Preparing Proforma Financial Statements

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Preparing Proforma Financial Statements
Lecture 5

• Completing the budget preparation process

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Proforma Income Statement

• Proforma IS can be prepared once we have budgeted
  sales, production, overhead and other support
  costs
• Proforma means it is a forecast and not yet a
  fact

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Interrelated Budgets
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Watch out for

• If disbursement budget rather than an expense
  budget is used to prepare proforma income
  statement

• Add noncash expenses
• Remove cash outlays for long-lived assets,
  repayment of long-term debt, dividends, etc.

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Proforma Income Statement

• We may need to complete the cash budget before
  finalizing proforma I/S
• Interest expense
• Interest revenue and dividends from investments
• Income taxes estimates will be affected if
  interest expense and investment income are added
  to operating budgets

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Proforma Balance Sheet

• The last statement to be prepared
• Determine ending balances in A/R, A/P,
  Inventory, etc. from cash budget
• Determine increases in PPE from disbursements
  for capital expenditures
• Compute accd depreciation by adding depreciation
  expense from proforma I/S
• Compute ending Retained Earnings by adding
  proforma net income less planned dividends

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Who prepares proforma financial statements?
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At the minimum

• The cash budget is ESSENTIAL to avoid growing the
  company into bankruptcy!
• Remember True Sound example in module

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Beyond Budgeting

• Is traditional budgeting the only way to go?

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Traditional Budgeting
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Beyond Budgeting
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Rolling forecasts whats needed

• A focus on fewer data elements and less
  information
• Cascading of firm top-down targets
• Effective and timely management reporting
  (typically technology enabled)
• Philosophical change on how to manage, view and
  compensate performance

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Rolling forecasts are . . .

• Appropriate when
• Planning, budgeting and forecasting are
  integrated
• Company faces highly dynamic external environment

• Inappropriate when
• Existing system is not integrated
• Corporate culture demands detailed information
  and is slow to react

Reference Omar Aguilar, How Strategic
Performance Management is Helping Companies
Create Business Value, Strategic Finance, January
2003.
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Lessons Attributes

• Technical, Behavioral and Cultural Issues

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Before we continue, lets review

• The objectives of budgeting
• Attributes
• Technical attributes
• Cultural attributes
• Behavioral attributes
• Lessons learned

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Objectives of budgeting

• To force planning on a regular basis
• To provide a basis for evaluating performance
• To achieve coordination of activities through
  communication about objectives

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Lets review the attributes

• This material is at the end of each of the
  modules youve used in Acct 310 and Acct 311

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Technical Attributes

• Decision Relevance
• Process Understanding

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Cultural Behavioral

• Cultural similar to those we discussed for
  capital budgeting
• Behavioral impact of budgeting can be both
  positive and negative

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Budgets Behaviors

• The impact of budgets on people
• Means of coercion
• Bad attitudes (low morale)
• Too tight or too loose
• Participation might lead to commitment

• The impact of people on budgets
• Padding budget
• Over-estimate costs
• Under-estimate revenues
• Focus on short-term instead of long-term
  strategic interests

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Lessons Learned

• See pages 78-79 in text for a list of lessons
  learned good review material!
• For example key points include
• Annual budget is part of long-term strategic
  planning process
• Budget is driven by sales forecast
• Budgeting involves many individuals and requires
  substantial time and effort

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Practice Problems Set 9

• Ex 7 and Ex 8 two cases on page 84
• Essay questions
• Prepare to discuss in class
• Come with brief written notes regarding solution
• Nothing to turn in
• Due Tues, Mar. 1
• Preparation earns attendance points!

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The Project

• You should now be ready to start work on
  sensitivity analysis.
• I suggest you use the Excel sheet with formulas
  that I sent by email if there is any question as
  to whether your own has all the correct formulas.
• The completed project is due March 3 (Thursday)
  but will be accepted through Tuesday March 8 by
  1200 Noon
• Since I want to post the solution so you can
  study it before the exam, NO LATE ASSIGNMENTS can
  be accepted

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Supplemental Materials

• Lessons Learned - Budgeting

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Lessons Learned (from module)

• Annual budgets are part of an organizations
  long-term strategic and profit plans. Budgets
  link short-term management objectives to
  long-term strategic objectives of an
  organization.
• Annual budgets are an early warning system for
  identifying problems that may derail efforts to
  achieve strategic goals
• Annual budgets take 5-7 months to prepare and
  involve many organizational participants at all
  levels

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Lessons Learned (from module)

• Annual budgets take 5-7 months to prepare and
  involve many organizational participants at all
  levels
• The sales forecast is the driver that starts
  detailed budget preparations
• Budget preparation requires activity analysis,
  estimation of resources needed for activities,
  and translation of resources into costs

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Lessons Learned (from module)

• Budgets reflect resources acquired and not
  resources needed. Organizations acquire excess
  resources to meet long-term needs, because of
  cost indivisibility, or because of an inability
  to operate at full capacity.
• Budgets help achieve effective resource
  allocation by funding strategically necessary
  activities

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Lessons Learned (from module)

• Well designed budgeting systems can motivate
  desired behaviors and reinforce ethical values of
  information sharing
• A budget process can encourage dysfunctional
  behaviors, such as budgetary slack, and create
  ethical dilemmas by overemphasizing budget
  accomplishment