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Corporate finance essay Essay

Proforma financial statement is a statement showing the financial results that would reflect and emphasize on future projected results. Proforma statements are used in following ways,

A. Business Planning

There statements are used as tools for planning and control purposes. The business arranges items side by side to the operating and financial statement and analyzes projected results of competing projects to choose the one the business will concentrate on.

The statements (Proforma statements) enhance management in,

ü  Pinpointing assumption that generate different scenarios

ü  Developing projections for budget

ü  Assembling results in income statement forecasts

ü  Translating data to cash flow forecast

ü  Comparing balance sheet results

ü  Use ratio analysis against similar companies

ü  Deliberate on the proposed decision

The management uses the procedures to choose budget alternative

B) Financial Modeling

Through the proforma statements we get data for calculating financial ratios to perform mathematical calculations. They help achieve firm’s goal if they are designed to.

ü  Test goals and plans of organization

ü  Give full finding on the organization

Through study of impact of variables the financial modeling tests assumption creating and how they relate to proposed plans.


 For statement prepared for stakeholders like shareholders, creditors profoma statements can be used. SEC requires profoma statement be provided when filling registration is been done

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or making any proxy statements SEC require for any major changes a proforma statement be prepared concerning those changes. The changes include;

a)      Change in accounting methodology

b)      Change in accounting principles

c)      Change in accounting estimates

d)     Change in tax coding


The steps that are involved in financial forecasting are

Projecting the firms sales
This is also like planning for better performance in future, the target sales are made and communicated to sales executive.

Projecting assets needed to support the sales
These are materials that will help achieve the projected sales. These are expenses and asset.

Determine internally generated resources
This includes looking at resources this includes looking at resources already in firm that are going to support projected funds

Project external funds needed
After determining internally generated funds the funds remaining are from outside

Decide on how to raise funds
The methods to acquire extra financing are calculated. This may include debts         e.t.c

See effects of plan on ratios and stock price decided to know if they are going to have advanced effects or projection on the ratios and stock price is decided to know if they are going to have advance effects or positive effects.

AFN= required – liabilities = change in retained earning

Change in liability = 0.050 x 500 million

                                         = 25,million

Changing in retained        = 0.027 x 2500 million x 0.6


                                         = 405

AFN= 250- 25- 30.4

                  = 184/50


a.       Sales increase

If sales increase we get more funds for the organization-generated internally hence the AFN would decrease.

b.      Dividend payout ratio increase

Payment of dividends results to funds outflow hence there would increase          outflow thus AFN increase

c).   Profit margin increase

Increase in point margin results to decrease in AFN since we shall general funds internally

d) Capital intensely ratio increases

This is an amount asset required per dollar of sales thus the higher the capital intensity ratio the higher the AFN.

             e) SEC beings paying creditors

This means resources are moving out of the company hence AFN shall be higher.


First step, you have to focast on the future sales. This serves as the base of estimating future expenses assets and liabilities the methods involves following steps

ü  Establish items that vary with sales and calculate percentage of sales for each item

ü  For items that don’t vary with sales list down the current balances

ü  In balance sheet calculate future retained earnings calculate percentage sales of net income and divideds

ü  By based on assumption the company is operating to fill capacity.

Financial requirement 2005
Income statement in million dollars

                                                           2004                                       2005

Sales                                                              2000                                       2500

Cost of goods sold                                        1200                                       1500

Sales general and administrative costs          700                                         875

Earning before interest and tax                     100                                         125

Interest                                                                      10                                           20

Earning before tax                                         90                                           105

Tax at 40%                                                    36                                           42

Net income                                                    54                                           63

divinces                                                         21.6                                        25.2

Transfer of retain earnings                             32/40                                      37/80

Balance sheet

                                                           2004                without AFN                    with afn

CASH                                                20                               25                               25

Account receivable                            240                             300                             300

Inventories                                         240                             300                             300

                                                           500                             625                             625

Net plant and equipment                   500                             625                             625

Total assets                                        1000                            1250                           1250

Liabilities and equality

Accounts payable and accrual           s          100                             125                             125

Notes payable                                    100                             100                             193.6

Total current liabilities                       200                             225                             318.6

Long term bonds                               100                             100                             193.6

Total liabilities                                   300                             325                             512.2

Common stock                                   500                             500                             500

Retained earning                                200                             237/80                        237/80

Total liabilities and equity                 1000                           1062/80                      1250

                                   ====                                                              ====

Required assets                                                                     1250

Specified sources of financing                                              1062/80

Additional fund needed                                                       187/20



In percentage of sales approach only the variables that are affected by sales are considered to make forecast, while in equation forecasting, all the items in financial statements are used. The equation approach is more accurate since it considers all variables.


2004                          Forecast

Net operating working capital                                   400                                         500

Total operating capital                                   900                                         1125

NOPAT                                                         60                                           75

Investment in capital                                                                                    225

F.CF                                                                                                             (150)

Return on invested capital                                                                6.67%    14%

Key ratios                              2004                            2005                industry

Profit margin                          2.7%                           2.52%             4.0%

Return on equity                    7.71%                         8.54%             15.6%

D.SO                                      43.80                          43.80               32

Inventory turnover                 8.33                            8.33                 11.00

Fixed asset turnover               4.0                              4.0                   5.0

Debt/assets                             30%                            40.98%           36%

TIC                                         10                               6.25                 9.4

Current ratio                           2.5                              1.96                 3.0

C) Proposed improvements

INPUTS                                            BEFORE                   AFTER

DSO                                                   43.80                          32.61

Account receivable /sales                   12%                            8.77%

Inventory turnover                             8.33                             11.00

Inventory/sales                                   12%                            9.09%

SGA/Sales                              35%                            33%

AFN                                       187.2                          15.2

F.CF                                       -150                            33.5

ROIC                                     6.7%                           10.8%

ROC                                       85%                            12.3%


Capacity         =                    actual sales
Sales                                             % age of capacity

=         2000


Capacity sales= 2.666.67

ii) Previously focasted AFN =                      187.2

Focasted additional fixed assets                   125

Thus AFN if there is excess capacity                        62/20


             I.      Economies of scale in use of assets

When a company is enjoying a large portfolio of asset, as the production increase, the cost per machine hour decreases thus decreasing the outflow of funds-this makes a saving and hence AFN equation is distorted.

          II.      Lumpy assets

Lumpy assets are that that don’t have a spare capacity. The assets are already congested and adding more to them shall result to overstretching them. Thus this would distort the accuracy of the AFN equation.


Brealey, Richard A.(2000). Principles of Corporate Finance. NY: McGraw Hill.

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