Training Workshop II:
Doing Financial Forecast
for Business Plan Writing
Hong Kong
Social Enterprise Challenge
2012
Training Workshop II- Doing Financial Forecast
FINANCIAL REPORTING AND FINANCIAL STATEMENT
Financial reporting

To provide information about performance, financial position, changes
in financial position
Financial Statement

Income statement, balance sheet & cash flow statement

Cash flow projection for business project

And their inter-relationship
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Training Workshop II- Doing Financial Forecast
INCOME STATEMENT
Net income = Revenues – Expenses
Sample Income Statement for the period from 1 Jan 20x1 to 31 Dec 20x1
+/+/-
-
-
+/+/-
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Revenues (Sales)
Operating expenses
Depreciation
Other income
Unusual or infrequent items
------------------------------------EBIT
Interest expenses
--------------------------------------Pretax earning from continuing operation
Tax expenses
--------------------------------------Income from continuing operation
Income(loss) from Discontinued Operation (net of tax)
Extraordinary item (net of tax)
------------------------------------------Net income
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Training Workshop II- Doing Financial Forecast
BALANCE SHEET
A snapshot at the year-end (usually Dec 31) on the company’s worth.
ASSET
 A form of storing wealth

future economic benefits obtained or controlled by the company
Current Asset
Cash
Marketable securities
Account receivables
Inventories
Prepaid expenses
Long-term Asset
Property
Plant & Equipment
Intangibles
Goodwill
Current assets – are expected to be liquidated or used up within one year or
one operating cycle.
Cash
Short-term Certificate of Deposits (CD), high-quality
commercial paper, treasure bills (< 3mths).
Short-term
investment
(marketable
securities)
Stocks, bonds that are traded in a public market.
Easily convert to cash within one operating cycle
Usually have maturities >90 days
Account receivables
Sales on credit
To be collected in short-term
Uncollectible allowances will be made each year
Inventories
Goods to be sold within next year
Inventories include raw materials, partially finished products
to finished products
Prepaid expenses
Money paid in advance for services being used by the
company next year
e.g. insurance premiums, rental payments
Long-term assets
Have useful life of more than one year
To appropriately charge the company each year, such assets
are depreciated over their estimated lives.
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Training Workshop II- Doing Financial Forecast
LIABILITIES

A future sacrifices of benefits (expenses) of the company
Current liabilities
Accounts payable
Accrued expenses
Income tax payable
Short-term debt
Current portion of long-term debt
Long-term liabilities
Long-term debt
Lease obligations
Deferred tax liabilities
Accounts payable
Money need to be paid to suppliers soon
Accrued expenses
Expenses that have been allocated this
year but are payable next year.
e.g., accrued wages, accrued interest
Future outlay of cash
Current portion of long-term debt
GAAP requires that the principal portion
of long-term liabilities be classified as a
current liabilities
Income tax payable
Taxes are not due until after the year-end.
The company still records a liability for
tax in the current year-end, so that this
expenses is matched with the revenues it
earned this year
Product warranties
Warranties and guarantees offered by the
company.
Liabilities (commitments) sooner or later
to be satisfied.
A liability reserves has to be set up for
such allowances
Vacation liabilities or Contingent
liabilities
Long-term liabilities
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Not expected to be repaid within one year
Eg. Bonds payable, mortgages payable,
long lease obligations, unfunded pension,
deferred income tax liabilities
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Training Workshop II- Doing Financial Forecast
EQUITY
Equity is the residual interest in the net assets of a company that remains after
deducting its liabilities
Equity = Asset – Liabilities
1. Capital
2. Additional paid-in capital – proceeds from common stocks sales in
excess of par value (Share repurchases are represented in the contra
account treasury stock)
3. Retained earnings – cumulative net income that has not been
distributed as dividends
4. Other comprehensive income – changes due to currency translation,
minimum pension liability changes and unrealized gain/loss on
investments
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Training Workshop II- Doing Financial Forecast
Cash flow Statement



Operating activities
Investing activities
Financing activities
Classification
Descriptions
Operating Activities
Sales of goods to customers (R)
Costs of providing goods (X)
Income tax expenses (X)
Hold short-term assets (inventory) (A)(L)
Investing Activities
Purchase or sale of Assets (A)
Purchase or sale of equity & debt in other entities
(A)
Financing Activities
Issue or repurchase of firm’s stock or preferred
stock (E)
Issues or repay debt (L)
Pay dividend (E)
Assets (A), Liabilities (L), Equity (E), Revenues (R), Expenses (X)
Other information



Notes and supplementary schedules
MD&A
Auditor reports
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Training Workshop II- Doing Financial Forecast
ACCOUNTING PRINCIPLES
Matching principle and Accrual concept

Revenues are recognized when goods/services are performed. The
relevant expenses are then matched to those revenues recognized.

Due to the matching principle, some revenues are not recognized even
though the cash have been received. For example, the magazine
subscription fees received in advance for 3 years. You would recognize
the revenues over a 3-year period rather than record the money
received on day one.

On the other hand, some costs are not recognized even though the cash
have been paid. For example, prepayment of rent for next year.

Accrual concepts recognize revenues occurring at the time when an
economic exchange takes place, rather than at the time that cash is
received.
Prepaid expenses – an asset; cash decreases
Accrued expenses – a liability; while expenses (income statement) increase
Going concern assumption – the valuation of assets & liability on the
balance sheet assumes that the company is continuing its operation in future
Historical cost – the value of asset and liability is stated on the balance sheet
its costs on the date of acquisition.
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Training Workshop II- Doing Financial Forecast
FIVE STATEMENTS AND THEIR INTER-RELATIONSHIPS
1. Balance Sheet
2. Income Statement
The net income, after deducting any dividend paid to shareholders, will
be added to the equity section (as retained earnings) on the balance
sheet
3. Statement of Cash Flows
Cash receipts or payments during the period
Classified into a) operating, b) investing and c) financing activities
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Training Workshop II- Doing Financial Forecast
Basic Equation
Asset - Liability = Equity
Equity = contributed capital + retained earnings
Retained earnings (End) = Retained earnings (Beg) + Net Income – Dividend
Increases in Asset = Use of cash
Increase in Liability = Source of cash
△ in Asset & Liability = Net Cash Flow
△ Retained earnings = Net income – Dividend declared
Liab.
Asset
Equity
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Training Workshop II- Doing Financial Forecast
CHARACTERISTICS OF ACCOUNTING INFORMATION
1. Relevance
Relevant to decision-making
Timeliness, information losses its value rapidly in today’s financial
world
2. Reliability
Verifiable, such as historic cost accounting
Representational faithfulness
3. Consistency and Comparability (secondary qualities)
Same measurement methods across all accounting periods
Comparable to different firms or different periods
4. Materiality
Which data is important to be included in financial statements
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Training Workshop II- Doing Financial Forecast
INCOME STATEMENT
REVENUE RECOGNITION
To recognizes revenues in the income statement, two conditions
1. Completion of Earning Process
The company has provided all or virtually all the services, the
company transferred to the buyer the significant risks and rewards of
the ownership of goods
2. Assurance of Payment
The revenue and cost can be measured reliably
EXPENSES MATCHING

Match the revenues

Period cost – less directly match the timing of revenues such as
administrative cost

Depreciation
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Training Workshop II- Doing Financial Forecast
ANALYSIS OF CASH FLOW



Generate enough cash flow from operation to sustain the business
Enough cash to continue investing new assets
Highlight the needs for additional finance
Basic classifications
CFO + CFI + CFF = NCF
CFO – cash from operating activities, such as sale of goods & services,
payment paid or money received.
CFI – cash from investing activities, such as spending on a new machine,
building a new plant, sales of asset (fixed assets)
CFF – cash from financing activities, such as obtaining loan from banks
(creditors), raising money from shareholders, repaying outstanding loans,
paying dividends to shareholders

Cash is unable to be manipulate

The NCF (net cash flow) should reconciled with the beginning and
year-end amount of cash at hand shown on the balances sheet
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Training Workshop II- Doing Financial Forecast
BALANCE SHEET
INVENTORY VALUATION
Basic Equation
BI + P – COGS = EI
BI
= Beginning Inventory
P
= Purchase for the year
COGS = Cost of Goods Sold
EI
= Ending Inventory
Beginning Inventory (BI)
Purchase (P)
Available for sale
Ending Inventory (EI)
COGS
100 units
800 units
-------------------------900 units
(150 units)
--------------------------750 units
How to value the inventory at the year-end ?
Costs of inventory – includes purchasing, transport, inspecting, and
manufacturing overheads. Some costs known as period costs are expensed in
the period rather than report as part of inventory – such as selling costs,
storage costs, adm. overhead & abnormal waste of materials.
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Training Workshop II- Doing Financial Forecast
LONG-TERM ASSETS



Held for more than one operating cycle
Not for resale
All costs incurred until the asset is ready to be used must be capitalized
 Invoice price
 Sales tax
 Insurance
 Transportation
 Installation
Depreciation of Fixed Assets
1. Straight-line
2. Accelerated depreciation
a. Double declining balance
3. Unit-of-production
Straight-line Depreciation
A plant costs $12,000 to buy and is going to last for 4 years. The estimated
residual value is $2,000. Compute the depreciation charge for each year.
(Cost – RV) / Total Life
Yr
Income statement
Depreciation
Balance Sheet
Acc. Dep
NBV
1
2
3
4
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Training Workshop II- Doing Financial Forecast
CASH FLOW PROJECTION (CAPITAL BUDGETING)
Capital, like other resources, is valuable because its supply is limited.
Steps in Capital Budgeting
1.
2.
3.
4.
Generating ideas
Analyzing proposals
Planning the Budget
Monitoring and Auditing
Principles of Capital Budgeting
Only cash flow is used in evaluating projects, accounting income is needed to
adjust for the non-cash elements.
1. Sunk Cost is irrelevant
2. Opportunity cost is counted – for example, an idle land can be sold at
$300,000. If it is used to build a new factory, such cost should be
counted as part of the initial investment though the land was purchased
long-time ago.
3. Incremental cash flow is the cash flow resulted directly from the
decision to undertake the project.
4. Externality refers to the effect on other cash flow of the company.
Positive externality is the benefits that arise in other part of the
company by undertaking a project, e.g. to build a ferry pier for an
island where the company has a lot of resort hotels. Negative
externality is also known as cannibalism
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Training Workshop II- Doing Financial Forecast
LEVERAGE
Business Risk


Associate with operating income (EBIT)
The higher the fixed cost, the higher the Operating Leverage
Firm A
Firm B
1,000,000
500,000
100,000
1,000,000
200,000
400,000
400,000
400,000
Firm A
Firm B
1,100,000
550,000
100,000
1,100,000
220,000
400,000
450,000 (↑12.5%)
480,000 (↑20%)
Sales
Variable cost
Fixed Cost
EBIT
If both firms increase sales by 10%
Sales (↑10%)
Variable cost
Fixed Cost
EBIT
DOL 

%EBIT
%Sales
Q( P  V )
Q( P  V )  F
Q = quantity of goods sold
P = unit price
V= variable cost per unit
F= fixed cost
(P-V) also known as the contribution margin per unit
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Training Workshop II- Doing Financial Forecast
Breakeven Analysis
Operating Breakeven = Qbreak-even =
Total Breakeven = Qbreak-even =
F
P V
FI
P V
Breakeven measures how many units needed to be sold in order to cover the
fixed costs. Each unit contributes its contribution margin (P-V) towards the
fixed cost (F).
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Training Workshop II- Doing Financial Forecast
Common Pitfalls in Cash Flow Projection
1. Economic responses – a successful investment may induce
competitions, usually profit will be erode by competitions and revert to
normal level
2. Standardized templates may not be suitable for a particular project
3. Use EPS/ Net income/ ROE or other accounting measures for
decision-making
4. Omit relevant cash flow, double-count cash flow or mishandle tax
5. Fail to consider other investment alternatives, opportunities costs.
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Training Workshop II- Doing Financial Forecast
DEVELOP YOUR OWN RATIO FOR YOUR PROJECT
Ratio
Descriptions
Retail Ratio
Same store sales
Sales per square foot
Measure how well we do in the same
store as compare to last year’s figure
How much sales we generate for the rent
we paid
Education/ Service Companies
Revenue per employee
How well should I paid my staff
Net income per employee
Hotel
Average daily rate
Room revenue / number of room sold
Occupancy rate
Number of room sold/ number of room
available.
Creative/ IT
Revenue per program
Revenue per design
Different Industries
Retail
Rent and sales per sq ft is important
Inventory should be considered
Initial investment in fitting, decoration  depreciation
Services/ IT
Usually not about fixed asset, but may need to buy
intangibles such as copyright, patent, software
Education
Employees are the key.
Not much upfront investment
Website
Website development costs should be expensed.
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Training Workshop II- Doing Financial Forecast
CHECKLIST FOR YOUR PREPARATION
Before you prepare the cash flow projection, income statement & balance
sheet, please answer the assumptions & reasoning for your financials.
Item/ Assumptions
Initial Investment
- Phase 1
- Phase 2
Data
$
Does the initial investment 1) a physical asset, 2)
intangible asset or 3) an expense?
- if it is (1) or (2), what is the depreciable life?
Give a simple description of your product/ service
What is the unit price?
$
How much is the direct cost associated with the sale of
one unit?
$
Contribution
$
How many unit can you sell in
o
o
o
o
o
o
1st month
2nd month
6th month
12th month
2nd year
3rd year
Why ??
How much is the promotion costs needed in order to
generate the above sales?
$
Will it change after 1st year?
How much is the fixed cost per month?
(don’t forget to incl. your salary)
$
Will the fixed cost change after 1st year?
$
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