Chapter 12 Forecasting and Short - Term Financial Planning

Chapter
12
Forecasting and Short-‐Term Financial
Planning
LEARNING OBJECTIVES (Slide 12-‐2)
1. Understand the sources and uses of cash in building a cash budget.
2. Explain how companies use sales forecasts to predict cash inflow.
3. Understand how production costs vary in terms of cash flow timing.
4. Explain possible ways to cover cash deficits and invest cash surplus.
5. Prepare a pro forma income statement and a pro forma balance sheet.
IN A NUTSHELL…
Financial forecasting and planning are tasks that every financial manager must perform
diligently so as to prevent cash flow problems and unnecessary higher costs of financing
in the future. A cash budget is the basic financial planning tool for any individual or
business, so the author begins by identifying the various sources and uses of cash that are
part of a cash budget. With sales being the base variable, affecting almost all parts of a
budget, the process of sales forecasting is covered next. This is followed by an
explanation of the timing of various production costs and their consequential effects on
possible cash deficits and surpluses. The alternative sources available to cover cash
shortages and the possible options for investing surplus cash are then discussed. In the
last section, the author illustrates the process of preparing a pro-forma income statement
and balance sheet as part of short-term financial planning.
LECTURE OUTLINE
12.1 Sources and Uses of Cash (Slides 12-‐3 to 12-‐5)
Cash is considered to be the life-blood of a business. Cash shortages can be stifling and
expensive while excesses can lead to poor returns.
Since most businesses do not function on a pure cash basis, it is critical for them to
forecast their needs for cash in advance.
The cash budget is the analytical tool that estimates the future timing of cash inflow and
cash outflow and projects potential shortfalls and surpluses.
Table 12.1 presents the summary of a cash budget prepared for a hypothetical
manufacturing firm, Bridge Water Pumps and Filters.
409
©2013 Pearson Education, Inc. Publishing as Prentice Hall
410 Brooks n Financial Management: Core Concepts, 2e
Notice how despite setting up a cash reserve, the firm is projected to have cash shortfalls
in 3 months and surpluses in 2 after all cash receipts and disbursements have been
forecasted for the first half of 2010.
Identifying all possible sources and uses of cash is essential for preparing a useful cash
budget.
Figure 12.1 lists the various avenues of cash inflow and outflow typically faced by a firm.
This list can serve as a guide when preparing a cash budget.
12.2 Cash Budgeting and the Sales Forecast (Slides 12-‐6 to 12-‐10)
Since sales revenue is the base variable driving almost all other items in the cash budget,
it is important to forecast sales as objectively as possible.
Moreover, since there is usually a time lag between when a sale is made and when the
cash receipts come in, keeping track of when the firm receives cash from sales is as
important as determining when the sales materialize.

Chapter 12 n Forecasting and Short-‐Term Financial Planning 411
Companies use internal data (information that is proprietary or unique to the firm) as well
as external data (publicly available information) sources to come up with objective
forecasts of sales.
12.2 (A) Cash Inflow from Sales: Firms typically sell products and services partially for
cash and partially on credit.
Thus, an analysis of a firm’s collection policy can help project cash inflow from sales.
It is quite common for firms to collect some of their receivables in the 2 months
following the sale, i.e. November 2008’s credit sales will be partially collected in
December and January.
Table 12.2 presents an example of how the cash inflow from a firm’s forecasted sales are
allocated for the purpose of preparing a cash budget.
Managers often figure in a small percentage of the forecasted sales as bad debts when
preparing a cash budget.
12.2 (B) Other Cash Receipts: Besides sales, which are the main contributor to a firm’s
cash inflow, the timing and magnitude of other occasional sources of cash such as asset
sales, funds raised through issuance and sale of securities, and income earned on
investments (dividends, interest, etc.) must be forecasted when preparing a cash budget.
12.3 Cash Outflow from Production (Slide 12-‐11)

The magnitude and timing of the various cash disbursements of a firm, depends to a large
extent on its forecasted sales.
These cash outflow items include payments for raw materials, labor costs, overheads such
as utilities and rent, shipping costs, etc.
As in the case of sales, there is often a time lag between when the firm receives and
records the benefit, and when it actually makes the payment for it. The cash budget can
be used as a handy planning document to keep track of the projected disbursements.
Note: Students often assume that depreciation should be accounted for as a cash
disbursement, which is incorrect, since depreciation is merely a tax write-off and not a
cash outflow.

12.4 The Cash Forecast: Short-‐Term

Deficits and Short-‐term Surpluses (Slides 12-‐12 to 12-‐15)
The main objective of developing a cash budget is to ensure that the firm has sufficient
cash available from its revenues and other receipts to cover its periodic cash
disbursements such as:
1. Accounts payables for materials and supplies;
2. Salaries, wages, taxes, other operating expenses;
3. Capital expenditures for plant, equipment, and machinery; and
4. Dividends, interest and floatation cost payments related to raising and servicing of
capital.
Over a short planning cycle, the total periodic cash inflow rarely matches the total
periodic outflow, primarily due to seasonal fluctuations and time lags.
This results in forecasted cash deficits and surpluses in certain periods.
Firms can avail of a variety of options to fund deficits and invest surpluses.
12.4 (A) Funding Cash Deficits: Cash shortfalls can be handled in 4 ways:
1. Cash from savings
2. Unsecured loans (letters of credit)
3. Secured loans (using accounts receivable or inventories)
4. Other sources (commercial paper, trade credit, or banker’s acceptance
12.4 (B) Investing Cash Surpluses: When a company has excess funds, it has 4 options:
1. Put the surplus in a savings account or invest it in marketable securities.
2. Repay lenders and owners (retire debt early or pay extra dividends).
3. Replace aging assets.
4. Invest in the company, accepting positive net present value projects.
12.5 Planning with Pro Forma

Financial Statements (Slides 12-‐16 to 12-‐27)
Cash budgeting, although critical, is only one aspect of short-term financial planning. In
addition, it is important for firms to forecast their operating cash flow and net income for
the forthcoming period by developing pro forma financial statements.
There are a variety of ways to produce pro forma statements, but the statements usually
rely on two primary inputs:
1. The prior year’s financial statements and the relationship of the account balances to
each other, and
2. The projected sales for the coming year.

The percentage of each item either to sales (income statement) or to total assets (balance
sheet) is computed for the prior year and then multiplied by the projected sales (income
statement) or total assets (balance sheet) for the coming year to develop pro forma
financial statements.
For example, let’s say that the cash balance for the prior year is $2 million and the total
assets are $100m. So cash is 2% of total assets. For the Pro Forma Balance Sheet, we
would forecast cash as 2% of the forecasted total assets as well, i.e. if total assets are
forecasted to increase by 20%è$120mèCash would be forecasted to be .02*120m =
$24m.
12.5 (A) Pro Forma Income Statement: Figure 12.3 shows how each income statement
item is expressed as a percentage of sales.
Figure 12.4, shows how the Pro Forma Income Statement is developed, i.e. by
multiplying the percentages of each item to sales by the forecasted sales for the next
period.
This approach, although a good first step, can be considered too simplistic in reality
because many financial statement items do not vary proportionately with sales. In
particular, depreciation decreases over time and cost of goods sold often declines due to
economies of scale.
The manager would have to fine-tune the forecasted values to make them more in line
with reality.

Fig.12.3

Fig.12.4
12.5 (B) Pro Forma Balance Sheet: To develop the pro forma balance sheet, a similar
procedure is used. Each prior year’s balance sheet item is expressed as a percent of total
assets, and then multiplied by the forecasted total assets figure for the next period.
Items which are obviously either constant each period, or which vary at a different rate
(for whatever reason) are accordingly adjusted for by the financial manager.
If total assets exceed total liabilities and owner’s equity, external financing is allocated
according to some pre-determined ratio to serve as the plug variable.

Figure 12.5 shows the balance sheet items of Bridge Water Pumps and Filters, expressed
as a % of total assets.
Based on the following assumptions, a pro forma balance sheet is developed in Figure
12.6.

Key calculations include:
Finally, the pro forma cash flow statement (Figure 12.7) is prepared to tie together all the
changes in operating, investment, and financing cash flows.

Questions
1. What are a company’s main sources of cash for a company? What are a
company’s main uses of cash?
The sources of cash (cash receipts or cash inflow) are:
(1) Cash Sales from products and services
(2) Payments received on Accounts Receivables (mainly credit sales)
(3) Cash sales of equipment or other assets of the company
(4) Funding sources (bank loans, bond sales, or stock sales)
The uses of cash (cash disbursements or cash outflow) are:
(1) Cash purchases (supplies, inventories, etc.)
(2) Accounts payable (to suppliers)
(3) Wages and Salaries
(4) Rent or lease or mortgage payments
(5) Utility payments (water, electricity, phones, etc.)
(6) Interest payments
(7) Dividend payments
(8) Paying off debt (loans and bonds)
(9) Repurchases of stock

2. What are two key timing issues with respect to predicting cash inflow for a sales
forecast?
The two key issues are the timing of the sale and the timing of the collection of the
sale, the cash inflow from the sale.
3. What are some of the production costs that are tied to the sales forecast?
Production costs include the wages paid to workers, the raw materials for
manufacturing products, the overheads (such as electricity, water, plant space, and so
on), and the shipping costs that get the product to the customer.
4. What is a line of credit? Why would a bank require a company with a line of
credit to have a zero balance for at least sixty days a year in its line of credit?
A line of credit is an unsecured bank loan whereby the bank agrees to lend a company
up to a specific amount of cash, at the discretion of the company. In other words, it is
just a pre-arranged loan. Often the bank will require the company to pay off the line
of credit (return the balance to zero) and keep it there for a specific period of time
each year. For example, a requirement might be that the line of credit remains at a
zero balance for at least one sixty-day period each year. This is called the clean-up
period. Banks require a clean-up period so the line of credit does not become a
permanent loan to the company.
5. What is the difference between a secured and an unsecured loan?
A secured loan has assets assigned to the loan to serve as collateral for the loan should
the borrower default. An unsecured loan has no pledged assets and in the case of
default, the lender is not entitled to any specific assets of the company.
6. Why can excess cash be an opportunity cost for a company?
Excess cash is unemployed cash of the company. If the cash is not needed it can be
invested in an interest bearing account or other assets that can produce income for the
company and therefore is lost potential is an opportunity cost.
7. If a pro forma income statement has 5% for the net income line, what does this
mean in terms of a company’s total sales and per dollar sales?
A 5% net income from a pro forma income statement means that for every dollar of
sale generated by the company, five cents will eventually hit the net income line.
Stated another way, for every dollar of sales, ninety-five cents is expensed in cost of
goods sold, depreciation, interest expense, and taxes leaving five cents for the owners.
8. In a pro forma income statement, why would a finance manager make changes
in the prior year’s percentages for different line items? Give an example of a line
item that you would expect to vary in percentage every year as sales forecasts
grow.
Not all expenses vary directly with sales. One example is fixed costs that by definition
do not vary with sales or production changes. These costs are constant and in a pro
forma statement should be adjusted by the finance manager.
9. In a pro forma balance sheet, what line item would you expect to be constant
from year to year in dollar terms and decreasing in terms of percentage of total
assets? When would this line item have a significant change in percentage?

Plant, Property and Equipment (P P & E) should be constant from year to year given
no capital spending for the year. P P & E is recorded at its original cost and this cost
remains on the books until disposal. There can be a significant change in this item in
years of significant capital spending.
10. Why are cash management and cash budgeting important to a company’s
survival?
Failure to manage cash flow can lead to extra borrowing costs, unhappy workers if
they are not paid on time, unhappy suppliers if payments are delayed and thus a
poorly managed business. Eventually it may lead to failure of the business as
expenses surpass income.
Prepping for Exams

1. a
2. c
3. d
4. a
5. c
6. a
7. d
8. c
9. c
10. c
Problems
1. Sales forecasts. For the prior three years, sales for National Beverage Company have
been $21,962,000 (2007), $23,104,000 (2008), and $24,088,000 (2009). The
company uses the prior two year’s average growth rate to predict the coming year’s
sales. What were the sales growth rates for 2008 and 2009? What is the expected
sales growth rate using a two-year average for 2010? What is the sales forecast for
2010?
ANSWER
Recall growth rates, g = (ending value / beginning value)1 / number of years – 1
Growth rate 2008 = ($23,104 / $21,962) – 1 = 5.2%
Growth rate 2009 = ($24,088 / $23,104) – 1 = 4.26%
Two year average = ($24,088 / $21,962)1/2 – 1 = 4.728390%
Sales Forecast 2010 = $24,088,000 × (1+(24,088/21,962) 1/2)) = $25,226,975
Note, the growth rate was not rounded in the final sales forecast answer.

2. Sales forecasts. For the prior three years, sales for California Cement Company have
been $20,011,000 (2009), $21,167,000 (2010), and $22,923,000 (2011). CCC uses
the prior two year’s average growth rate to predict the coming year’s sales. What
were the sales growth rates for 2010 and 2011? What is the expected sales growth
rate using a two-year average for 2012? What is the sales forecast for 2012?
ANSWER
Recall growth rates, g = (ending value / beginning value)1 / number of years – 1
Growth rate 2009 = ($21,167 / $20,011) – 1 = 5.78%
Growth rate 2010 = ($22,923 / $21,167) – 1 = 8.30%
Two year average = ($22,923 / $20,011)1/2 – 1 = 7.028966%
Sales Forecast 2011 = $22,923,000 × 1.07028966 = $24,534,250
Note, the growth rate was not rounded in the final sales forecast answer.
3. Sales forecast based on external data. Raspberry Phones uses external data to
forecast the coming year’s sales. Raspberry Phones have 8% of all new phone sales in
the United States and 6% of all replacement phones. Industry forecasts predict an
additional 18 million new phone buyers and replacement sales of 31 million phones
in 2010. If the average Raspberry phone costs $85, what sales revenues is the
company forecasting for 2010?
ANSWER
New phones, 18,000,000 × 0.08 × $85 = $122,400,000
Replacement phones, 31,000,000 × 0.06 × $85 = $158,100,000
Total Sales 2010 = $122,400,000 + $158,100,000 =
$280,500,000
4. Sales forecast based on external data. Nelson Heating and Ventilating Company
estimates the coming year’s sales revenue based on external data. The company’s
main business is new shopping mall construction, and uses the square footage of each
mall as a “yardstick” for many financial statements and projections. The company
does business in four Midwest states. Last year, it completed heating and ventilating
systems on four shopping malls with an average square footage of 3,000,000 square
feet for sales revenues of $9,600,000. Nelson is hired for one-third of the new malls
in the four- state area. This coming year, nine new malls are being built with an
average footage of 4,500,000 square feet. What is Nelson’s anticipated sales revenue
for the coming year?
ANSWER
Sales per square foot = $9,600,000 / (4 × 3,000,000) = $0.80 per square foot
Coming year hire, 9 / 3 = 3 malls
Sales forecast = 3 × 4,500,000 × $0.80 = $10,800,000

5. Sales receipts. National Beverage Company anticipates the following first-quarter

sales for 2010: $1,800,000 (January), $1,600,000 (February), and $2,100,000
(March). It posted the following sales figures for the last quarter of 2009: $1,900,000
(October), $2,050,000 (November), and $2,200,000 (December). NBC sells 40% of
its products on credit; 60% are cash sales. The credit sales are collected as follows:
30% in the following month, 50% two months later, 18% three months later, and 2%
defaults. What are the anticipated cash inflows for the first quarter of 2010?
ANSWER
October Sales, $1,900,000
Collected in October = $1,900,000 × 0.60 = $1,140,000
Collected in November = $1,900,000 × 0.40 × 0.30 = $228,000
Collected in December = $1,900,000 × 0.40 × 0.50 = $380,000
Collected in January = $1,900,000 × 0.40 × 0.18 = $136,800
Not collected (bad debt) = $1,900,000 × 0.40 × 0.02 = $15,200
November Sales $2,050,000
Collected in November = $2,050,000 × 0.60 = $1,230,000
Collected in February = $2,050,000 × 0.40 × 0.18 = $147,600
December Sales $2,200,000
Collected in December = $2,200,000 × 0.60 = $1,320,000
Collected in March = $2,200,000 × 0.40 × 0.18 = $158,400
January Sales $1,800,000
Collected in January = $1,800,000 × 0.60 = $1,080,000
Collected in March = $1,800,000x 0.40 × 0.50 = $360,000
Collected in April = $1,800,000 × 0.40 × 0.18 = $129,600
February Sales $1,600,000
Collected in February = $1,600,000 × 0.60 = $960,000
Collected in April = $1,600,000x 0.40 × 0.50 = $320,000
Collected in May = $1,600,000 × 0.40 × 0.18 = $115,200
March Sales $2,100,000
Collected in March = $2,100,000 × 0.60 = $1,260,000
Collected in April = $2,100,000 × 0.40 × 0.30 = $252,000
Collected in May = $2,100,000x 0.40 × 0.50 = $420,000
Collected in June = $2,100,000 × 0.40 × 0.18 = $151,200


FROM January Receipts February Receipts March Receipts
October $136,800
November $410,000 $147,600
December $264,000 $440,000 $158,400
January $1,080,000 $216,000 $360,000
February $960,000 $192,000
March $1,260,000
TOTAL $1,890,800 $1,763,600 $1,970,400
6. Sales receipts. California Cement Company anticipates the following fourth-quarter

sales for 2009: $1,800,000 (October), $1,600,000 (November), and $2,100,000
(December). It posted the following sales figures for the third quarter of 2009:
$1,900,000 (July), $2,050,000 (August), and $2,200,000 (September). CCC sells 90%
of its products on credit; 10% are cash sales. The credit sales are collected as follows:
60% in the following month, 20% two months later, 19% three months later, and 1%
defaults. What are the anticipated cash inflows for the last quarter of 2009?
ANSWER
July Sales, $1,900,000
Collected in July = $1,900,000 × 0.10 = $190,000
Collected in August = $1,900,000 × 0.90 × 0.60 = $1,026,000
Collected in September = $1,900,000 × 0.90 × 0.20 = $342,000
Collected in October = $1,900,000 × 0.90 × 0.19 = $324,900
Not Collected (bad debts) = $1,900,000 × 0.90 × 0.01 = $17,100
August Sales, $2,050,000
Collected in August = $2,050,000 × 0.10 = $205,000
Collected in September = $2,050,000 × 0.90 × 0.60 = $1,107,000
Collected in October = $2,050,000 × 0.90 × 0.20 = $369,000
September Sales, $2,200,000
Collected in September = $2,200,000 × 0.10 = $220,000
Collected in October = $2,200,000 × 0.90 × 0.60 = $1,188,000
October Sales, $1,800,000
Collected in October = $1,800,000 × 0.10 = $180,000


November Sales, $1,600,000
Collected in November = $1,600,000 × 0.10 = $160,000
December Sales, $2,100,000
Collected in December = $2,100,000 × 0.10 = $210,000
Collected in January = $2,100,000 × 0.90 × 0.60 = $1,134,000
FROM October Receipts November Receipts December Receipts
July $324,900
August $369,000 $350,550
September $1,188,000 $396,000 $376,200
October $180,000 $972,000 $324,000
November $160,000 $864,000
December $210,000
TOTAL $2,061,900 $1,878,550 $1,774,200
7. Production cash outflow. National Beverage Company produces its products two
months in advance of anticipated sales and ships to warehouse centers the month
before sale. The inventory safety stock is 10% of the anticipated month’s sale.
Beginning inventory in October 2009 was 267,143 units. Each unit costs $0.25 to
make. The average selling price is $0.70 per unit. The cost is made up of 40% labor,
50% materials, and 10% shipping (to warehouse). Labor is paid the month of
production, shipping the month after production, and raw materials the month prior to
production. What is the production cash outflow for the month of October 2009
production, and in what months does it occur? Note: October production is based on
December anticipated sales. Use the fourth-quarter sales forecasts from Problem 5.

ANSWER
Anticipated Sales in December is $2,200,000/$0.70 = 3,142,857 units
Safety stock = 3,142,857 × 0.10 = 314,286
Desired Ending Inventory = 3,142,857 + 314,286 = 3,457,143
Beginning Inventory = 267,143
Required Production for October = 3,457,143 – 267, 143 = 3,190,000
Production Costs:
Labor = 3,190,000 × $0.25 × 0.40 = $319,000
Raw materials = 3,190,000 × $0.25 × 0.50 = $398,750
Shipping = 3,190,000 × $0.25 × 0.10 = $79,750
TOTAL OCTOBER PRODUCTION COSTS = 3,190,000 × $0.25 = $797,500
Cash Outflow is in
September for raw materials, $398,750
October for labor, $319,000
November for shipping, $79,750
8. Production cash outflow. California Cement Co. produces its products two months in
advance of anticipated sales and ships to warehouse centers the month before sale.
The inventory safety stock is 20% of the anticipated month’s sale. Beginning
inventory in September 2009 was 33,913 units. Each unit costs $2.80 to make. The
average sales price per unit is $5.75. The cost is made up of 30% labor, 65%
materials, and 5% shipping (to warehouse). Labor is paid the month of production,
shipping the month after production, and raw materials the month prior to production.
What is the production cash outflow for the month of September 2009 production,
and in what months does it occur? Note: September production is based on November
anticipated sales. Use the fourth-quarter sales forecasts from Problem 6.
ANSWER
Anticipated Sales in November is $1,600,000 / $5.75 = 278,261 units
Safety stock = 278,261 × 0.20 = 55,652
Desired Ending Inventory = 278,261 + 55,652 = 333,913
Beginning Inventory = 33,913
Required Production for September = 333,913 – 33,913 = 300,000
Production Costs:
Labor = 300,000 × $2.80 × 0.30 = $252,000
Raw materials = 300,000 × $2.80 × 0.65 = $546,000
Shipping = 300,000 × $2.80 × 0.05 = $42,000
TOTAL September PRODUCTION COSTS = 300,000 × $2.80 = $840,000
Cash Outflow is in
August for raw materials, $546,000
September for labor, $252,000
October for shipping, $42,000

9. Pro forma income statement. Given the income statement below for National
Beverage Company for 2009, and the sales forecast from Problem 1, prepare a pro
forma income statement for 2010.
National Beverage Company
Income Statement for 2009
Sales Revenue $24,088,000
COGS 8,164,000
SG&A Expenses 7,616,000
Depreciation Expenses 2,388,000
EBIT $ 5,920,000
Interest Expense 220,000
Taxable Income $ 5,700,000
Taxes 2,498,000
Net Income $ 3,202,000
ANSWER
First find the percentage of each income statement line from 2009 as a percent of sales.
Sales Revenue $24,088,000 100.00%
COGS 8,164,000 33.89%
SG&A Expenses 7,616,000 31.62%
Depreciation Expenses 2,388,000 9.91%
EBIT $ 5,920,000 24.58%
Interest Expense 220,000 0.91%
Taxable Income $ 5,700,000 23.66%
Taxes 2,498,000 10.37%
Net Income $ 3,202,000 13.29%
Sales Forecast 2010 = $24,088,000 × 1.04728390 = $25,226,975
Pro Forma Income Statement for 2010
Sales Revenue $25,226,975 100.00%
COGS 8,550,026 33.89%
SG&A Expenses 7,976,114 31.62%
EBIT $ 6,199,921 24.58%
Taxable Income $ 5,969,519 23.66%
Taxes 2,616,115 10.37%
Net Income $ 3,353,404 13.29%
Note, the percentages used were not rounded, for example, the COGS is figured as
($8,164,000 / $24,088,000) × $25,226,975 = $8,550,025.90

10. Pro forma income statement. Given the income statement below for California
Cement Company for 2009, and the sales forecast from Problem 2, prepare a pro
forma income statement for CCC for 2010.
California Cement Company
COGS 11,713,000
Depreciation Expenses 1,420,000
EBIT $ 5,747,000
Interest Expense 173,000
Taxable Income $ 5,574,000
Taxes 1,723,000
Net Income $ 3,851,000
ANSWER
First find the percentages of each income statement line as a percent of sales.
Sales Revenue $22,923,000 100.00%
COGS 11,713,000 51.10%
SG&A Expenses 4,043,000 17.64%
EBIT $ 5,747,000 25.07%
Taxable Income $ 5,574,000 24.32%
Taxes 1,723,000 7.52%
Net Income $ 3,851,000 16.80%
Sales Forecast for CCC from problem number two:
Sales Forecast 2010 = $22,923,000 × 1.07028967 = $24,534,250
Pro Forma Income Statement for 2010
Sales Revenue $24,534,250 100.00%
COGS 12,536,303 51.10%
SG&A Expenses 4,327,181 17.64%
EBIT $ 6,150,955 25.07%
Taxable Income $ 5,965,795 24.32%
Taxes 1,844,109 7.52%
Net Income $ 4,121,686 16.80%
Note, the percentages used were not rounded, for example, the COGS is figured as
($11,713,000 / $22,923,000) × $24,534,250 = $12,536,302.85

11. Pro forma balance sheet.

Balance Sheet for the Year Ending 2009
Current Assets
Cash $2,440,000
Marketable Securities 1,656,000
Accounts Receivable 2,704,000
Inventories 1,641,000
Total Current Assets $ 8,441,000
Long-term Assets
Plant, Property & Equip. $13,686,000
Goodwill 1,403,000
Intangible Assets 6,433,000
Total Long-term Assets $21,522,000
TOTAL ASSETS $29,963,000
Current Liabilities
Accounts Payable $ 5,622,000
Other Current Liabilities $ 3,268,000
Total Current Liabilities $ 8,890,000
Long-term Liabilities
Long-Term Debt $ 1,314,000
Other Long-term Liab. $ 2,839,000
Total Long-Term Liabilities $ 4,153,000
TOTAL LIABILITIES $13,043,000
Owners’ Equity
Common Stock $ 6,861,000
Retained Earnings $10,059,000
TOTAL OWNERS’ EQUITY $16,920,000
TOTAL LIABILITIES & OWNER’S EQUITY $29,963,000
Next year, National Beverage Company will increase its Plant, Property, and
Equipment (PPE) by $4,000,000 with a plant expansion. The inventories will grow by
30%, accounts receivable will grow by 20%, and marketable securities will be
reduced by 50% to help finance the expansion. If all other asset accounts remain the
same and long-term debt will be used to finance the remaining costs of the expansion
(no change in common stock or retained earnings), prepare a pro forma balance sheet
for 2010. How much additional debt will be estimated using this pro forma balance
sheet?
ANSWER
Start by changing the known asset accounts and then total up assets. Then use the total
assets for total liabilities and owner’s equity balance. Finally, make the required change
in long-term debt to balance the balance sheet.


Pro Forma Balance Sheet for the Year Ending 2010
Current Assets
Cash $2,440,000
Marketable Securities 828,000 (down 50%)
Accounts Receivable 3,244,800 (up 20%)
Inventories 2,133,300 (up 30%)
Long-term Assets
Goodwill 1,403,000
Current Liabilities
Owner’s Equity
TOTAL OWNER’S EQUITY $16,920,000
Change in long-term debt is: $5,519,100 - $1,314,000 = $4,205,100
12. Pro forma balance sheet.

Current Assets
Cash $1,447,000
Marketable Securities 1,129,000
Long-term Assets
Plant, Property & Equip. $ 6,760,000
Goodwill 4,082,000

Current Liabilities
Owner’s Equity
Retained Earnings $ 7,466,000
TOTAL OWNER’S EQUITY $ 9,959,000
Next year, California Cement Company will increase its Plant, Property, and Equipment
(PPE) by $6,000,000 with a plant expansion. The inventories will grow by 80%, accounts
receivable will grow by 70%, and marketable securities will be reduced by 60% to help
finance the expansion. If all other asset accounts remain the same and long-term debt will
be used to finance the remaining costs of the expansion (no change in common stock or
retained earnings), prepare a pro forma balance sheet for 2011. How much additional
debt will be estimated using this pro forma balance sheet?
ANSWER
Pro Forma Balance Sheet for the Year Ending 2008
Current Assets
Cash $1,447,000
Marketable Securities 451,600
Total Current Assets $12,987,700
Long-term Assets
Goodwill 4,082,000
Current Liabilities
Long-Term Debt $12,529,700


Total Long-Term Liabilities $14,053,700
Owner’s Equity
Retained Earnings $ 7,466,000
TOTAL OWNER’S EQUITY $ 9,959,000
Change in Long-term debt: $12,529,700 - $2,488,000 = $10,041,700
Solutions to Advanced Problems for Spreadsheet Application

1. Cash flow forecasting.
Regional Construction
Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul
Actual and Projected Housing Starts 18 16 11 7 12 12 16 20 32 32 30
Projected Cash Flows by Month 2010

JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV
Revenue from Sale of Homes $ 8,100,000 $ 7,200,000 $ 4,950,000 $ 3,150,000 $ 5,400,000 $ 5,400,000 $ 7,200,000 $ 9,000,000 $ 14,400,000 $ 14,400,000 $ 13,500,000
Cash Outflows
Raw Materials $ 2,340,000 $ 2,418,000 $ 3,120,000 $ 3,744,000 $ 5,304,000 $ 6,552,000 $ 7,332,000 $ 6,708,000 $ 5,928,000 $ 4,992,000 $ 4,056,000
Labor Costs $ 1,417,500 $ 1,165,500 $ 1,354,500 $ 1,638,000 $ 2,016,000 $ 2,772,000 $ 3,654,000 $ 3,969,000 $ 3,654,000 $ 3,150,000 $ 2,709,000
Fees and Licences $ 216,000 $ 288,000 $ 360,000 $ 576,000 $ 576,000 $ 540,000 $ 432,000 $ 396,000 $ 324,000 $ 216,000 $ 72,000
Legal and Title Transfer Costs $ 162,000 $ 162,000 $ 216,000 $ 270,000 $ 432,000 $ 432,000 $ 405,000 $ 324,000 $ 297,000 $ 243,000 $ 162,000
NET CASH FLOW $ 3,964,500 $ 3,166,500 $ (100,500) $ (3,078,000) $ (2,928,000) $ (4,896,000) $ (4,623,000) $ (2,397,000) $ 4,197,000 $ 5,799,000 $ 6,501,000
Negative Cash Flow Months yes yes yes yes yes yes
2. Pro forma income statements.

SW ZIA Company Pro Forma Statement Adjusted Pro Forma
2009 2010 2011 2012 2012 2010 2011
Percent
of
Income Statement Revenue
Revenue $ 12,345,000.00 100.00% $ 12,900,525.00 $ 13,481,048.63 $ 14,087,695.81 $ 12,900,525.00 $ 13,481,048.63 $ 14,087,695.81
Returns $ 185,175.00 1.50% $ 193,507.88 $ 202,215.73 $ 211,315.44 $ 193,507.88 $ 202,215.73 $ 211,315.44
NET REVENUE $ 12,159,825.00 98.50% $ 12,707,017.13 $ 13,278,832.90 $ 13,876,380.38 $ 12,707,017.13 $ 13,278,832.90 $ 13,876,380.38
Costs
COGS $ 5,555,250.00 45.00% $ 5,805,236.25 $ 6,066,471.88 $ 6,339,463.12 $ 5,805,236.25 $ 6,066,471.88 $ 6,339,463.12
Fixed Costs $ 1,975,200.00 16.00% $ 2,064,084.00 $ 2,156,967.78 $ 2,254,031.33 $ 1,975,200.00 $ 1,975,200.00 $ 1,975,200.00
SG& A $ 1,481,400.00 12.00% $ 1,548,063.00 $ 1,617,725.84 $ 1,690,523.50 $ 1,548,063.00 $ 1,617,725.84 $ 1,690,523.50
Depreciation $ 988,320.00 8.01% $ 1,032,794.40 $ 1,079,270.15 $ 1,127,837.30 $ 1,032,794.40 $ 1,079,270.15 $ 1,127,837.30
EBIT $ 2,159,655.00 17.49% $ 2,256,839.48 $ 2,358,397.25 $ 2,464,525.13 $ 2,345,723.48 $ 2,540,165.03 $ 2,743,356.46
Interest Expense $ 802,425.00 6.50% $ 838,534.13 $ 876,268.16 $ 915,700.23 $ 838,534.13 $ 876,268.16 $ 915,700.23
TAXABLE INCOME $ 1,357,230.00 10.99% $ 1,418,305.35 $ 1,482,129.09 $ 1,548,824.90 $ 1,507,189.35 $ 1,663,896.87 $ 1,827,656.23
Taxes $ 515,747.40 4.18% $ 538,956.03 $ 563,209.05 $ 588,553.46 $ 572,731.95 $ 632,280.81 $ 694,509.37
NET INCOME $ 841,482.60 6.82% $ 879,349.32 $ 918,920.04 $ 960,271.44 $ 934,457.40 $ 1,031,616.06 $ 1,133,146.86
Growth in
Net Inc. 4.50% 4.50% 4.50% 11.05% 10.40% 9.84%

Solutions to Mini-‐Case

Midwest Properties: Quarterly Forecasting
In this mini-case, both the importance and the techniques of cash flow budgeting are
emphasized by focusing on a business with highly seasonal cash flow patterns. The
nature of the business is such that students should have a quick intuitive grasp of the
issues. The case also requires construction of a pro-forma income statement based on the
budget. This exercise requires the student to think about the difference between cash
flows and accrual accounting measures.
1. Complete the following table of cash collections for the months of July, August,
and September. Use Table 12.1 as a model.
April May June July August September
Occupied Direct
Rental Units 150 150 100 75 50 150
Collections from
Direct Rentals $90,000 $90,000 $60,000 $45,000 $30,000 $94,500
Contract Rental
Payments 75,000 78,750
Damage
Assessments 0 0 7,500 5,000 5,000 2,500
Total Cash Flow $90,000 $90,000 $142,500 $50,000 $35,000 $175,750
2. Complete the following table of cash outflows for the months of July, August,
and September.

Total occupied
units 200 200 125 100 75 200
Payments for
Supplies and
Materials
Purchases $5,000 $5,000 $5,000 $15,000 $15,000 $15,000
Salaries 8,000 8,000 8,000 8,000 8,000 8,000
Labor 2,000 2,000 10,000 10,000 10,000 2,000
Payments for
Utilities 16000 16000 16000 10000 8000 6000

Payment on debt 150,000 150,000

Property Taxes 31,500 31,500
Insurance 15,500 15,500
Total cash
outflow $31,000 $31,000 $236,000 $43,000 $41,000 $228,000
3. Complete the following monthly cash flow estimate for the months of July,
August, and September. Use Table 12.4 as a model.

Beginning cash $25,000 $84,000 $143,000 $49,500 $56,500 $50,500
Incoming
Collections from
Direct Rentals $90,000 $90,000 $60,000 $45,000 $30,000 $94,500
Contract Rental
Payments 75,000 78,750
Damage
Assessments 0 0 7,500 5,000 5,000 2,500
Total In $90,000 $90,000 $142,500 $50,000 $35,000 $175,750

Outgoing
Supplies, Materials 5,000 5,000 5,000 15,000 15,000 15,000
Salaries 8,000 8,000 8,000 8,000 8,000 8,000
Labor 2,000 2,000 10,000 10,000 10,000 2,000
Payments for
Utilities 16,000 16,000 16,000 10,000 8,000 6,000
Payment on debt 150,000 150,000
Property Taxes 31,500 31,500
Insurance 15,500 15,500
Total Out 31,000 31,000 236,000 43,000 41,000 228,000
$ $ $ $
Net CF 59,000 $ 59,000 (93,500) $ 7,000 (6,000) (52,250)
Ending Balance $84,000 $143,000 $49,500 $56,500 $50,500 ($1,750)

4. Your monthly cash flow estimate should show a small cash shortage at the end of
September. Is this shortage a cause for concern? Based on Midwest’s collection
and payment patterns, would you expect a cash deficit or surplus by the end of
October? No calculations are required, but briefly explain your prediction.
The apartment buildings appear to generate strong positive net cash flows for 8
months a year and negative net cash flows for four months a year. October should
look like April and May, or a little better because of the 5% increase in rents. If so,
the deficit will disappear and Midwest should easily be able to repay any short-term
loans in October or November.
5. Construct a pro forma income statement for the properties managed by Dennis
for the third quarter (July, August, and September). Use Figure 12.4 as a model.
Show dollar amounts and percent of revenues. September's expenses include
$5,000 for supplies and materials and $16,000 for utilities. The payment on debt
includes $105,000 in interest, and $45,000 toward retirement of the principal.
Midwest's tax rate is 34%. Remember that the income statement is based on
accrual rather than cash flow principles.
Midwest Properties
Income Statement
Quarter Ending September 30 200X
Revenues Amount Percentage
Direct Rental $169,500 68.28%
Contract Rentals $78,750 31.72%
Total Revenues $248,250 100.00%
Expenses
Materials(1) 35,000 14.10%
Salaries and Labor 46,000 18.53%
Utilities(1) 30,000 12.08%
Property Taxes 31,500 12.69%
Insurance 15,500 6.24%
Total Expenses $158,000 63.65%
Operating Profit $90,250 36.35%
Interest Expense $105,000 42.30%
Taxable Income ($14,750) -5.94%
Taxes(2) (5,015) -2.02%
Net Profit ($9,735) -3.92%

(1) Materials and utilities expenses are for the month preceding cash payments.
(2) The "negative tax" assumes that losses will be applied to the preceding or following
periods or to
some other part of Midwest's
operations.
6. Does the period July through September fairly represent Midwest’s
profitability?
The income statement for the second quarter, July through September, covers the period
where anticipated revenues are lowest and expenses are highest. The period represents an
important part of Mid-West’s financial picture, but should be considered in the context of
an entire year.
Additional Problems with Solutions

1. Sales forecast. You have been asked to forecast sales for the coming year. Being
convinced that the compound average growth rate is the best way to forecast growth,
you collect data for the prior three years as listed below. Using the data compute the
compound growth rate for each of the years and then forecast next year’s sales by
using the two-year average growth rate (round off the growth rate to 2 decimal
places).
Year Sales
2007 $1,200,000
2008 $1,750,000
2009 $2,100,000
2010 ?
ANSWER (Slides 12-‐28 to 12-‐29)

g = (ending value / beginning value)1 / number of years – 1
2008 growth rate =[ (2008 Sales/2007 sales)] -1 = (1.75m/1.2m) -1
2008 growth rate = 45.83%
2009 growth rate = =[ (2009 Sales/2008 sales)] -1 = (2.1m/1.75m) -1
2009 growth rate 20%
2-year average growth rate = (2009 Sales/2007 Sales)1/2 =1= (2.1m/1.2m)1/2 -1
2-year average growth rate =32.29% (rounded at two decimals)
2010. Sales Forecast =$ 2,100,000*(1.3229) = $2,778,090
2. Sales receipts. The financial manager of Hearty Cereals is in the process of preparing
a cash budget for the first quarter of 2010. The firm typically sells 1/3 of its monthly
sales on cash terms and the rest on credit. An analysis of the accounts receivables
shows that on average 40% of the sales are collected in the next month, 50% in 60
days, 7% in 90 days, with the rest ending up as bad debts. As the manager’s assistant

it is your job to project the sales receipts for the first quarter of 2010, using the
monthly sales figures listed below.
2009 Sales
October $1,750,000
November $2,000,000
December $2,450,000
2010 Forecasted Sales
January $1,850,000
February $1,650,000
March $1,900,000

Oct Nov Dec Jan Feb March
1,750,00 2,000,00 2,450,00 1,650,00 1,900,00
0 0 0 1,850,000 0 0
Cash 1/3 0.33 $583,333 $666,667 $816,667 $616,667 $550,000 $633,333
Credit 2/3 0.67 $388,889 $444,444 $544,444 $411,111 $366,667 $422,222
Bad debt
3% of $11,666.
Credit sales 0.03 67 $13,333 $16,333 $12,333 $11,000 $12,667
40% in 30
days =
.4*Prior
month's
credit sales 0.4 $155,556 $177,778 $217,778 $164,444 $146,667
50%in 60
days=.6* 2
month
earlier sales 0.5 $194,444 $222,222 $272,222 $205,556
7% in 90
days=.07 *
3 month
earlier sales 0.07 $27,222 $31,111 $38,111
1
Total
Receipts $1,056,66
from Sales 7 $986,667 $985,556

3. Production cash outflow. The Creative Products Corporation produces its products
two months in advance of anticipated sales and ships to warehouse centers the month
before sale. The inventory safety stock is 15% of the anticipated month’s sale.
Beginning inventory in October 2009 was 120,000 units. Each unit costs $1.50 to
make. The average selling price is $2.50 per unit. The cost is made up of 60% labor,
30% materials, and 10% shipping (to warehouse). Labor is paid the month of
production, shipping the month after production, and raw materials the month prior to
production. What is the production cash outflow for the month of October 2009
production, and in what months does it occur? Assume that the sales forecast for
December 2009 is $2,500,000

Unit Sales forecast for December 2009 = $2,500,000/$2.5è1 million units
Safety stock required = 15% of December sales = 150,000 units
Beginning Inventory (October 2009) = 120,000 units
Production needed in October = Dec. ‘09 Sales + Safety Stock – Beg. Inventory
Production needed in October = 1,000,000 + 150,000 – 120,000=970,000 units
Cost of Production (Oct. 2009) = 970,000*$1.50= $1,455,000
Labor cost = .60*$1,455,000 = $873,000 èpaid in October 2009
Shipping cost = .10*$1,455,000 = $145,500 èpaid in November 2009
Material cost = .30*$1,455,000 = $436,500 èpaid in September 2009

4. Pro forma income statement. Given the income statement below for Imperial
Products Corporation for 2009, and a 20% growth in sales for 2010, prepare a pro
forma income statement.
Imperial Products Corp.
COGS 11,400,000
Depreciation
Expenses 2,300,000
EBIT $8,300,000
Interest Expense 1,200,000
Taxable Income $7,100,000
Taxes $2,414,000.00
Net Income $4,686,000.00

First divide each item by sales
Then multiply each proportion by forecast sales for 2010
Forecast sales = 28,800,000*(1.2) = $34, 560,000
% of 2010
2009 sales Forecast
Sales Revenue $28,800,000 100.00% $34,560,000
COGS 11,400,000 39.58% $13,680,000
SG&A Expenses 6,800,000 23.61% $8,160,000
Depreciation
Expenses 2,300,000 7.99% $2,760,000
EBIT $8,300,000 28.82% $9,960,000
Interest Expense 1,200,000 4.17% $1,440,000
Taxable Income $7,100,000 24.65% $8,520,000
Taxes $2,414,000.00 8.38% $2,896,800
Net Income $4,686,000.00 16.27% $5,623,200

5. Pro forma balance sheet. The Global Growth Corporation is planning for next year
and wants you to help them prepare a Pro Forma Balance Sheet for 2011. Their
current Balance Sheet is shown below along with some pre-determined changes in
key balance sheet accounts. How will you proceed?
The Global Growth Corporation
Current Assets 2010
Cash $1,500,000
Marketable Securities 830,000
Total Current Assets $8,280,000
Long-term Assets
Goodwill 3,500,000
Current Liabilities
Accounts Payable $5,125,000
Other Current Liabilities $1,350,000
Total Current Liabilities $6,475,000
Long-Term Debt $3,200,000
Other Long-term Liab. $1,650,000
Total Long-Term
Liabilities $4,850,000
Owner’s Equity
Common Stock $2,500,000
TOTAL OWNER’S
EQUITY $10,305,000

Next year, the firm will increase its Plant, Property, and Equipment (PPE) by $7,000,000
with a plant expansion. The inventories will grow by 70%, but accounts payables will
grow by 60%, and marketable securities will be reduced by 50% to help finance the
expansion. If all other asset accounts remain the same and long-term debt will be used to
finance the remaining costs of the expansion (no change in common stock or retained
earnings), prepare a pro forma balance sheet for 2011. How much additional debt will be
estimated using this pro forma balance sheet?

i.e. PPE will be $8,500,000+$7,000,000 = $15,500,000
Inventories = 70% higher è(1.7)*2500000=4,250,000
Accounts payables = 60% higher è5,125,000*1.6=8,200,000
Marketable Securities = 50% lower = 830,000*.5 è415,000

2011
Current Assets 2010 proforma
Cash $1,500,000 $1,500,000
Marketable Securities 830,000 415000
Accounts Receivable 3,450,000 3,450,000
Inventories 2,500,000 4250000
Total Current Assets $8,280,000 $9,615,000
Long-term Assets
$15,500,00
Plant, Property & Equip. $8,500,000 0
Goodwill 3,500,000 3,500,000
Intangible Assets 1,350,000 1,350,000
$13,350,00 $20,350,00
Total Long-term Assets 0 0
$21,630,00 $29,965,00
TOTAL ASSETS 0 0
Current Liabilities
$8,200,000.
Accounts Payable $5,125,000 0
Other Current Liabilities $1,350,000 $1,350,000
Total Current Liabilities $6,475,000 $9,550,000
Long-Term Debt $3,200,000 $8,460,000
Other Long-term Liab. $1,650,000 $1,650,000
Total Long-Term
Liabilities $4,850,000 $10,110,000
TOTAL LIABILITIES $11,325,000 $16,585,000
Owner’s Equity
Common Stock $2,500,000 $2,500,000
Retained Earnings $7,805,000 $7,805,000
TOTAL OWNER’S
EQUITY $10,305,000 $10,305,000
TOTAL LIABILITIES &
OWNER’S EQUITY $21,630,000 $29,965,000
CHANGE IN LONG_TERM DEBT =$8.46m -$3.2m =
$5.26 m

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Chapter

This list can serve as a guide when preparing a cash budget.

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12.3 Cash Outflow from Production (Slide 12-­‐11)

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12.4 The Cash Forecast: Short-­‐Term

12.5 Planning with Pro Forma

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Key calculations include:

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Prepping for Exams

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5. Sales receipts. National Beverage Company anticipates the following first-quarter

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Not collected (bad debt) = $2,100,000 × 0.40 × 0.02 = $16,800

6. Sales receipts. California Cement Company anticipates the following fourth-quarter

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Collected in November = $1,800,000 × 0.90 × 0.60 = $972,000

FROM October Receipts November Receipts December Receipts

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11. Pro forma balance sheet.

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National Beverage Company

12. Pro forma balance sheet.

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Other Long-term Liab. $ 1,524,000

Solutions to Advanced Problems for Spreadsheet Application

Projected Cash Flows by Month 2010

2. Pro forma income statements.

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Solutions to Mini-­‐Case

April May June July August September

Total Cash Flow $90,000 $90,000 $142,500 $50,000 $35,000 $175,750

April May June July August September

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Payment on debt 150,000 150,000

April May June July August September

Total In $90,000 $90,000 $142,500 $50,000 $35,000 $175,750

Ending Balance $84,000 $143,000 $49,500 $56,500 $50,500 ($1,750)

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Additional Problems with Solutions

ANSWER (Slides 12-­‐28 to 12-­‐29)

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ANSWER (Slides 12-­‐30 to 12-­‐31)

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ANSWER (Slides 12-­‐32 to 12-­‐33)

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ANSWER (Slides 12-­‐34 to 12-­‐35)

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ANSWER (Slides 12-­‐36 to 12-­‐41)

12.3 Cash Outflow from Production (Slide 12-‐11)

12.4 The Cash Forecast: Short-‐Term

Solutions to Mini-‐Case

ANSWER (Slides 12-‐28 to 12-‐29)

ANSWER (Slides 12-‐30 to 12-‐31)

ANSWER (Slides 12-‐32 to 12-‐33)

ANSWER (Slides 12-‐34 to 12-‐35)

ANSWER (Slides 12-‐36 to 12-‐41)