Introduction
One of the most common things in corporate finance is the projections of financial analysis and forecasting of future cash flows and expenditures. This has become an important aspect of financial analysis because of the role it plays in budgeting and strategic planning due to how much the company will require (Takhtaei, & Karimi, 2017). Additionally, many corporates and business have used these types of tools to create their competitive strategies. There are several tools that a company can use to achieve such projections. Some of them include; accounting data, historical sales and the use of assumptions for future costs and sales. Although, there are three common ways that are used to create projections and eventually analysis, this paper compares two ways, namely; use of historical sales and assumptions for future costs and sales (Reiboldt, & Reiboldt, 2020). Further, more it goes ahead and analyzes if the latter is a good prediction for the future costs and sales.
To achieve standard projections, it is vital to use financial statement projections, which are also known as Pro Forma financial statements. Undertaking such a task requires one to undertake several steps (Takhtaei, & Karimi, 2017). Most of the inputs required to undertaken in this task are mainly required in the first step. The rest of the steps are mainly reviewing the outputs that have been generated.
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Income Statement
A pro forma income statement is one that is one that mainly shows the projected income flow based the projected item. Basically, it is used to describe how several items that are included in the income statement would generally look like (Reiboldt, & Reiboldt, 2020). Some of the items that are usually shown and affected in the Pro Forma income statement include; expenses, revenue, depreciation, and in other instances taxes (Takhtaei, & Karimi, 2017). They generally forecast EBIT and sales, which means other items that are generally generated by investment flows while financing is not affected.
To prepare the Pro Forma income statement, this paper will undertake several steps that might not necessarily follow the steps highlighted in the figure above. This is because, the historical data provided for Tag-it is only on historical sales.
Using historical data
Step 1:
For preparation of a Pro Forma invoice using historical sales data, it was important to forecast the sales revenue for the following year. To do this, this paper used the projection given by the C.E.O:
Although it is important to note that in some instance the use of simple regression analysis might be helpful in improving the accuracy of the projection, in this case study it was important to use the projection that was given by the C.E.O. The formula used was by calculating the number of sales given in the next year by using the current year. To do this, the percentage projection was added to 100%, which resulted into 112%. This percentage was multiplied into the current sales, which gave the final projections. The figures are given below:
The use of the projected percentage showed that the projected revenue for the following year was $ 80,504
Step 2:
Calculation of the projection enabled this paper to calculate the common size income statement. In this type of income statement, the different entries are presented in terms of percentage revenue of sales (Reiboldt, & Reiboldt, 2020). The common size income statement for the current is as shown below:
As can be seen most of the expenses are related to the level of revenue. This is because items such as raw materials increase with an increase with sales
Step 3:
Calculation of percentage growth rate
Involves creating a Pro Forma income statement based on the estimates. The formula used are outlined below:
• Sales Growth Rate = (Sales in Current Year - Sales in Previous Year) / Sales in Previous Year
• Cost of Sales in year 1 = Cost of Sales in year 1 / Sales year 1
• Cost of Sales in 2000 = Cost of Sales in year 2 / Sales in year 2
• Depreciation in year 1 = Depreciation in year 1 / Sales in year 1
Revenues
Sales*
Cost and expenses:
Cost of sales*
Selling, general and administrative expense (SG&A)* Research and Development*
Depreciation*
Operating income = Sales - Cost and expenses
Interest
Interest expense* Interest income*
Net Interest = Interest income - Interest expense Income before taxes = Operating income + Net Interest Income taxes*
Net income = Income before taxes - Income taxes
The final pro forma income statement is as shown below:
Analysis of the Pro Forma Income Statement
The percentage growth for the four periods would be calculated as:
11%-(-6%)
Which would give 17%. The percentage would have to be divided by the four periods. To do this, the paper would have to divide the 17% by 4 periods. This would give 4.125%. This means that the amount estimated by the total average growth rate is around 4.125%. Therefore the percentage of growth estimated by the Chief Executive Officer is not realistic. This is because, the 12% growth projection is way above the average of 4.125%. Owing to this fact, the company needs to adjust its projection in order to meet the realistic number of sales that might be achieved. However, the company can adjust some of its strategy in the long run to achieve this projection. But it is important to note that it will be very difficult to achieve.
References
Reiboldt, M., & Reiboldt, J. (2020). The utility of Pro Forma Income Statements. The Journal of medical practice management: MPM, 18(2), 86-91. https://europepmc.org/article/med/12389329
Takhtaei, N., & Karimi, H. (2017). Relative ability of earnings data and cash flow in predicting future cash flows. International Journal of Accounting and Financial Reporting, 3(1), 214. http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.1027.4529&rep=rep1&type=pdf
