Projected Financial Statement:
For the purposes of this chapter, the financial statement method will be used in projecting financial statement. Based
on this approach, the following steps will be followed:
1. Forecast sales. In making financial projections, always start with the statement of profit or loss and the most
important account to forecast first is sales.
2. Forecast cost of sales and operating expenses. For the cost of sales, the average cost of sales over the historical
data analyzed can be used. If there are plans to improve cost efficiency, then such improved cost efficiency can
also be considered. For example, if the average cost of sales for the past five years is 60% but the management
feels that given their plans to improve production efficiency, cost of sales can be reduced to 58%. In the
projection, this 58% cost of sales percentage can be used.
3. For the operating expenses, try to figure out which are variable and which are fixed. Variable operating expenses
include commissions. Fixed operating expenses include depreciation of office building, salaries, and some
maintenance expenses.
4. Forecast net income and retained earnings. To forecast net income, there should be information on income taxes
and how much financing cost a company will have. Financing costs will be based on the amount of loans the
company has and the payment terms for these loans. There should also be assumptions on the interest rates for
the projection period.
5. Determine balance sheet items that will vary with sales or whose balances will be highly correlated with sales.
Balance sheet items that may vary with sales or will be highly correlated with sales are cash, accounts receivable,
inventories, accounts payable, and accrued expenses payable.
6. Determine payment schedule for loans. The payment schedule for loans can be based on the disclosures provided
in the notes to financial statements or the plans of management on how to pay the loans if no details about
payment terms are provided in the notes to financial statements.
Determine external funds needed (EFN). This amount is more of a balancing figure or a squeeze figure. The
balance sheet has to balance. Therefore, after assumptions are made to project different balance sheet accounts,
the projected statement of financial position has to balance. The formula for this EFN is shown below:
EFN = Change in Total Assets- (Change in Total Liabilities+ Total Change in Stockholders Equity)
If the EFN is put on the liabilities and stockholders equity section and the amount is positive, this means that
there will be additional financing. However, if the amount is negative, this means that there will be excess cash.
Both negative and positive balance can be disposed later on by management. They do not have to be resolved in
the first iteration of the projected statement of financial position For the purpose of this book, it is enough to
determine the interpretation of a negative and a positive balance.
7. Determine how external funds needed will be financed. Once EFN is computed, the management decides how to
Finance it. it can all be through debt or equity or a Combination of debt and equity.
Illustrative Example: Before the end of 2014, the president of ]SC Foods Corporation had instructed the Vice
President for Finance to prepare the 2015 projected financial statements based on their most recent planning
workshop, the following assumptions were prepared for the 2015 projected financial statements.
a. Sales are expected to increase by 10% in 2015 from the 2014 sales level. This growth assumption is based on
the assessment of the external and internal factors related to JSC Foods Corporation and the historical growth of
the company. The company's sales grew by 10.4% annually from 2010 to 2014 (Refer to Chapter 2 data on the
historical financial statements of JSC Foods Corporation).
b. The following financial statement accounts are expected to vary with sales based on the 2014 financial
statements:
i. Cost of sales
ii. Cash
iii. Trade accounts receivable
iv. Inventories
v. Other current assets
vi. Trade accounts payable
Variable operating expense is 7.5% of sales. Depreciation expense is 10% of the gross beginning balance of property,
plant, and equipment. As of December 31, 2014, the gross balance of PPE is Php 26, 000, 000. For January 2015, Php
5, 000, 000 new PPE will be acquired. It is the policy of the company that PPE acquired in the first half of the year will
be depreciated for one full year.
c. As of December 31, 2014, there are two long-term loans. Both have annual interest rate of 8%.
i. The first loan will mature on June 30, 2015 and the remaining principal balance to be paid on June 30, 2015
is Php 1,250,000.
ii. The second loan amounting to Php 3,000 000 which was incurred on December 31, 2014 is paid at the rate
of Php500, 000 principal balance every June 30 and December 31 .
New loans of Php 3,500, 000 will be incurred on December 31, 2015 payable at the rate of 9,500,000 every June 30
and December 31. Annual interest rate is expected at 8%.
This annual growth rate is known in finance as compounded annual growth rate or CAGR. For JSC Foods Corporation, the formula for computing it
from 2010 to 2014 is as follows:
CAGR = (2014 sales / 2010 sales)(1/4) - 1) x 100%
CAGR = (52,501, 085 / 35, 336,643) (1/4) - 1) ) x 100%
CAGR = 10.4% .
¼ - There are four years from 2010 to 2014. If the period covered is from 2009 to 2014 which covers five years, then the superscript will be (1/5).
d. Other non-current assets and other current liabilities will remain unchanged.
e. Income tax rate is 30% of the income before taxes. Seventy-five percent of the income tax expense will be paid
in 2015 while the balance will be paid in 2016.
f. Cash dividends of P2,000,000 will be paid for 2015.
Found in Table 3.2 to 3.4 are the projected financial statements of JSC Foods Corporation in 2015.
Table 3.2: SC Foods Corporation
Projected Statement of Profit or Loss
For the Year Ending December 31, 2015
Net Sales 57,751,194
Cost of Sales 46,148, 979
Gross Profit 11,602,215
Operating Expenses 7, 431,340
Operating Income 4,170,875
Interest Expense 270,000
Income before Taxes 3,900,875
Taxes 1,170,262
Net Income 2,730,613
This is how the cost of sales was computed:
Cost of Sales Percentage in 2014 = (41,954,730 + 52,501,085) x 100%
Cost of Sales Percentage in 2014 = 79.91%
Projected Cost of Sales in 2015 = 79.91% x 57,751,194
Projected Cost of Sales in 2015 = 46,148,979
The operating expenses were computed as follows:
Variable (7.5% x Sales of 57,751,194) 4,331,340
Fixed (Depreciation Expense) 3,100,000
Total Operating Expenses 7,431,340
Depreciation expense is 10% of the beginning balance of gross PPE Php 26 million and the new acquisition of PPE
worth Php 5 million.
The interest expense for 2015 was computed as follows:
First Loan
Interest from January 1 to June 30, 2015
1,250, 000 x 8% x (6 months / 12 months) 50,000
Second Loan
Interest from January 1 to June 30, 2015 .
(1, 000,000 + 2,000,000 ) x 08% x ( 6 months / 12 months ) 120,000
Interest from July to December 31, 2015
(500,000 + 2,000,000 )8 % X ( 6 months / 12 months )
100,000
Total interest Expense for 2015 270,000
Note that the current portion of long-term debt of Php 1 million is added to long-term portion of Php 2 million for
the second loan to determine the interest expense for the first six months of 2015. The year has to be divided
into two because there is a principal payment of Php 500,000 on June 30, 2015 which will reduce the principal
balance stating July 1, 2015 which will reduce the principal balance starting July 1, 2015. The interest expense
will also go down for the second half of 2015 because the principal balance has gone down.
The next table show the projected statement of financial position for 2015.
Table 3.3: JSC Foods Corporation
Projected Statement of Financial Position
December 31, 2015
Assets
Current Assets
Cash 1,166,574
Receivables 2,529,502
Inventories 5,336,210
Other Current Assets 1,155,024
Total Current Assets *10,187,311
Noncurrent Assets
Property, Plant, and Equipment, Net 14,100,000
Other Non-current Assets 835,689
Total Non-current Asset 14,935,689
Total Assets *21,123,000
Liabilities and Equity
Current Liabilities
Note Payable (External funds needed ) 479,998
Trade Payable 5,555,665
Income Taxes Payable 292,566
Current Portion of Long-term Debt 2,000,000
Other Current Liabilities 85,600
*8,413,828
Noncurrent Liabilities
Long-term Debt, Net of Current Portion 3,500,000
Total Liabilities *11,913,828
Stockholders' Equity
Capital Stock 8,000,000
Retained Earnings 5,209,171
Total Stockholdrers' Equity 13,209,171
Total Liabilities and Stockholders' Equity *25,123,000
This is how the following balance sheet account were computed :
1. Cash
Cash as Percentage of Sales in 2014 = (1,062,527 -:- 52,501,085) x 100%
Cash as a Percentage of Sales in 2014 = 2.02%
Projected Cash in 2015 = 2.02 % x 57,751,194
Projected Cash in 2015 = 1,166,574
2. Accounts Receivable
Accounts Receivable as a % of Sales in 2014 = (2,300,500 + 52,501,085) X100%
Accounts Receivable as a % of Sales in 2014 = 4.38%
Projected Accounts Receivable in 2015 = 4.38% x 57,751,194
Projected Accounts Receivable in 2015 = 2,529,502
3. Inventories
Inventories as a % of Sales in 2014 = (4,849,403 + 52,501,085) x 100%
Inventories as a % of Sales in 2014 = 9.24%
Projected Inventories in 2015 = 9.24% x 57,751,194
Projected Inventories in 2015 = 5,336,210
4. Other Current Assets
Other Current Asset as a % of Sales in 2014 = (1,050,000 + 52,501,085) x 100%
Other Current Asset as a % of Sales in 2014 = 2%
Projected Other Current Assets in 2015 = 2% x 57,751,194
Projected Other Current Assets in 2015 = 1,155,024
5. Accounts Payable
Accounts Payable as a % of Sales in 2014 = (5,050,810 + 52,501,085) x 100%
Accounts Payable as a % of Sales in 2014 = 9.62%
Projected Accounts Payable in 2015 = 9.62% x 57 751 194
Projected Accounts Payable in 2015 = 5,555,665
6. Current Portion of Long-term Debt and Long term Portion of Long-term Debt.
For the 2015 projected statement of financial position, this will be the breakdown of the remaining balances
Of long-term loans as to current portion and long-term portion as of December 31, 2015.
Loan Current Long term Total
Portion Portion
Loan of 3 million incurred on December 31, 2014 1,000,000 1,000,000 2,000,000
Loan of P35 million to be incurred on December 31, 1,000,000 2,500,000 3,500,000
2015
Total 2,000,000 3,500,000 5,500,000
7. External funds needed (EFN) is just a balancing figure. Below is the formula for computing EFN.
EFN = Change in Total Assets - (Change in Total Liabilities + Total Change in Stockholders' Equity)
EFN = 2,824,980 (1,614,369 + 730,612)
EFN = 479, 9986
Refer to the table below for the details of the computation of EFN in 2015.
2015 Balances 2014 Balances Change
Without EFN
Total Assets 25,123,000 22,298,020 2,824,980
Total Liabilities 11,433,830 9,819,461 1,614,369
Total Stockholders' 13,209,171 12,478,559 730,612
Equity
479,998
There are rounding off differences. With two decimal numbers, these are the numbers:
Change in Total Assets = 2,824,979.53; Change in Total Liabilities = 1,614,369.08; Change in Equity = 730,612.34
EFN = 2,824,979.53 (1,614,369.08 + 730,612.34)
EFN = 479,998.11
Table 3.4: JSC Foods Corporation
Projected Statement of Cash Flows
For the Year Ending December 31, 2015
Cash Flows from Operating Activities
Income before Taxes 3,900,875
Adjustments:
Depreciation 3,100,000
Changes in the following accounts:
Decrease (increase) in Accounts Receivable -229,002
Decrease (increase) in Inventories -486,906
Decrease (increase) in Other Current Assets -105,024
Increase (decrease) in Accounts Payable 504,855
Increase (decrease) in Other Current Liabilities -
Income Taxes Paid -1,310,748
Cash Flows from Operating Activities 5,374,049
Cash Flows from Investing Activities
Acquisition of PPE -5,000,000
Acquisition of Other Noncurrent Assets -
Cash Flows from Investing Activities -5,000,000
Income Taxes Payable
Cash Flows from Financing Activities
Payment of Cash Dividends -2,000,000
Short-term Notes payable ( EFN ) -
Loans, Net of Payments 1,250,000
Cash Flows from Financing Activities -750,000
Net Change in Cash -375,951
Cash, Beginning 1,062,527
Cash, Ending 686,576
Questions
1. Why is sales the most important financial statement account in forecasting?
2. Enumerate at least five external factors considered in sales forecasting.
3. Enumerate at least five internal factors considered in sales forecasting.
4. What is the meaning of a positive EFN? a negative EFN?
Working Capital Management
Working capital refers to the current assets used in the operations of the business.
This includes cash, accounts receivable, inventories, and prepaid expenses. The amount of resources that a
company sets aside to these working capital accounts can be reduced by current liabilities such as trade accounts
payable and accrued expenses payable. The difference between these current assets and current liabilities used in
the operations of the business is net working capital.
