16: Financial PlanningexampleTable 16.1 shows the 2016 balance sheet and income
statement for Walk-A-Bout Shoes. We will use this
historical information plus some assumptions to
generate pro forma financial statements for 2017.
We make the following assumptions:
1 Walk-A-Bout Shoes plans to increase sales by 30%
in 2017.
2 The company’s gross profit margin will remain at
35%.
3 Operating expenses will equal 10% of sales, as
they did in 2016.
4 Walk-A-Bout Shoes pays 10% interest on both its
long-term debt and its credit line.
5 Walk-A-Bout Shoes will invest an additional $20
million in fixed assets in 2017, which will increase
depreciation expense from $10 million to $15
million in 2017.
6 The company faces a 35% tax rate.
7 The company plans to increase cash holdings by
$1 million next year.
8 Accounts receivable equal 8.5% of sales.
9 Inventories equal 10% of sales.
10 Accounts payable equal 12% of cost of goods
sold.
11 The company will repay an additional $5 million in
long-term debt in 2017.
12 The company will pay out 50% of its net income
as a cash dividend.
13 The company plans to use its credit line as the
plug figure.
From this set of assumptions and the data
in Table 16.1, we can construct the pro forma
statements for 2017 shown in Table 16.2. To build
the pro forma income statement, we first note
that Walk-A-Bout Shoes’ sales increase to $325
million. Cost of goods sold and operating expenses
increase 30% over the previous year (hitting the
percentage-of-sales assumptions above). This is true
because gross profit margin is assumed to remain
at 35%, meaning that the cost of goods sold must
increase by the same percentage as sales. Similarly,
since operating expenses will remain at 10% of
sales, the same argument holds true – they will
also increase by 30%. Interest expense is a tricky
item. To begin, assume that Walk-A-Bout Shoes will
maintain a $5 million balance on its credit line and
will retire the current portion of long-term debt ($5
million). This means that its total outstanding debt
during 2017 will be $25 million. At 10%, interest
expense should equal $2.5 million. (We shall see
that this assumption may change as we continue to
build the statements.)
Putting these figures together in the pro forma
income statement, we see that Walk-A-Bout Shoes
earns a net profit of just over $41 million, half of
which it pays out to shareholders.
Next, we build the pro forma balance sheet.
Cash is given at $11 million ($10 million in 2016
plus a $1 million increase). Accounts receivable
and inventory increase with sales as stated, so
current assets increase to $71,125 million. With the
additional investment in fixed assets of $20 million
(less 2017’s depreciation expense), net fixed assets
grow to $65 million. Total assets equal $136,125
million.TABLE 16.1 FINANCIAL STATEMENTS FOR 2016 ($ IN THOUSANDS)Walk-A-Bout Shoes balance sheet as at 31 December 2016
Assets Liabilities and equity
Cash $ 10,000 Accounts payable $ 19,500
Accounts receivable 21,250 Credit line 5,000
Inventory 25,000 Current long-term debt 5,000
Current assets $ 56,250 Current liabilities $ 29,500
Gross fixed assets $ 80,000 Long-term debt 20,000
Less: Accumulated depreciation 20,000 Ordinary shareholder equity 20,200
Net fixed assets $ 60,000 Retained earnings 46,550
Total assets $116,250 Total liabilities and equity $116,250
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