A. This answer results from not including the addition to retained earnings in the equity section of the pro forma balance sheet.
B. This answer results from not deducting taxes from net income in calculating the addition to retained earnings on the pro forma balance sheet.
C. To construct a pro forma balance sheet and income statement in order to determine the amount of external financing that will be needed next year, we begin with the sales forecast and forecast the income statement. For each line item on the income statement with the exception of net interest expense, we use the same ratio to forecasted sales as in the past year. (Note: You can also calculate these amounts by multiplying the past year's amounts by 1.15.)
PRO FORMA INCOME STATEMENT
Net sales $100,000 × 1.15 $115,000
Cost of goods sold $115,000 × .662 76,130
Gross profit $ 38,870
Selling expense $115,000 × .164 18,860
General & admin. expense $115,000 × .112 12,880
EBIT $ 7,130
Net interest expense 1,396(see Note 1)
EBT $5,734
Taxes @ 35% 2,007
Net income $ 3,727
Minus: dividends $975 × 1.04 1,014
Addition to retained earnings $ 2,713
Note 1: Net interest expense = (10,000 × .055) + (35,600 × .075) - (45,600 × .04) = 1,396
The next step is to forecast the balance sheet. Held-to-maturity securities, notes payable, long-term debt, common stock and additional paid-in capital will be the same as last year. The company's fixed assets are presently being used at 85% of their capacity to generate sales of $100,000. If they were being used at 100% of their capacity, sales would be $100,000 ÷ .85, which is $117,647. Therefore, since sales are forecasted to grow to $115,000 and that is less than $117,647, no new fixed assets will be required and net fixed assets will also be the same as last year. Cash, accounts receivable,
inventory, accounts payable and accrued liabilities will be the same percentage of forecasted sales as they were of actual sales. Retained earnings will be last year's amount plus the addition to retained earnings calculated above.
PRO FORMA BALANCE SHEET
Assets Liabilities
Cash ($115,000 × .097) $ 11,155 A/P ($115,000 × .03) $ 3,450
A/R ($115,000 × .153) 17,595 Notes payable 10,000
Inv ($115,000 × .185) 21,275 Accr liab ($115,000 × .06 ) 6,900
Total current assets $ 50,025 Total current liabilities $ 20,350
Held-to-maturity securities $ 45,600 Long-term debt $ 35,600
Net fixed assets 32,200 Total liabilities $ 55,950
Total long-term assets $ 77,800
Equity
Total assets $127,825 Common stock $ 10,000
Additional paid-in capital 30,000
Ret earnings ($26,700 + $2,713) 29,413
Total equity $ 69,413
Total liabilities & equity $ 125,363
Additional funds needed $ 2,462
The additional funds needed of $2,462 is the difference between total assets of $127,825 and total liabilities & equity of $125,363.
D. This answer results from using an addition to retained earnings equal to the full amount of the net income on the pro forma balance sheet. However, the addition to retained earnings should be net income minus dividends to be paid.
