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Procedural Ordering

Pro Forma Financial Statement Analysis Review Session #2 Created by Patrick Badolato Accounting Doctoral Student Duke University’s Fuqua School of Business. Procedural Ordering.

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Procedural Ordering

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  1. Pro FormaFinancial Statement AnalysisReview Session #2Created by Patrick BadolatoAccounting Doctoral StudentDuke University’s Fuqua School of Business

  2. Procedural Ordering Assumptions can be used as long as they make sense in terms of logic, economics (think real business decisions) and accounting • Sales/Revenue • Expenses directly related to Sales • Balance Sheet items related to Sales • Balance Sheet items related to other Balance Sheet items • Expenses related to the Balance Sheet • Balance Sheet plugged item (you should only need to plug one item) • The Statement of Cash Flows • Note, I am covering how to do pro formas as an assignment, this is only a guide—not an exact method for doing this in the real world

  3. Income Statement • Begin with Revenue • Determine a Growth Rate • Consider past performance, industry trends, competitors, new products or offerings, R&D, and other relevant information, such as assets, affects revenues • Expenses • Determine what drives each expense item • e.g. CGS and most expenses are based on sales • Interest expense should be based on debt • Depreciation should be based on PPE • Tax Expense is based on the given (or determined) tax rate • On your first pass through, hold off on the expense items that are based on B/S numbers

  4. The Balance Sheet • Many accounts will be based on the sales number • (This makes sense as there is a relationship between sales and assets) • Unless other assumptions prevail, you can use the prior year(s) to determine the asset amount as a % of Sales

  5. Balance Sheet Throughout, keep in mind where you will make the “plug”—the plug is the final number that enables the B/S to balance What makes sense? Should cash have a great degree of fluctuation? What do companies do if they need cash? What do they do if they have “excess” cash? Why would cash “sit” on the B/S? Consider (realistic) Debt or Equity Choices

  6. Balance Sheet • Debt • If a firm needs extra cash to run its business it can (usually) obtain more debt • (journal entry is debit cash credit debt) • If a firm has “extra” cash they can pay down their debt • (journal entry is credit cash and debit debt) • Many firms have relatively liquid access to debt markets (currently do we see an exception?)

  7. Balance Sheet • Equity • If a firm needs extra cash it can go to the equity market and issue stock (IPO, SEO) • (journal entry is debit cash credit common stock) • If a firm has extra cash they can buy back their stock (it becomes treasury stock) or they can pay dividends • (journal entry is credit cash and debit retained earnings for a dividend payment) • Realistically, firms do not have constant access to equity markets (but this option is common for major changes/growth—i.e. an IPO) • Recently ExxonMobil repurchased a significant amount of its stock

  8. Statement of Cash Flows • Do not begin until the B/S and the I/S are complete, balanced and finalized • The SCF is determined in the exact same manner as when the B/S and the I/S are directly provided (as taught in review session #1).

  9. Things to Watch out for… Watch out for circular references in excel Be aware of the line item that you chose to plug (equity, dividends, debt) Make sure the Balance Sheet balances Make sure the Beginning Balance Retained Earnings + NI –Dividends = an Ending Balance that allows the B/S to balance Make sure the change in Cash on the SCF matches the B/S

  10. have fun…

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