PART 5: SPECIAL TOPICS
Walk-A-Bout Shoes pro forma income statement for
the year ended 31 December 2017
Sales $325,000
Less: Cost of goods sold 211,250
Gross profit $113,750
Less: Operating expenses 32,500
Less: Interest expense 2,500
Less: Depreciation 15,000
Pre-tax income $ 63,750
Less: Taxes 22,312
Net income $ 41,438
Dividends $ 20,719On the liabilities/equity side, accounts payable
increase with sales, the current portion of long-term
debt remains at $5 million, total long-term debt
declines by $5 million, and ordinary shareholder
equity does not change. The retained earnings figure
for 2017 equals the 2016 figure plus half of 2017’snet income. Walk-A-Bout Shoes uses its credit line
as the plug figure. That is, given all the assumptions
so far, the credit line will decline from $5 million to
$3,306 million, because otherwise the assets will not
balance with the sum of liabilities and equity.
Yet, because the credit line declines, our
estimate of interest expense in the income
statement is too high. Recall that we predicted
interest expense of $2.5 million based on a 10%
interest rate on total outstanding debt of $25
million. The pro forma balance sheet now shows
long-term and short-term debt of just $23,306
million, so interest expense falls to $2.33 million.
A decline in interest expense leads to an increase
in profits and retained earnings. Higher retained
earnings means that the company can reduce the
line of credit even more, and the cycle repeats. To
find the amount of borrowing on the credit line and
the corresponding interest expense that reconciles
the balance sheet with the income statement, an
analyst would need to use an iterative approach,
such as Excel’s ‘Solver’ feature.exampleWalk-A-Bout Shoe income statement as at 31 December 2016
Sales $250,000
Less: Cost of goods sold 162,500
Gross profit $ 87,500
Less: Operating expenses 25,000
Less: Interest expense 3,000
Less: Depreciation 10,000
Pre-tax income $ 49,500
Less: Taxes 17,325
Net income $ 32,175TABLE 16.2 PRO FORMA FINANCIAL STATEMENTS FOR 2017 ($ IN THOUSANDS)Walk-A-Bout Shoes pro forma balance sheet as at 31 December 2017
Assets Liabilities and equity
Cash $ 11,000 Accounts payable $ 25,350
Accounts receivable 27,625 Credit line 3,306
Inventory 32,500 Current long-term debt 5,000
Current assets $ 71,125 Current liabilities $ 33,656
Gross fixed assets $100,000 Long-term debt 15,000
Less: Accumulated depreciation 35,000 Ordinary shareholder equity 20,200
Net fixed assets $ 65,000 Retained earnings 67,269
Total assets $136,125 Total liabilities and equity $136,125