414 CHAPTER 11 Financial Planning and Forecasting Financial Statements
of cost to sales, and the ratio dropped to 87.2 percent in 2002. The table also shows
the historical average, which in this case is the average of the two prior years. The last
column shows the ratio of cost to sales for the industry composite, which is the sum of
the financial statements for all firms in the industry. Note that MicroDrive has im-
proved its cost/sales ratio, but it still is higher than the industry average.
The table also shows the ratio of depreciation to net plant and equipment. Because
depreciation depends on the asset base, it is more reasonable to forecast depreciation
as a percent of net plant and equipment rather than of sales.
Many other items on MicroDrive’s balance sheets will also increase with sales. The
company writes and deposits checks every day. Because managers don’t know exactly
when all of the checks will clear, they can’t predict exactly what the balance in their
checking accounts will be on any given day. Therefore, they must maintain a balance of
cash and cash equivalents (such as very short-term marketable securities) to avoid over-
drawing their accounts. We discuss the issue of cash management in Chapter 16, but for
now we simply assume that the cash required to support the company’s operations is
proportional to its sales. Table 11-1 shows the ratio of cash to sale for the past two years,
as well as the historical average and the industry composite ratio. All of the remaining
pro forma balance sheet ratios, which we discuss below, also are shown in Table 11-1.
Unless a company changes its credit policy or has a change in its customer base,
accounts receivable should be proportional to sales. Furthermore, as sales increase,
firms generally must carry more inventories. Chapter 16 discusses inventory manage-
ment in detail, but for now we assume that inventory will also be proportional to
sales.
It might be reasonable to assume that cash, accounts receivable, and inventories
will be proportional to sales, but will the amount of net plant and equipment go up
and down as sales go up and down? The correct answer could be either yes or no.
When companies acquire plant and equipment, they often install more capacity than
they currently need due to economies of scale in building capacity. For example, it was
economically better for GM to build its Tennessee Saturn plant with a capacity of
about 320,000 cars per year than to build a plant with a capacity equal to the initial
projected sales of 50,000 and then add capacity as sales expanded. Saturn’s sales were
far below 320,000 units for the first few years of production, so it was possible to in-
crease sales during those years without increasing plant and equipment. Moreover,
even if a plant is operating at its maximum rated capacity, most companies can produce
additional units by reducing downtime for scheduled maintenance, by running ma-
chinery at a higher than optimal speed, or by adding a second or third shift. There-
fore, at least in the short run, companies may not have a very close relationship be-
tween sales and net plant and equipment.TABLE 11-1 Historical Ratios for MicroDrive Inc.Actual Actual Historical Industry
2001 2002 Average Average
Costs to sales 87.6% 87.2% 87.4% 87.1%
Depreciation to net plant and equipment 10.3 10.0 10.2 10.2
Cash to sales 0.5 0.3 0.4 1.0
Accounts receivable to sales 11.1 12.5 11.8 10.0
Inventory to sales 14.6 20.5 17.5 11.1
Net plant and equipment to sales 30.5 33.3 31. 933.3
Accounts payable to sales 1.1 2.0 1.5 1.0
Accruals to sales 4.6 4.7 4.6 2.0See Ch 11 Tool Kit.xls
for details.