In proprietorship, owner prepares that whereas in partnership/corporation, Managers prepare it and owner approves it.
First find expected sales and from it, find the cost of these sales and ending inventory. Important considerations are total production required and level of inventory
Second find Operating Costs that includes Fixed Expenses like rent, utilities, salaries interest, deprecation and Variable Expenses like Adv. and Selling expenses etc.
Capital Budget provides the basis for expenditures impacting business for more than one year e.g. new equipments, vehicles, computers or new factory etc.
Proforma Income Statement
Proforma income is the projected net profit calculated from projected revenues minus projected costs and expenses
Preparing the Proforma Income Statement involves, calculate Sales by months, basis may be marketing research, industry sales and some trial experiences. Certain forecasting techniques like survey of buyers intentions, sales force opinions, expert opinions etc can be used to calculate the sales.
List down Projected Operating Expenses that shall have room for adjustment. E.g. selling expenses increase with increase in business sales and they are usually high in start.
Finding cost of goods sold that can be either computed variable cost of production and times number of units sold or by industry percentage of sale
Salaries and wages can be calculated by number of employees required and their roles.
Increased insurance costs, trade show participation or added space for warehousing shall also be considered. Unusual expenses like Trade Show participation etc shall be flagged at the bottom of Proforma Income Statement.
New machinery depreciation shall be added
Proforma Income statement shall be prepared First year month wise, and for the year 2 and 3, it shall also be prepared year wise. This can be done through calculating percentages of cost of goods sold and operating expense in relation to the sales and multiplying these percentages with the next year forecasted figures. 2 | P a g e
For projected expenses in year 2 and 3, first look at the expenses that remain stable e.g. depreciation, utilities, rent, insurance etc. Be conservative for initial planning purposes.
In case of an Internet Startup, purchase/lease computers, extensive advertising expenses e.g. banner advertisement, Search Engine Listing etc, and inventory expenses are more important.
Proforma Cash Flow
Cash flow is the difference between cash receipts and cash payments (not all sales are made in cash and not all bills are paid in cash)
Deprecation expense dont account for cash outflow, similarly in an internet startup, fee going as merchant charges through credit card transactions sales are not received by the companies.
Using profit as the only measure of a success may mislead if there is a negative cash flow
Mostly used method for calculating cash flow is Indirect method, objectives of which is to understand that there are some adjustments that need to be made to the net income based on the fact that actual cash may or may not have actually been received or disbursed (figure 10.5)
Monthly projections of cash flow shall be prepared.
If disbursement are more than receipts, entrepreneur has to borrow or use cash in bank an if receipts are more, he shall invest in short term or deposit in banks
It is difficult to project cash flows on exactly on the basis of monthly receipts and disbursements. One method is anticipate that 60% of sale in each month is received as cash and 40% in the subsequent month.
Per month cash flow helps in determining level of borrowings and surplus cash can be used to repay any debt or invested in highly liquid assets or used to purchase any new equipment.
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Proforma Balance Sheet Summarizes the projected assets, liabilities and net worth of the business. It depicts the situation of the business at end of the year.
Assets represents items that are owned or available to be used by the business. Divided in to Current Assets, those are highly liquid assets including cash or can be converted in to cash and consumed in a period of less than one year. Fixed Assets are tangible and will be used over a long period of time.
Liabilities represent every thing that is owed to the creditors. Current Liabilities are those which are due within a year whereas Long term Liabilities includes loans/debts taken by the business for a long time period.
Owner Equity represents excess of all assets over all liabilities showing net worth of the business. It is the amount invested by the owner. Profits are shown as Retained Earnings in the Proforma Balance Sheet.
Break Even Analysis Break Even is the volume of sales where the venture neither makes a profit nor incur a loss. This point dictates volume of sales need to cover Total Variable and Fixed Expenses.
It is important to find out when a profit may be achieved thus showing financial potential for the startup business. Break Even analysis shows how much units must be sold or how much sales volume must be achieved in order to break even.
Determining the Break Even Formula
Total Revenue (TR) = Total Cost (TC) Where TR = Selling Price x Quantity (SP x Q) And TC = Total Fixed Cost (TFC) + Total Variable Cost (TVC) SP x Q = TFC + TVC where TVC = Variable cost per unit x Qty (VC/Unit x Q) SP x Q = TFC + VC/Unit x Q (SP x Q) VC/Unit x Q = TFC Q(SP VC/Unit)) = TFC Q = TFC/SP-VC/unit Which is the break even quantity
There is a major problem in declaring which cost is variable and which is fixed. Reasonably deprecation, salaries, wages, rent and insurance are considered as fixed whereas materials, selling expenses and direct labor are taken as variable costs.
Companies having more than one product, Break Even is calculated for every product differently. 4 | P a g e
Proforma Sources and Uses of Funds
Summaries all the projected sources of funds available for the venture and how these funds will be disbursed.
Purpose is to show how net income and financing were used to increase assets or pay off debts.
Typical sources of funds are from operations, new investments, long term borrowings and sale of assets. Profit is also included as source of fund and deprecation is added back as it does not go out of pocket.
Applications of funds may include increased assets, retire long term liabilities, reduce owner equity and pay dividends.
The statement of Proforma Sources and Application of funds statement helps the entrepreneur and investors in understanding the financial well being of the company and effectiveness of financial management policies of the company.
Software Packages
Used for tracking financial data and generate financial statements. Other purpose may include check writing, payroll, invoicing, inventory management, bill paying, credit management and taxes. They are helpful in presenting different scenarios and to asses their impact on the Proforma statements. MS Excel, Quick Book, Peach Tree Accounting, MS Financial Manager are few good options as ready made packages.
Startup Company shall select very simple and easy to use soft wares.