PROJECTED FINANCIAL STATEMENTS

The financial statement method will be used in projecting financial statement. Based on this
approach, the following steps will be followed:

1. Forecast sales. In making financial projections, always start with the statement of profit or loss
and the most important account to forecast first is sales.
2. Forecast cost of sales and operating expenses.
For the cost of sales, the average cost of sales over the historical data analyzed can be
used. If there are plans to improve cost efficiency, then such improved cost efficiency can also
be considered.
For the operating expenses, try to figure out which are variable and which are fixed.
Variable operating expenses include commissions. Fixed operating expenses include
depreciation of office building, salaries and some maintenance expenses.
3. Forecast net income and retained earnings. To forecast net income, there should be
information on income taxes and how much financing cost a company will have. Financing costs
will be based on the amount of loans the company has and the payment terms for these loans.
There should also be assumptions on the interest rates for the projection period.
4. Determine balance sheet items that will vary with sales or whose balances will be highly
correlated with sales. Balance sheet items that may vary with sales or will be highly correlated
with sales are cash, accounts receivable, inventories, accounts payable and accrued expenses
payable.
5. Determine payment schedule for loans. The payment schedule for loans can be based on the
disclosures provided in the notes to financial statements or the plans of management on how to
pay the loans if no details about payment terms are provided in the notes to financial
statements.
6. Determine external funds needed (EFN). This amount is more of a balancing figure or a squeeze
figure. The balance sheet has to balance. Therefore after assumptions are made to project
different balance sheet accounts, the projected statement of financial position has to balance.
The formula for the EFN is shown below:
EFN = Change in Total Assets – (Change in Total Liabilities + Total change in Stockholders’ Equity)
If the EFN is put on the liabilities and stockholders’ equity sections and the amount is positive,
this means that there will be additional financing. However if the amount is negative, this means
that there will be excess cash.
7. Determine how external funds needed will be financed. Once EFN is computed, the
management decides how to finance it. It can all be through debt or equity or a combination of
debt and equity.
Illustrative Example: Before the end of 2014, the president of JSC Foods Corp. had instructed
the Vice President for Finance to prepare the 2015 projected financial statements based on their
most recent planning workshop. Based on the results of the planning workshops, the following
assumptions were prepared for the 2015 projected financial statements.
a. Sales are expected to increase by 10% in 2015 from the 2014 sales level. This growth
assumption is based on the assessment of the external and internal factors related to JSC
Foods Corp. and the historical growth of the company. The company’s sales grew by 10.4%
annually from the 2010 to 2014. (Refer to Chapter 2 data on the financial statements of JSC
Foods Corporation).
b. The following financial statement accounts are expected to vary with sales based on the
2014 financial statements:
I. Cost of Sales
II. Cash
III. Trade accounts receivable
IV. Inventories
V. Other current assets
VI. Trade accounts payable

Variable operating expense is 7.5% of sales. Depreciation expense is 10% of the gross
beginning balance of property, plant and equipment. As of December 31, 2014, the gross
balance of PPE is ₱26,000,000. For January 2015, ₱5,000,000 new PPE will be acquired. It is
the policy of the company that PPE acquired in the first half of the year will be depreciated
for one full year.

c. As of December 31, 2014, there are two long-term loans. Both have annual interest rate of
8%.
I. The first loan will mature on June 30, 2015 and the remaining principal balance to
be paid on June 30, 2015 is ₱1,250,000.
II. The second loan amounting to ₱3,000,000 which was incurred on December 31,
2014 is paid at the rate of ₱500,000 principal balance every June 30 and December
31.
III. New loans of ₱3,500,000 will be incurred on December 31, 2015 payable at the rate
of ₱500,000 every June 30 and December 31. Annual interest rate is expected at 8%.
d. Other non-current assets and other current liabilities will remain unchanged.
e. Income tax rate is 30% of the income before taxes. Seventy-five percent of the income tax
expense will be paid in 2015 while the balance will be paid in 2016.
f. Cash dividends of ₱2,000,000 will be paid for 2015.