Pro Forma Financial Statements
Dr. Nancy Mangold
California State University, East Bay
Preparing Pro Forma Financial
Statements – Step 1
 Project Operating Revenue


Sales revenue
Other revenue
Preparing Pro Forma Financial
Statements – Step 2
 Projecting Operating Expenses



Cost of Goods Sold
Selling and Administrative Expenses
Net Income Before Interest and Taxes
Preparing Pro Forma Financial
Statements – Step 3
 Project Assets







Cash
Accounts Receivable
Inventories
Other Current Assets
Investments
Fixed Assets
Other Assets
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
Preparing Pro Forma Financial
Statements – Step 5
 Project Retained Earnings

Retained Earnings
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
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
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
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
Projecting Other Revenues
 Use historical percentage of sales
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
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
EXHIBIT 10.2
Pro Forma Statement of Income and Retained Earnings for Coke
(amounts in millions)
Year 8
Year 9
Year 10 Year 11 Year 12
Projected Projected Projected Projected Projected
Sales
$19, 659 $20, 839 $22, 089 $23, 414 $24, 819
Other Revenues
590
625
663
702
745
Cost of Goods Sold
( 7, 077) ( 7, 502) ( 7, 952) ( 8, 429) ( 8, 935)
Selling and Administrative
( 7, 864) ( 8, 335) ( 8, 836) ( 9, 366) ( 9, 928)
Interest Expense
( 325)
( 403)
( 494)
( 599)
( 716)
Net Income before Income Taxes
$4, 983
$5, 223 $5, 470
$5, 723 $5, 985
Income Tax Expense
1, 545
1, 619
1, 696
1, 774
1, 855
Net Income
$3, 438
$3, 604 $3, 774
$3, 949 $4, 130
Dividends
( 1, 397) ( 1, 564) ( 1, 752) ( 1, 962) ( 2, 198)
Change in Retained Earnings
$2, 041
$2, 040 $2, 022
$1, 987 $1, 932
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
Project the Assets on the Balance
Sheet
 Projected Total Assets Approach
 Use historical growth rate in assets

compound annual growth rate over five years
Year 7 Actual Assets
Year 8 Projected Assets
Year 9 Projected Assets
Year 10 Projected Assets
Year 11 Projected Assets
Year 12 Projected Assets
Amount
$16,161
$17,729
$19,448
$21,335
$23,404
$25,674
Percentage Change
—
9.7%
9.7%
9.7%
9.7%
9.7%
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
Total Assets
Sales
Year 8 Projected Assets
Year 9 Projected Assets
Year 10 Projected Assets
Year 11 Projected Assets
Year 12 Projected Assets
$19, 659
$20, 839
$22, 089
$23, 414
$24, 819
Total Average
Assets Total Beginning End of
Turnover Assets of Year Year
1. 2
1. 2
1. 2
1. 2
1. 2
$16, 383
$17, 365
$18, 407
$19, 512
$20, 683
$16, 161
$16, 604
$18, 216
$18, 689
$20, 334
$16, 604
$18, 216
$18, 689
$20, 334
$21, 031
Project Assets on Balance Sheet
 May create sawtooth problem
Illustration of Difficulty Sometimes Encountered
When Projecting Total Assets Using Assets Turnover
Sales
Assets
1
3
2
Year
4
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)
Year 7
Year 8
Year 9
Year 10
Year 11
Year 12
Year-End Percentage Year-End Percentage
Assets Increase Assets Increase
$16,161 7.40% $16,161
$16,604 2.70% $17,035 5.41%
$18,216 9.20% $17,957 5.41%
$18,689 3.10% $18,928 5.41%
$20,334 8.80% $19,952 5.41%
$21,031 3.40% $21,031 5.41%
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
Year 7 Actual
Year 8 Projected
Year 9 Projected
Year 10 Projected
Year 11 Projected
Year 12 Projected
Sales
$18,546
$19,659
$20,839
$22,089
$23,414
$24,819
Total
Assets
1.15
1.15
1.15
1.15
1.15
1.15
Year-End Percentage
Assets Increase
$16,161
$17,095
6%
$18,120
6%
$19,208
6%
$20,360
6%
$21,582
6%
Project Assets on Balance Sheet
 Use common size balance sheet percentages
to allocate the total assets to individual
assets
Pro Forma Balance Sheet for Coke
(amounts in millions)
Year 8
Year 9
Year 10
Projected
Projected Projected
Assets
Cash
Marketable Securities
Accounts Receivable
Inventories
Other Current Assets
Total Current Assets
Investments
Property, Plant, and Equipment (cost)
Accumulated Depreciation
Other Assets
Total Assets
Liabilities and Shareholders' Equity
Accounts Payable
Notes Payable
Current Maturities of Long-Term Debt
Other Current Liabilities
Total Current Liabilities
Long-term Debt
Deferred Income Taxes
Other Noncurrent Liabilities
Total Liabilities
Common Stock
Retained Earnings
Other Equity Adjustments
Treasury Stock
Total Shareholders' Equity
Total Liabilities and Shareholders' Equity
Year 11
Projected
Year 12
Projected
$1, 585
176
1, 768
1, 045
1, 759
$6, 333
6, 543
6, 188
( 2, 252)
798
$17, 610
$1, 732
192
1, 904
1, 148
1, 865
$6, 841
7, 197
6, 859
( 2, 496)
846
$19, 247
$1, 894
210
2, 051
1, 261
1, 976
$7, 392
7, 917
7, 604
( 2, 767)
897
$21, 043
$2, 071
230
2, 210
1, 384
2, 095
$7, 990
8, 708
8, 430
( 3, 068)
951
$23, 011
$2, 265
252
2, 380
1, 520
2, 220
$8, 637
9, 579
9, 346
( 3, 401)
1, 008
$25, 169
$3, 125
4, 288
9
1, 099
8, 521
1, 233
319
1, 253
$3, 285
5, 115
422
1, 165
9, 987
1, 347
338
1, 329
$3, 454
7, 015
16
1, 235
11, 720
1, 473
358
1, 408
$3, 632
8, 470
257
1, 310
13, 669
1, 611
380
1, 492
$3, 819
10, 563
2
1, 387
15, 771
1, 762
403
1, 582
$11, 326
$2, 203
17, 169
( 601)
( 12, 487)
$6, 284
$17, 610
$13, 001
$2, 534
19, 209
( 637)
( 14, 860)
$6, 246
$19, 247
$14, 959
$2, 914
21, 231
( 675)
( 17, 386)
$6, 084
$21, 043
$17, 152
$3, 351
23, 218
( 716)
( 19, 994)
$5, 859
$23, 011
$19, 518
$3, 854
25, 149
( 759)
( 22, 593)
$5, 651
$25, 169
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
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
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
Accounts
Year 8 Projected
Year 9 Projected
Year 10 Projected
Year 11 Projected
Year 12 Projected
Sales
$19,659
$20,839
$22,089
$23,414
$24,819
Average
Receivable Accounts
Turnover Receivable
11.1 $1,771
11.1 $1,877
11.1 $1,990
11.1 $2,109
11.1 $2,236
Accounts Receivable
Beginning End of
of Year Year
$1,641 $1,901
$1,901 $1,854
$1,854 $2,126
$2,126 $2,092
$2,092 $2,380
Year-End Accounts Receivable Percentage Increase
Year 7 Actual
Year 8 Projected
Year 9 Projected
Year 10 Projected
Year 11 Projected
Year 12 Projected
$1,641
$1,768
$1,904
$2,051
$2,210
$2,380
—
7.72%
7.72%
7.72%
7.72%
7.72%
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
Year 8 Projected
Year 9 Projected
Year 10 Projected
Year 11 Projected
Year 12 Projected
Cost of Inventory Average Beginning End of
Goods Sold Turnover Inventories of Year Year
$7,077
6.5 $1,089 $952 $1,226
$7,502
$7,952
$8,429
$8,935
6.5
6.5
6.5
6.5
$1,154
$1,223
$1,297
$1,375
$1,226
$1,082
$1,365
$1,229
$1,082
$1,365
$1,229
$1,520
Year 7 Actual
Year-End Inventories
$952
Percentage Increase
—
Year 8 Projected
$1,045
9.81%
Year 9 Projected
Year 10 Projected
Year 11 Projected
Year 12 Projected
$1,148
$1,261
$1,384
$1,520
9.81%
9.81%
9.81%
9.81%
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
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
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
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
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
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

use growth rate in sales
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
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
Project Income Tax Expense
 Income Taxes

use effective tax rate
Project Retained Earnings
 Dividends

use compound annual dividend growth rate
 Change in Retained Earnings

Beginning R/E + Net income - Dividends =
Ending Retained Earnings
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
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
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
EXHIBIT 10.5
Pro Forma Statement of Cash Flows for Coke
(amounts in millions)
Year 8
Year 9
Year 10 Year 11 Year 12
Projected Projected Projected Projected Projected
Operations
(1) Net Income
$3, 438
$3, 604
$3, 774
$3, 949
$4, 130
(2) Depreciation
221
244
271
300
334
(3) Other Addbacks (net)
55
58
62
65
69
(4) (Increase) in Accounts Receivable
( 127)
( 136)
( 147)
( 159)
( 170)
(5) (Increase) in Inventories
( 93)
( 103)
( 113)
( 123)
( 136)
(6) (Increase) in Prepayments
( 100)
( 106)
( 112)
( 119)
( 126)
(7) Increase in Accounts Payable
153
160
169
178
187
(8) Increase in Other Current Liabilities
63
67
70
75
78
Cash Flow from Operations
$3, 610
$3, 788
$3, 974
$4, 166
$4, 366
Investing
(9) Acquisition of Marketable Securities and Investments
( $546)
(net) ( $671)
( $738)
( $811)
( $892)
(10) Acquisition of Property, Plant, and Equipment ( 607)
( 671)
( 745)
( 825)
( 917)
(11) Other Investing Transactions
( 45)
( 48)
( 51)
( 55)
( 57)
Cash Flow from Investing
( $1, 198) ( $1, 390) ( $1, 534) ( $1, 691) ( $1, 866)
Financing
(12) Increase (Decrease) in Short-term Borrowing $900
$827
$1, 899
$1, 456
$2, 092
(13) Increase in Long-term Debt
117
528
( 280)
379
( 104)
(14) Increase in Common Stock
287
331
380
437
503
(15) Dividends
( 1, 397) ( 1, 564) ( 1, 752) ( 1, 962) ( 2, 198)
(16) Acquisition of Common Stock
( 2, 167) ( 2, 373) ( 2, 526) ( 2, 608) ( 2, 599)
Cash Flow from Financing
( $2, 260) ( $2, 251) ( $2, 279) ( $2, 298) ( $2, 306)
(17) Change in Cash
152
147
161
177
194
Cash-Beginning of Year
1, 433
1, 585
1, 732
1, 894
2, 071
Cash-End of Year
$1, 585
$1, 732
$1, 893
$2, 071
$2, 265
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