Chapter 10

The Financial Plan

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

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Learning Objectives

• To understand the role of budgets in preparing pro forma statements

• To understand why positive profits can still result in a negative cash flow

• To learn how to prepare monthly pro forma cash flow, income, balance sheet, and sources and applications of funds statements for the first year of operation

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Learning Objectives

• To explain the application and calculation of the break-even point for the new venture

• To illustrate the alternative software packages that can be used for preparing financial statements

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Operating and Capital Budgets

• Sales budget - An estimate of the expected volume of sales by month• Determined on the basis of sales forecasts• Manufacturing ventures - Costs of internal

production and subcontracting are compared• Includes ending inventory estimation

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Table 10.1 - A Sample Manufacturing Budget for First Three Months

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Operating and Capital Budgets

• Operating costs• Fixed expenses incurred regardless of sales

volume• Variable expenses must be linked to strategy in the

business plan• Capital budgets - Provide a basis for evaluating

expenditures

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Table 10.2 - A Sample Operating Budget for First Three Months ($000s)

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Pro Forma Income Statements

• Pro forma income: • Projects net profit calculated from projected

revenue minus projected costs and expenses.• Starts by calculating monthly sales• Projects operating expenses for each of the

months during the first year• Projections should be made for years 2 and 3 as

well

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Table 10.3 - MPP Plastics Inc., Pro Forma Income Statement, First Year by Month ($000s)

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Pro Forma Cash Flow

• Projected cash available calculated from projected cash accumulations minus projected cash disbursements

• Not the same as profit• Sales may not be regarded as cash• Profit as a measure of success may be deceiving if

there is significant negative cash flow• Can be projected using the indirect or direct

method

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Table 10.5 - Statement of Cash Flows: The Indirect Method

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Table 10.6 - MPP Plastics Inc., Pro Forma Cash Flow, First Year by Month ($000s)

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Pro Forma Balance Sheet

• Summarizes the projected assets, liabilities, and net worth of the new venture

• Consists of:• Assets • Liabilities • Owner’s equity: Amount invested and/or retained from

the venture operations

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Table 10.7 - MPP Plastics Inc., Pro Forma Balance Sheet, End of First Year ($000s)

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Break-Even Analysis

• Breakeven: Volume of sales where the venture neither makes a profit nor incurs a loss

• The break-even formulaB/E(Q) = __________TFC______________

SP-VC/unit (marginal contribution)• Weakness - Determining if a cost is a fixed or

variable

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Table 10.8- Determining Break-Even Formula

*Fixed costs are those costs that, without change in present productive capacity, are not affected by changes in volume of output.† Variable costs are those that are affected in total by changes in volume of output.‡ The variable costs per unit is all those costs attributable to producing one unit. This cost is constant within defined ranges of production.

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Figure 10.1 - Graphic Illustration of Breakeven

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Pro Forma Sources and Applications of Funds

• Summarize all the projected sources of funds available and how these funds will be disbursed

• Sources of funds• Operations• New investments• Long-term borrowing• Sale of assets

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Pro Forma Sources and Applications of Funds

• Uses• Increase assets• Retire long-term liabilities• Reduce owner or stockholders’ equity• Pay dividends

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Software Packages

• Track financial data and generate financial statements

• Present different scenarios and assess their impact on the pro forma statements