Download Total liabilities and equity

Projecting Consistent Financial
Statements
1
Objective: Completing the Pro Forma
Projections
In the last chapter, only the items we needed for
calculating free cash flow were projected. The
remaining financial statement items reflect
managerial decisions about how to finance
the assets required for operations. They
reflect financial policies rather than
operations.
2
Three Categories of Policies
• Cash management
• Capital structure
• Dividends
3
Financial Policy Decisions
• How much debt?
– Short-term? Long-term?
• How much equity?
• Dividends? Repurchases?
• How much marketable securities?
4
Long-Term Debt
• Usually decided by senior managers or board
of directors
– Many companies maintain debt at a relatively
constant proportion of total assets.
– This chapter models debt as a percentage of
operating assets (later chapters show alternative
debt policies).
5
Common Stock
• Issuing common stock is expensive, so
companies do it infrequently.
– The assumption is that Van Leer will not issue
common stock. Instead, it will fund its equity
needs by retaining its profits rather than paying
them out as dividends.
6
Dividends
• Board of directors sets dividend payments.
– Within bounds, dividends can be just about any
level at all.
– In this chapter, dividends are assumed to grow at
their historical rate.
– Later chapters show alternative dividend policies.
7
Balancing the Balance Sheet
• The “plug approach”
– Based on the assumed financial policies, there are
only two items left to make the balance sheet
balance.
• Short-term investments
• Short-term debt
8
How to Make the Balance Sheet
Balance
• Suppose projected total assets (ignoring shortterm investments) are greater than projected
total liabilities and equity (ignoring short-term
debt).
• Then there are not enough sources of funding
to pay for the planned asset purchases.
9
How to Make the Balance Sheet
Balance
• Must either:
– Change financial policy (i.e.,issue more debt or
equity, or pay less dividends).
– Buy fewer operating assets.
– Liquidate short-term investments.
10
How to Make the Balance Sheet
Balance
• Board of directors sets financial policy,
especially with respect to dividends, long-term
debt, and issuing equity.
• Reducing operating assets will hurt firm, since
these are the operating assets required to
support the projected level of sales.
11
How to Make the Balance Sheet
Balance
• Assume firm will:
– First liquidate any short-term investments;
– Then borrow using short-term debt to cover any
remaining shortfall.
12
Plug
• In this case, short-term debt is used to “plug”
the shortfall in liabilities.
13
How to Make the Balance Sheet
Balance
• Suppose projected total assets (ignoring shortterm investments) are less than projected
total liabilities and equity (ignoring short-term
debt).
• Then the firm has more financing than it
needs to implement its operating plan.
14
How to Make the Balance Sheet
Balance
• Assume firm will:
– First pay off any short-term debt;
– Then put any remaining funds into short-term
investments.
15
Plug
• In this case, short-term investments (also
called marketable securities) are used to plug
the shortfall in assets.
16
Completing the Income Statement
•
•
•
•
Project interest income/expense
Project dividends
Project long-term debt level
Plug short-term debt or short-term
investments to make balance sheet balance
17
Interest Income and Expense
• Interest expense depends on debt, but debt changes
throughout the year.
– Base it on beginning of year debt in this chapter. Chapter 8
explains how to base interest on the average level of debt
during the year.
• Interest income depends on short-term investments,
but this changes throughout the year too. In this
chapter, base it on beginning of year short-term
investments.
18
Explicit Non-operating Assumptions
•
Interest rates:
– 3% on short-term investments
– 9% on all debt
•
Dividends were $16 million in 2014. They
will grow by 10% to $17.6 million in 2015.
19
More Non-operating Assumptions
• Long-term debt will decline from 18.9% of operating
assets to 15% of operating assets.
• Projected operating assets = cash + accounts
receivable + inventories + net PPE = $33.3 + $84.4 +
$122.1 + $377.4 = $617.2 million. (See Chapter 5.)
• Projected long-term debt = 0.15($617.2) = $92.6
million.
20
Assumptions so far….
2013
Ratios to calculate operating profit
Sales growth rate
na
COGS / Sales
61.9%
SGA / Sales
23.8%
Depreciation / Net PPE
14.9%
Ratios to calculate operating capital
Cash / Sales
5.0%
Inventory/ Sales
8.9%
Accts. Rec. / Sales
7.7%
Net PPE / Sales
32.7%
Accts. Pay./ Sales
9.5%
Accruals / Sales
1.0%
2014
2015 Avg.
Proj.
12.4% 5.9% 9.2% 11.0%
66.2% 64.0% 64.0% 62.5%
21.7% 21.5% 22.3% 22.5%
15.0% 15.0% 15.0% 15.0%
5.0% 5.0% 5.0% 3.0%
9.0% 10.0% 9.3% 11.0%
7.4% 7.5% 7.6% 7.6%
29.7% 30.0% 30.8% 34.0%
7.4% 7.5% 8.1% 8.1%
1.1% 1.0% 1.0% 1.0%
21
Assumptions so far….
Ratios to calculate operating taxes 2013 2014 2015
Tax Rate (Taxes/EBT)
40.0% 39.1% 40.0%
Dividend and debt ratios
Dividend policy: growth rate
na -8.3% 45.5%
Long-term Debt / operating assets 11.8% 17.4% 18.9%
Interest Rates
Interest rate on short-term invest.
na 10.0% 0.0%
Interest rate on debt
na 8.7% 8.8%
Avg.
Proj.
39.7% 39.7%
18.6% 10.0%
16.0% 15.0%
5.0%
8.7%
3.0%
9.0%
22
Projections
• Based on the non-operating assumptions, the
income statement and balance sheet will look
like:
23
Van Leer Products, Inc.
Actual
Income Statement
2013
Net Sales
840.0
Cost Of Goods Sold
520.0
Selling, general & administrative 200.0
Depreciation
41.0
Operating profit 79.0
Interest income
Interest expense
9.0
Earnings before taxes 70.0
Taxes
28.0
Net income 42.0
Dividends
12.0
Additions to RE
30.0
Actual Actual
Proj.
2014
2015
2016
944.0 1,000.0 1,110.0
625.0 640.0 693.8
205.0 215.0 249.8
42.0
45.0
56.6
72.0 100.0 109.9
1.0
0.8
9.0
10.0
11.2
64.0
90.0
99.5
25.0
36.0
39.5
39.0
54.0
60.0
11.0
16.0
17.6
28.0
38.0
42.4
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Preliminary Balance Sheet
• Note: This won't balance yet.
• Retained earnings calculation for 2016:
– RE2016 = RE2015 + Additions to RE in 2016
–
= 216.0 + 42.4 = 258.4
25
Actual Actual Actual
2013 2014 2015
Balance sheet
Cash
42.0
47.0
50.0
Short term investments
10.0
15.0
25.0
Inventory
75.0
85.0 100.0
Accounts receivable
65.0
70.0
75.0
Total current assets 192.0 217.0 250.0
Net PP&E
275.0 280.0 300.0
Total assets 467.0 497.0 550.0
Proj.
2016
33.3
122.1
84.4
239.8
377.4
617.2
26
Accounts payable
Accrued expenses
Short-term debt
Total current liabilities
Long-term debt
Total liabilities
Common stock
Retained earnings
Total common equity
Total liabilities and
equity
2013
80.0
8.0
50.0
138.0
54.0
192.0
125.0
150.0
275.0
467.0
2014
70.0
10.0
30.0
110.0
84.0
194.0
125.0
178.0
303.0
497.0
2015
75.0
10.0
25.0
110.0
99.0
209.0
125.0
216.0
341.0
550.0
2016
89.9
11.1
101.0
92.6
193.6
125.0
258.4
383.4
577.0
27
Balance Sheets Don't Balance
• Total assets (excluding short-term
investments) = $617.2
• Total liabilities and equity (excluding shortterm debt) = $577.0
• Van Leer’s financing plan is $40.2 million
short.
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Plug
• Add short-term debt = $40.2 million.
• Don’t have any short-term investments.
29
Final Projections
Actual Actual Actual
2013 2014 2015
Balance sheet
Cash
42.0
47.0
50.0
Short term investments
10.0
15.0
25.0
Inventory
75.0
85.0 100.0
Accounts receivable
65.0
70.0
75.0
Total current assets 192.0 217.0 250.0
Net PP&E
275.0 280.0 300.0
Total assets 467.0 497.0 550.0
Proj.
2016
33.3
122.1
84.4
239.8
377.4
617.2
30
Accounts payable
Accrued expenses
Short-term debt
Total current liabilities
Long-term debt
Total liabilities
Common stock
Retained earnings
Total common equity
Total liabilities and
equity
2013
80.0
8.0
50.0
138.0
54.0
192.0
125.0
150.0
275.0
467.0
2014
70.0
10.0
30.0
110.0
84.0
194.0
125.0
178.0
303.0
497.0
2015
75.0
10.0
25.0
110.0
99.0
209.0
125.0
216.0
341.0
550.0
2016
89.9
11.1
40.2
141.2
92.6
233.8
125.0
258.4
383.4
617.2
31
Checking for reasonableness
• Are asset and liability changes from year to
year smooth? If not, is that expected?
– For example, PPE increases $77.4 million in 2016,
but that was predicted because a new plant is
coming online.
– Cash falls in 2016. But that is also predicted due
to changes in information technology.
32
Reasonableness
• Short-term investments decrease to zero—this is
because we projected that Van Leer wouldn’t
simultaneously borrow short-term and invest shortterm.
• Short-term borrowing increases substantially. If this
happens in subsequent years, the long-term debt
policy (or dividend policy) may need to be revisited.
33