are
- selling, general, and admin
- depreciation expense
Key Variables on the Pro Forma Balance Sheet
Cash, AR, Inventory, Fixed Assets, Total Assets, Total Liabilities, Equity, Total Liabilities and Equity, AP, Long-Term Debt
Assumption made about cash on the pro forma balance sheet
Minimum balance required
Common assumption made about AR on the pro forma balance sheet
Collection period
Common assumption made about inventory on the pro forma balance sheet
Inventory period
Common assumption made about fixed assets on the pro forma balance sheet
Management forecast of new assets accounting for depreciation or as a fixed asset turnover ratio
Common assumption made about AP on the pro forma balance sheet
Payables period
Common assumption made about long-term debt on the pro forma balance sheet
Total liabilities less AP
AR is often given or found based on
Age of AR / Average Daily Sales
Ending fixed assets in the pro forma balance sheet =
Beg. Fixed assets + new fixed asset - depreciation
Total assets on the pro forma balance sheet is generated by
Cash + AR + Inventory + Fixed Assets
Pro forma equity on the pro forma balance sheet is generated by
Beg equity + NE - dividend payments
Pro forma accounts payable on the balance sheet is calculated by
Accounts payable / average daily purchases
An alternative and equivalent method of projecting future financial needs is to create this direct cash flow forecasting method often based on monthly cash flows
Prom Forma Cash Budget
Involves changing one variable in the pro forma statements to answer “what if?” Questions such as “what if sales were 10% lower than projected?
Sensitivity Analysis
Is similar to sensitivity analysis but involves changing several variables at one time
Scenario Analysis
Performing sensitivity rate is important because these three variables are critical to daily operations and success
Sales, Interest, Working Capital
The maximum rate at which revenues can grow without negatively impacting a firm’s financial resources
Sustainable Growth Rate
Sustainable Growth Rate Formula
Return on Equity X Retention Ratio
The fraction of net earnings available to common shareholders not paid out dividends and is also equal to 1 - the dividend payout ratio
Retention Ratio
If a firms is growing above its sustainable growth rate it must what?
Improve profit margin or generate more revenue
Pro forma statements answer 3 questions
1 how profitable do we expect to be
2 what is the anticipated financing amt
3 what is the right amount of sale growth
