Building a Pro Forma Forecasting Spreadsheet in Excel
By Steven C. Isberg, Ph.D
January 2002
Introduction
As you have learned in this course, a financial statement forecast is usually based
on a set of forecast parameters that measure certain values as a percentage of sales and as
a percentage of other performance outcomes. In this model, the notion of such
parameters will be broadened to include other relationships that are used in forecasting,
for example, the fact that inventory is more closely associated with the cost of goods sold
as opposed to sales. What will be done in this exercise is twofold. First, we will build a
forecast of an income statement and partial balance sheet using these parametric
relationships; second, we will convert the forecast data into a net cash flow and discount
it to determine value of the entity for which the forecast is being made. In this case, the
entity is a company.
As you work through this exercise, it will be a good idea to print this document
and work through it with Excel open on your computer. This will give you step-by-step
instructions in building the spreadsheet. You can start by opening the Excel file named:
proformabuilding.xls.
Proformabuilding.xls
What you will see in this file are several rows and columns of information. The
first column provides the titles of balance sheet and income statement accounts. The
labels included in parentheses ( ), indicate what parameter is used to forecast values for
that account in the future. For example, when you look at row 17, accounts receivable,
you can see that the accounts receivable turnover will be used as a parameter to forecast
future account receivable balances. Column B provides the actual data for the year 2001,
and column C provides the values of the parameters to be used in the forecasts. Column
D repeats the information for 2001.
Parameters
Forecast parameters are usually determined by a combination of financial analysis
and the judgement of the financial analyst him or herself. They may be based on targets
set by the company in determining its strategy. In the next few steps, we’ll go through
each line and discuss the parametric relationships.
Sales
The parameter for forecasting sales is the sales growth rate. The growth rate is an
estimate based on all information available to the analyst. It is subjective in nature, but
may be based upon analysis of trends in the past. For this example, it is estimated to be
5%.
Gross Profit
The parameter used to forecast gross profit is the gross profit margin. It can be
determined based on past performance of the company or it can be subjectively set based
on a target or a value based on expected changes in the market for the product. In this
case, the 40% gross profit margin is based upon the most recent actual performance of the
company (gross margin = gross profit/sales = $60,000/$150,000 = 40%).
Cost of Goods Sold
Cost of goods sold is simply the difference between sales and gross profit, so we
don’t need a separate parameter to forecast it.
Operating Expenses
Operating expenses here are forecasted by relating them directly to sales. In this
case, it is assumed that operating expenses will be 15% of sales, as they were in the year
2001.
Depreciation Expense
Depreciation expense is driven by the value of the gross fixed assets and the
particular depreciation method being used. For the purposes of the simple forecast, we
will assume that depreciation expense in any given year will be 10% of the previous
year’s gross fixed assets. As you will see, this will help avoid a circularity problem in
Excel when we set up our forecast.
Net Operating Income
NOI is simply the difference between gross profit and the operating and
depreciation expense, so no parameter is needed.
Taxes
Taxes are based on a tax rate, which in this case is assumed to be 40% based on
the company’s tax paying position and situation.
Net Income
No parameter is needed because net income is simply EBIT less taxes.
Copyright © Steven C. Isberg- 2002-Page 2
Cash
Cash is typically forecasted as a percentage of sales. In this case, the parameter
for forecasting cash is going to be 2% of sales, which reflects the relationship for 2001.
Accounts Receivable
Accounts receivable are usually benchmarked and forecasted by an analysis of the
turnover or days sales outstanding. This is done because these are the two ratios used to
evaluate the accounts receivable management performance (you know this from the
chapter on financial ratios). The turnover is the simpler of the two to use, and in this
case, it is set to 10 times per year based on the 2001 performance.
Inventory
Like accounts receivable, inventory is benchmarked using either a turnover or
days cost (of good sold) outstanding. Rather than being linked to sales, inventory
turnover is more correctly related to cost of goods sold. The turnover parameter of four
(4) used in this example is again based on the company’s performance for 2001.
Gross Fixed Assets
Gross fixed assets are not usually related directly to sales on a year-to-year basis.
Rather, fixed asset investment decisions are made on a discretionary basis by
management, and may differ from year to year. For the purposes of this example, we are
going to assume that management will reinvest all depreciation PLUS and additional
$1,000 per year in additional capital expenditures.
Accumulated Depreciation
Accumulated depreciation for any given year is simply the sum of last year’s
accumulated depreciation and the current year’s depreciation expense.
Net Fixed Assets
As you well know, net fixed assets are the difference between gross fixed asets
and accumulated depreciation.
Accounts Payable
Like accounts receivable, accounts payable are usually benchmarked in a
financial analysis by a turnover or days cost (of good sold) outstanding. They are related
to cost of good sold since such purchases tend to be for inventory. The turnover ratio of
10 times per year is chosen here based on their recent performance.
Copyright © Steven C. Isberg- 2002-Page 3
Accruals
Accrued expenses or accruals, are created by things such as wages and salaries
payable, and are related to operating expenses. In this example, the forecast parameter of
10% of operating expense is based on the company’s performance for 2001.
From Parameters to Forecast
The actual balance sheet and income statement data are copied into column D to
make the actual forecasting calculations easier. The forecast begins with a sales forecast
and proceeds down the spreadsheet to calculate other values, many of which depend on
the sales forecast. As you work through this part of the exercise, you will be directed to
set up your forecast by creating formulas within the Excel spreadsheet. By the end of the
exercise, you should be able to create your own forecast from scratch (YES—believe
it!!). Begin by entering the label “2002E” into cell E2 (enter what is within the quotation
marks, not the quotation marks themselves). Be sure to properly format the cells where
you will be working to display currency values with no decimal places and dollar signs in
front. Also be sure to set it up so it displays negative values in parentheses. Use the
“FORMAT CELLS” option to do this.
Sales Forecast
The sales forecast for 2002 will be based on actual sales for 2001 and the
forecasted sales growth rate parameter. The mathematical relationship is:
Sales t = Sales t-1 * (1+ g).
In Excel you will input the following formula into cell E4, but before you put it in, read
past the next line:
=D4*(1+$C$4).
To put this formula into cell E4, let your mouse be of service to you by completing the
following steps:
1.
2.
3.
4.
5.
6.
type an “=” sign (do not type in the quotation marks, only what is within them)
Move your mouse and click on sales for 2001 in cell D4, notice that the reference
for cell D4 will now appear in the formula you are creating.
Type the “*” symbol.
Type in a left parentheses “(“
Type in “1 +”
Move your mouse and click on cell C4 (the 5% parameter) and then hit the F4
key. You will notice that when you hit the F4 key, a $ will appear in front of the
C and the 5. What this does is to “lock” that reference onto that cell, so when you
copy the formulas over to the next four years of the forecast, each formula will
refer back to that exact cell to find the growth rate. Otherwise, when you copy the
Copyright © Steven C. Isberg- 2002-Page 4
7.
8.
9.
formula over to the next column (i.e., the next year in the forecast) it will change
the cell reference from C5 to D5, which you don’t want to happen.
Type in a right parenthesis “)”
Hit “ENTER”
What should appear in cell E4 is the value $157,500 for sales for 2002E.
From now on, you will NOT be typing cell references into your Excel spreadsheet.
Whenever you want to refer to a value in a cell, you simply move your mouse to click on
the cell. Be sure that before you do this you have the proper mathematical or function
operator inputted. For example, I start every formula in Excel by typing in the “=.” This
tells Excel that you want to create a formula and it allows you to then point to a cell.
Likewise, I could point to cell C5 in the previous equation because I had inputted a “+”
before doing so.
Gross Profit Forecast
Gross profit will be 40% of sales. Example: Sales * GP%. In Excel, this will be
handled by a formula that multiplies sales for the year (found in E4) by the GP% found
in C6. This formula in cell E6 is:
=E4 * $C$6.
To write the formula, use the following steps:
1.
2.
3.
4.
5.
Type “=”
Move your mouse and click on cell E4
Type the “*” sign
Move your mouse and click on cell C6 and hit the F4 key
Hit “ENTER”
If you have done so correctly, you should have a value of $63,000 as a gross profit for
2002E.
Cost of Goods Sold
Cost of goods sold will be the difference between sales and gross profit. It should
appear as a negative value since it is a cost. You will enter the following formula in cell
E5:
=(E4-E6)*-1
Again, let your mouse do the work:
1.
2.
3.
Type “=(“
Move mouse and click on cell E4
Type “-“
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4.
5.
6.
Move mouse and click on cell E6
Type “)”
Hit enter.
The correct input will result in a value of ($94,500). You did not put $’s in front of either
the row or column references because as you copy that formula to the next year, you want
the formula to use sales and gross profits from that year to calculate cost of good sold for
that year. When you do copy that formula over into F5, it will appear as =(F4-F6)*-1.
From here on, you will not be prompted to let the mouse do the work of entering cell
references into formulae. If you want to take full advantage of Excel and work faster, it
is the only way to go!
Operating Expenses
Operating Expenses are 10% of the current year’s sales. To put this into a
formula in cell E7, you will need to multiply this year’s sales by 10% parameter found in
column C, and then by negative one to reflect is as an expense, as follows:
=E4*$C$7*-1.
The correct entry will yield a value of ($23,625), with the parentheses indicating a
negative value in Excel (if you have the cell formatted to show a negative dollar value in
parentheses instead of with a negative sign).
Depreciation Expense
As mentioned earlier, depreciation expense will be based on a straight-line
percentage and the gross fixed asset value for the previous year. In this case, what you
want to do for 2002 is to multiply the gross fixed asset value for 2001A by the
depreciation percentage of 10% in the parameters, as follows (input in cell E8):
=D21*$C$8 *-1.
Again, you multiply be negative one to convert the value to a negative number. The
correct value should be ($10,000).
Net Operating Income
The net operating income is simply the sum of the gross profit and the operating
and depreciation expenses. You can use a simple summation function because the
expenses have the proper negative signs. In Excel, you may either build a formula or use
the “SUM” function. To get an index of functions and how to use them, you can click on
the “function help” key in Excel, which is the fx icon in the toolbar. Your formula will
look like this in cell E9:
Copyright © Steven C. Isberg- 2002-Page 6
=SUM(E6:E8).
To enter this formula, do the following:
1.
2.
3.
4.
5.
6.
Type “=sum(“
Move your mouse to cell E6, click AND HOLD
Pull the mouse down to cell E8 while holding
Release the click
Type “)”
Hit ENTER
The value displayed should be $29,375.
Taxes and Net Income
Taxes are simply 40% of the net operating income, and net income is the
difference between NOI and taxes. You will need to input the following formulae. Be
sure to let the mouse do the work as often as possible.
In cell E10:
In cell E11:
=E9*$C$10*-1
=SUM(E9:E10)
You should get ($11,750) for taxes and $17,625 for net income.
The Balance Sheet
Cash
Cash is a simple percentage of sales. You have done formulae for percentages of
sales already (gross profits, operating expenses). See if you can figure this out and set it
up on your own. The correct answer for cash as 2% of sales is $3,150.
Accounts Receivable
Accounts receivable (A/R) are benchmarked using a turnover ratio. The turnover
ratio is typically calculated as follows:
A/RTO = Sales/ Accounts Receivable
In order to predict and accounts receivable balance given that you know sales, you simply
solve this equation for A/R, as follows:
A/R = Sales / A/RTO
The A/RTO is used as the parameter in cell C17, so you need the following formula in
cell E17:
Copyright © Steven C. Isberg- 2002-Page 7
=E4/$C$17.
The correct answer is $15,750.
Inventory
The inventory is usually benchmarked by inventory turnover or days cost in
inventory outstanding. In this case, the turnover measure is used in the same way as it is
used for accounts receivable, except that it is indexed against the cost of goods sold. The
formula for turnover is:
INVTO = Cost of Goods Sold/Inventory
Solving for inventory yields:
Inventory = Cost of Goods Sold / INVTO
You therefore need the following formula in cell E18:
=E5/$C$18*-1.
The negative one is needed to remove the negative sign from cost of sales. The correct
answer is $23,625.
Add the current asset items together using the “=sum” function in cell E19 to get the total
current assets of $42,525.
Gross Fixed Assets
In this model, gross fixed assets will increase as a result of two things:
reinvestment of depreciation expense and additional capital expenditures of $1,000 per
year. The additional capital expenditures are included in the parameters and show in cell
C21. For any given year, the gross fixed assets will be equal to last year’s balance plus
reinvested depreciation plus new capital expenditures. The formula needed in cell E21
will be:
=D21+$C$21+(E8*-1).
The negative one is needed to offset the negative sign on depreciation. The correct
answer should be $111,000.
Copyright © Steven C. Isberg- 2002-Page 8
Accumulated Depreciation
The accumulated depreciation for any given year will equal the accumulated
depreciation for the prior year plus depreciation expense for the current year. The
formula needed in cell E22 will therefore be:
=D22+E8
The correct answer for accumulated depreciation in 2002E will be ($30,000). Net fixed
assets are the sum of gross fixed assets and accumulated depreciation. User the “=sum”
function to enter that result into cell E23. Total assets are the sum of cells E19 and E23.
You can either write a mathematical formula or use the “=sum” function to get the result
of $123,525 for total assets in 2002E.
Accounts Payable and Accruals
Accounts payable are benchmarked with a turnover measure against cost of goods
sold. The formula should look a lot like the formula for inventory. See if you can come
up with it yourself. The accruals are a percentage of operating expenses. You can also
see if you can do this on your own. Remember to multiply be negative one in both cases
to offset the negative signs on cost of goods sold and operating expenses. The correct
answers are $9,450 for accounts payable and $2,363 for accruals. In the next row, add
these two together to obtain a result for total current liabilities ($11,813).
Long Term Liabilities
For the sake of simplicity in this problem, we will assume that long term
liabilities remain constant and that interest expense, if it exists, is included in operating
expenses. A future problem will challenge you to make adjustments for interest expense
at a later time. To keep long term liabilities constant, enter the formula =D34 in cell E34.
Net Worth
Net worth is composed of two elements. The first is common equity (at issue
value). This will change if additional equity is issued. Since this is a purely discretionary
decision on the part of the firm, it will remain constant. Follow the same logic that was
used to write the formula for long term liabilities to set up this part of the forecast.
Retained earnings represent an accumulation of net income that has not been paid
out as dividends. Retained earnings increases (or decreases) by the amount of net income
less any dividends paid. Hence, retained earnings for any given year is equal to the
balance from the prior year plus net income less any dividends paid. Since dividends will
not be paid in this example, the formula for calculating retained earnings, to be entered
into cell E40, is as follows:
=D40+E11.
Copyright © Steven C. Isberg- 2002-Page 9
The correct answer should be $74,375. Net worth is obtained by adding common equity
to retained earnings. Write the appropriate formula in cell E41 to obtain a value of
$84,375.
Available Capital (before plug) and the Plug
The amount of available capital, before the plug value, is equal to the total
liabilities and net worth shown on the forecasted balance sheet for the corresponding
year. The formula will add these values together in cell E43, as follows:
=sum(E36,E41).
This number may be more or less than total assets. If it is less than total assets, it means
that available capital is not sufficient to fund the assets required, and additional external
financing is required. If this amount is greater than assets required, it means that we have
a surplus of available capital, and no external funding is needed. In this case, the surplus
can be reinvested, used to pay debt or dividends, or used to repurchase debt or equity
securities in the open markets. The formula for the plug (cell E45) is:
=E25-E43.
The correct answer for Available Capital (before plug) is $138,688. For the plug, the
answer is ($15,163). This implies that the firm has excess capital given the forecast
parameters.
.
External Financing Needed
In the first year of the forecast, the plug and external financing needed are the
same value. The plug, however, is cumulative from one year to the next. Therefore,
from year-to-year, the EFN will actually be equal to the change in the plug from the prior
year. In order to calculate this result, input the following formula:
=E45-D45.
Completing the Five Year Forecast
Once your forecast is complete for 2002E, you can simply copy your formulae
over to the next four columns to forecast through the year 2006. To do so, highlight your
column with the mouse, click and hold on the square at the lower right corner of the
shaded area and move the mouse over four columns. When you have those four columns
shaded, release the click and your forecast will be complete for five years. The resulting
numbers are shown in the file proformabuildnum.xls.
Copyright © Steven C. Isberg- 2002-Page 10