Chapter 9

Prospective Analysis

Prospective Analysis is the forecasting of future financial

information

Projecting and Income Statement

Perhaps the most critical step is the projection of revenue

growth. For our purposes we will assume an observed growth
rate, but in a full analysis you should also consider:
o Economy wide factors
o Industry wide factors
o Company specific factors

Process:

1. Project revenue using the most recent period amount and the
most recent period growth rate.

So if a company had revenue of 1,000,000 in the prior year (say,

2006) and 1,200,000 in revenue in the current year (say, 2007),
then the growth rate would be 20% [(1,200,000-
1,000,000)/1,000,000] and we would project the next year (say,
2008) to have revenue of 1,440,000 [1,200,000 X 1.2].

2. Project the gross profit using the most recent period’s gross
profit rate.

So, if cost of goods sold for the current year was 900,000, then
the gross profit rate would be 25% [(1,200,000-
900,000)/1,200,000]. Therefore we would project the gross profit
for the next year to be 360,000 [1,440,000 X .25].
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3. Once you know the revenue and the gross profit you can
determine the cost of goods sold.

Since GP = Sales – COGS, therefore COGS = Sales – GP

1,080,000 = 1,440,000-360,000

4. Operating Expenses* can be projected by using the historical

OE/Sales rate with the projected sales.

So, if current year Operating Expenses are 120,000, then the

OE/Sales rate is 10% [120,000/1,200,000]. Therefore we would
project OE for the next year as 144,000 [1,440,000 X .10].

*In the chapter the author assume that total SG&A is decomposed
into operating expenses and depreciation expense. If they are not
presented that way in the income statement you can separate
them out by getting depreciation expense from the Statement of
Cash Flows and the subtracting it from total SG&A.

5. Depreciation Expense can be projected by using the historical

rate of depreciation expense to gross PPE from the prior year.

So, if the prior period’s balance sheet had Gross PPE of 1,200,000
and the current period depreciation expense was 60,000, then the
rate would be 5% [60,000/1,200,000]. Therefore, if Gross PPE at
the end of the current year was 1,500,000 we would project
Deprecation Expense for next year to be 75,000.

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6. Interest Expense is estimated by computing the interest rate
paid in the current year. This rate is computed by dividing
interest expense by total interest bearing debt from the prior
year’s balance sheet. Then the projected interest expense is
computed by multiplying the total interest bearing debt at the
end of the current period by this rate.

So, if the prior period’s balance sheet had total interest bearing
debt of 500,000 and current period interest expense was 35,000,
then the interest rate would be 7%. Therefore if the current
period balance sheet included 600,000 of interest bearing debt,
projected interest would be 42,000.

7. Income Tax Expense is projected multiplying the current year

income tax rate by the projected income before income taxes.
The income tax rate would be computed by dividing current
income tax expense by current income before tax.

So, if income before tax in the current year was 85,000 and the
income tax expense was 34,000, the income tax rate would be
40% [34,000/85,000]. Therefore income tax expense would be
projected to be 39,600 [(1,440,000-1,080,000-144,000-75,000-
42,000)X.4]

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Best Buy Exercise

1. Project Sales

2. Project Gross Profit

3. Determine COGS

4. Project Operating Expenses (excluding depreciation)

5. Project Depreciation

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6. Project Interest Expense

7. Project Income Tax Expense

Best Buy Projected Income Statement

Sales 34,689
Cost of Goods Sold 25,999
Gross Profit 8,690
Operating Expenses 6,327
Depreciation Expense 526
Interest Expense 35
Net Income Before Tax 1,802
Income Tax Expense 608
Net Income 1,194

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Projected Balance Sheet

Basic Process
o Project most current asset and liability accounts using
historical turnover ratios combined with projected income
statement numbers
o Project PPE using historical Capital Expenditures
o Project current maturities of long-term debt from current
year footnote information
o Assume short-term debt, other long-term liabilities and
initial common stock amounts based on current year
balance
o Calculated Projected Retained Earnings based on current
ending retained earnings, projected Net Income and
projected Dividends
o Assume all other Stockholders’ Equity accounts based on
current balances

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 o At this point you will have a projected amount for Total
Liabilities and Total Stockholders’ Equity and, therefore,
you will have a projected amount for Total Assets. You can
determine projected Cash based on Projected Total Assets
less Projected amount for all non-Cash Current Assets and
all non-Current Assets
o If projected Cash is negative you can issue additional debt
and equity keeping historical levels of financial leverage.
o If projected Cash is unusually high you can reduce the
balance by using it to retire debt and/or repurchase stock,
again keeping financial leverage in line with historical levels

Item Turnover Ratio Ratio Formula

Accounts Receivable Accounts Receivable Sales/Accounts
Turnover Receivable
Inventory Inventory Turnover Cost of Goods
Sold/Inventory
Accounts Payable Accounts Payable Cost of Goods
Turnover Sold/Accounts Payable
Accrued Expenses Accrued Expenses Sales/Accrued Expenses
Turnover Payable
Taxes Payable Historical Rate Taxes Payable/Income
Tax Expense
Dividends Dividends per Share Total Dividends/Number
of Shares Oustanding
Capital Expenditures CAPEX/Sales Capital
Expenditures/Sales

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Best Buy Example

1. Receivables

2. Inventory

3. Plant and Equipment, Net

4. Accounts Payable

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 5. Accrued Expenses Payable

6. Income Taxes Payable

7. Long-Term Debt

8. Retained Earnings

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Best Buy Projected Balance Sheet

Assets
Cash and Short-Term Investments 4,325
Receivables 569
Inventory 3,752
Other Current Assets 409
Total Current Assets 9,055
Plant and Equipment, Net 2,914
Other Non-current Assets 1,167
Total Assets 13,136

Liabilities and Stockholders’ Equity

Accounts Payable 3,636
Accrued Expenses 1,912
Accrued Income Taxes 736
Current Portion of LT Debt 16
Total Current Liabilities 6,300
Long Term Liabilities 373
Long Term Debt 162
Total Liabilities 6,835
Common Stock 49
Additional Paid-in Capital 643
Retained Earnings 5,348
AOCI 261
Total Stockholders’ Equity 6,301
Total Liabilities and Stockholders’ Equity 13,136

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Best Buy Projected Statement of Cash Flows

Operating Activities
Net Income 1,194
Add: Depreciation Expense 526
Increase in Receivables (63)
Increase in Inventory (414)
Increase in Accounts Payable 402
Increase in Accrued Expenses 211
Increase in Income Taxes Payable 33
Net Cash Flow from Operations 1,889

Investing Activities
Capital Expenditures (728)
Net Cash Flow from Investing Activities (728)

Financing Activities
Long Term Debt (418)
Dividends (150)
Net Cash Flow from Financing Activities (568)
Net Increase in Cash and ST Investments 593
Beginning Cash and ST Investments 3,732
Ending Cash and ST Investments 4,325

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Best Buy - Consolidated Balance Sheets ($ in millions, except per share amounts)

Assets February 25, February 26,

Current Assets 2006 2005

Cash and cash equivalents $ 681 $ 354
Short-term investments 3,051 2,994
Receivables 506 375
Merchandise inventories 3,338 2,851
Other current assets 409 329
Total current assets 7,985 6,903
Property and Equipment
Land and buildings 580 506
Leasehold improvements 1,325 1,139
Fixtures and equipment 2,898 2,458
Property under master and capital lease 33 89
4,836 4,192
Less accumulated depreciation 2,124 1,728
Net property and equipment 2,712 2,464
Goodwill 557 513
Tradename 44 40
Long-Term Investments 218 148
Other Assets 348 226
Total Assets $ 11,864 $ 10,294
Liabilities and Shareholders’ Equity
Current Liabilities
Accounts payable $ 3,234 $ 2,824
Unredeemed gift card liabilities 469 410
Accrued compensation and related expenses 354 234
Accrued liabilities 878 844
Accrued income taxes 703 575
Current portion of long-term debt 418 72
Total current liabilities 6,056 4,959
Long-Term Liabilities 373 358
Long-Term Debt 178 528
Shareholders’ Equity
Preferred stock, $1.00 par value: Authorized — 400,000 shares; Issued and outstanding — none — —
Common stock, $.10 par value: Authorized — 1 billion shares; Issued and outstanding — 485,098,000 and 49 49
492,512,000 shares, respectively
Additional paid-in capital 643 936
Retained earnings 4,304 3,315
Accumulated other comprehensive income 261 149
Total shareholders’ equity 5,257 4,449
Total Liabilities and Shareholders’ Equity $ 11,864 $ 10,294

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Best Buy - Consolidated Statements of Earnings ($ in millions, except per share amounts)

For the Fiscal Years Ended February 25, February 26, February 28,

Revenue $ 30,848
2006 $ 27,433
2005 $ 24,548
2004

Cost of goods sold 23,122 20,938 18,677

Gross profit 7,726 6,495 5,871

Selling, general and administrative expenses 6,082 5,053 4,567

Operating income 1,644 1,442 1,304

Net interest income (expense) 77 1 (8)

Earnings from continuing operations before income tax expense 1,721 1,443 1,296
Income tax expense 581 509 496

Earnings from continuing operations 1,140 934 800

Loss from discontinued operations (Note 2), net of tax — — (29)
Gain (loss) on disposal of discontinued operations (Note 2), net of tax — 50 (66)

Net earnings $ 1,140 $ 984 $ 705

Basic earnings (loss) per share:

Continuing operations $ 2.33 $ 1.91 $ 1.65
Discontinued operations — — (0.06)
Gain (loss) on disposal of discontinued operations — 0.10 (0.14)

Basic earnings per share $ 2.33 $ 2.01 $ 1.45

Diluted earnings (loss) per share:

Continuing operations $ 2.27 $ 1.86 $ 1.61
Discontinued operations — — (0.06)
Gain (loss) on disposal of discontinued operations — 0.10 (0.13)

Diluted earnings per share $ 2.27 $ 1.96 $ 1.42

Basic weighted-average common shares outstanding (in millions) 490.3 488.9 485.0
Diluted weighted-average common shares outstanding (in millions) 504.8 505.0 500.8

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Best Buy - Consolidated Statements of Cash Flows ($ in millions)
For the Fiscal Years Ended February 25, 2006 February 26, 2005 February 28, 2004

Operating Activities
Net earnings $ 1,140 $ 984 $ 705
(Gain) loss from and disposal of discontinued operations, net of tax — (50) 95
Earnings from continuing operations 1,140 934 800
Adjustments to reconcile earnings from continuing operations to total cash provided by operating
activities from continuing operations:
Depreciation 456 459 385
Asset impairment charges 4 22 22
Stock-based compensation 132 (1) 8
Deferred income taxes (151) (28) (14)
Excess tax benefits from stock-based compensation (33) — —
Other, net (3) 24 8
Changes in operating assets and liabilities, net of acquired assets and liabilities:
Receivables (110) (30) (27)
Merchandise inventories (457) (240) (507)
Other assets (11) (50) (7)
Accounts payable 385 347 272
Other liabilities 165 243 250
Accrued income taxes 178 301 197
Total cash provided by operating activities from continuing operations 1,695 1,981 1,387
Investing Activities
Additions to property and equipment, net of $75, $117 and $26 non-cash capital expenditures in (648) (502) (545)
fiscal 2006, 2005 and 2004, respectively
Purchases of available-for-sale securities (4,319) (8,517) (2,989)
Sales of available-for-sale securities 4,187 7,730 2,175
Change in restricted assets (20) (140) (18)
Other, net 46 7 1
Total cash used in investing activities from continuing operations (754) (1,422) (1,376)
Financing Activities
Repurchase of common stock (772) (200) (100)
Issuance of common stock under employee stock purchase plan and for the exercise of stock 292 256 114
options paid
Dividends (151) (137) (130)
Long-term debt payments (69) (371) (17)
Net proceeds from issuance of long-term debt 36 — —
Excess tax benefits from stock-based compensation 33 — —
Other, net (10) (7) 46
Total cash used in financing activities from continuing operations (641) (459) (87)
Effect of Exchange Rate Changes on Cash 27 9 1
Cash Flows from Discontinued Operations (Revised — See Note 2)
Operating cash flows — — (52)
Investing cash flows — — (1)
Net Cash Used in Discontinued Operations — — (53)
Increase (Decrease) in Cash and Cash Equivalents 327 109 (128)
Cash and Cash Equivalents at Beginning of Year 354 245 373
Cash and Cash Equivalents at End of Year $ 681 $ 354 $ 245
Supplemental Disclosure of Cash Flow Information
Income tax paid $ 547 $ 241 $ 306
Interest paid 16 35 22

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Sensitivity Analysis
Since the projected financial statements are built
around a series of assumptions you should perform
sensitivity analysis
The purpose of this is to examine which results are
particularly sensitive to your assumptions

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