CHAPTER 7

PREPARING, ANALYZING,
AND FORECASTING
FINANCIAL
STATEMENTS:
QUANTIFYING THE
BUSINESS PLAN
The intention of this reading is not about teaching entrepreneur how to be
an expert accountants. Rather, it is simply about trying to understand,
construct, and enterpret financial statements.more specefically, it is
meant to translate the business plan into numerical format composed of
financial statement.these financial statement summarize what is going
to happen to the business plan is carried out well.let us begin by
assuming that an entrepreneur has set up ABC Corporation
A corporation separate legal personality created by law.it can sue and be
sued.
At the beginning,ABC corporation has nothing.However,
Stockholders will be giving cash to the corporation.
Second ABC corporation may need more money and goes ahead to
borrow this from banks or rather financial institution
If we assume that ABC corporation is manufacturing concern, then there
will be a third source of funds and these raw materials suppliers.the
suppliers wo would give raw materials and \or suppliers to ABC
corporation and they will be paid later.
From the cash of corporation, it may want to invest in
land,building,machinery,equipment,furniture,fixtures and vehicles.
It will then try to activate the factory by converting
the raw materials into finishing goods. While in
the factory, however, the corporation would need
power and water, which they would pay from their
cash. So cash will be spent to buy power and
water, which would be used in the factory
Cash will also be used to pay for labor and
supervisors, which again would be used inside
the factory.
When the goods are completed, they become
finished goods inventory
Meanwhile, the accountant will concoct an account
called depreciation.
These are the other operating expenses that the corporation
would have to pay for in cash. These are the salaries, the
supplies, the electricity, and other expenses (e.g., travel,
and representation, rental, etc.)
Notice that there are two types of costs. The cost of making
the product becomes the product cost. The finished goods
when sold become the cost of goods sold. Then, there are
the period costs, which are the selling, general, and
administrative expenses.
Next, ABC corporation pays, in cash, non-operating
expenses, which are really the interest expenses and other
financial and other financial changes owed to the banks
Next ABC Corporation would have to pay cash to the
government for taxes.
Once the company sells the finished goods to the customers,
they become cost of goods sold. In exchange, sales or
revenues are gotten from the customers.
Some customers will pay cash, so the sales and
revenues go back to the cash account. Some
customers would avail of credit. Unpaid sales
become accounts receivable. And when the
customers finally pay, the amount of accounts
receivables transforms back into cash
ABC Corporation might have investments in
marketable securities, in which case they might
have non-operating income. And this non-
operating income comes back in the form of cash
Figure 7.1(D) shows the complete flow of funds
from the first business transaction to the last
( and all the others subsequence transaction)
DISCERNIMG FOUR FINANCIAL
STATEMENTS
The figure 7.1(D) is called funds flow.
Funds going from one container or one circle to
another container or another circle comprise the
funds flow except for the account called
depreciation, which is a figment of the imagination
of the accountant depreciation is not really part of
the funds flow
The funds flow is the first financial statement that we
have encountered.
The second financial statement is on the right side of figure
7.1 (D). If you will notice these re the sales and non-
operating income, which actually enter back to the
company. However, there are expenses and costs that
permanently exit the company.
The third financial statement that we can see from figure
7.1(D) that is the cash flow. Just focus on the cash
container or circle. There are arrows pointing to the circle.
These are the cash inflows.
There are arrows emanating of the cash circle. These are the
cash outflow.
The cash inflow and outflows constitute the cash flow
If we have the cash flow are greater than cash outflow, we
have a net cash inflow. However, if the cash outflows are
greater than the cash inflows, then we will have a net cash
outflow.
So, the third financial statement we have encountered is the
CONSTRUCTING FINANCIAL
STATEMENTS
We have already noted from figure 7.1 (D) that the
funds from one container to another.
The sourcing and usage or application of funds in
the financial transaction. So in every, entry there is
a source of funds there is a use of funds.
This is called double entry accounting, which is the
basis for the entire construction of the financial
statement.
Focusing on a few accounts of the funds flow
statement, specially loans, cash, and inventory, as
a examples, as example, we can follow how these
containers of funds relate to one another
Let us begin with the loan. ABC corporation borrows
1 million pesos from the bank. So there is an
increase in loan 1 million pesos while the same
time, ABC Corporation increases its cash by 1
million pesos. There is a source of funds from
loans of 1 million and a use of funds in cash for
the same 1 million pesos. From the 1 million pesos
in cash, ABC corporation might take out 0.5
million pesos from the cash container and this
gets entered into the inventory container which is
again a use of funds
Note that we have constructed T accounts for
each container, the T account divide the left
side from the right side of the fund
container.
For consistency, the account sources funds
from a container by making it exit on the
right side of container. When funds are
transformed to another container, these
funds enter on the left side of the container,
as shown below
The accounts made a rule. The right side of each container
(exit) is a source of funds.
The left side of each container (entry) is a use of funds.
There are also pattern that we are able to discern. All
increase in liabilities are sources of funds, and all
decreases in liabilities are uses of funds.
To sum up, All increase in liabilities and all decreases assets
are source of funds . They are recorded on the right side of
the containers. The technical term given by the accountant
for right side exits are credits.
All decreases in liabilities and all increase in assets are uses
funds.
Uses of funds are recorded on the left container.
The technical term for recording on the left side debits.
Hence, the accountant always has two accounting entries:
a credit followed by a debit or a debit followed by a credit.
In figure 7.2 (a) and figure 7.2 (B), we see these containers. We can divide
the containers into two sides: the right side and the left side. This division
creates the accountants T accounts. On the right side are the sources of
funds or the credits. On the left side are the uses of funds or the debits.
The accountant will then create a chart of accounts.Each account represents
a container of funds In this case ,the containers are the accounts for
cash,accounts receivable, inventory,fixed assets,and other assets.In the
liabilities side,we have the stockholders equity,short term debt ,long term
debt, supplier's credit,and accrued expenses.
ABC Corporation will source cash from the stockholder's equity.This is
recorded as source of funds in the stockholder's equity and enters cash
as the use of funds.
ABC Corporation may also get long-term loans and short-terms from the
banks.This loans are the sources of funds and put into use in the form of
cash.
From the cash ,the company may withdraw also some cash amount and it
exits on the right side as a source of funds.The company may buy
inventory,Fixed assets,and other assets with the cash.Cash would be the
source of funds while the purchased assets would be the uses of funds.
The company may also use the cash to pay for supplier's credit ,to pay for
short term debt and to pay for long term debt.
Let us now put some numbers in this financial
statement
ANALYZING FINANCIAL
STATEMENTS’
Financial statements are nothing but
abstraction of all the business transactions
going on in an enterprise. Analyzing or
intepreting financial statements can give
very powerful insights into how an
enterprise in conducting itself. One of the
most easily understood financial
statements is the income statement, also
called the profit and loss statement.
INCOME STATEMENT ANALYSIS
The top line of the income statements
is Sales. One can compare the Sales
figures of an Interprise over the
years to see whether it is growing or
not. This comparative analysis over
several years (or months) is called
time series analysis or a horizontal
analysis ( since the sales figure are
usually put along horizontal plane in
a piece of paper). The growth rate
from year to year can be computed
on a percentage basis as a show in
 Figure 7.4. Time Series or Horizontal Analysis

Year 2011 2012 Annual 2013 Annual

percenta percenta
ge ge
growth growth
2011- 2012-
2012 2013
Amount 3,000,000 3,300,000 10% 3,960,000 20%
Below the gross profit is the line up of
operating expenses, also known as
selling, general, and Administrative
(SGA) expenses. The various expenses
items that are not directly part of the
costs involved in making the product
or delivering the service are include
here. The typical operating expenses
accounts are as follow:
• Salaries Wages
• Sales Commissions
• Rental or office leases
• Advertising and Promotion
• Professional Fees
• Travel and Transportation
• Training and education
• Employees’ Benefits
• Light, Water and Power
• Office supplies
• of office
• Representation expenses
• Miscellaneous or other expenses
Balance sheet analysis
The balance sheet items are logically arranged by
the accountant for convenient analysis.
 Current Assets
Current ration =
Current Liabilities

Cash, Marketable Securities, and

accounts recievables
Quick ratio =
Current Liabilities
 total liabilities
Total debt- to- owners equity ratio =
owners equity

Long- Term Debt

Long – term debt- to- Owner equity ratio =
Owners ‘ equity
The third group of ratios is the pfofitability ratios. The net profit
after taxes of the enterprise are related to the sales , assets and
owners equity of the enterprise.the ratio of net profit after taxes
to sales provides the return on sales (ROS). The ratio of net profit
after taxes to assets gives the return on assets (ROA). The ratio
of the net profit after taxes to owners equity yields return on
equity (ROA).
 NET PROFIT AFTER TAXES
Return on Sales =
SALES

NET PROFIT AFTER TAXES

Return on assets (ROA) =
ASSETS
Forcasting Financial Statements
The art of financial forecasting is popular
among entrepreneurs who know their
business inside out.It enables them to ask
the following questions,among many prior to
a financial exercise:
• What will happen to the market
conditions tomorrow?
• What will competition do?
• What product and services will come out?
• What technology is in store for us?
• What will interest rates be like?
• How will the e on grow?
• What regulations might the government
Income Statement Forecasting
There are usually a very close relationship
Sales and Cost of Sales (or Cost of Goods
Sold).Many companies,In determining their
selling prices,coviently add a specific
percentage mark-up or margin to the cost of
Sales,thus establishing a predictable ratio
between the two items.If an enterprise decides
to slap a hundred percent mark-up on its cost
sales,the sales figure will double the cost of
Sales.
 TABLE 7.8 FORECASTING SALES AND COST OF SALES FOR XYZ (PESO IN
THOUSANDS)
Year 2011 % 2012 % 2013 % 2014 % 2015 %

Sales forecast

Past sales 1000.0 100. 1,100 100.0 1,210. 100.0 100.0 100.0
(000) 0 .0 0

Sales Forecast 1,331.0 1,464.0

(000)

Past cost 700.0 70.0 781.0 71.0 835.0 69.0

sales (000)

Cost sales
Forecast

In percentage 70.0 70.0

Terms

In peso value 932.0 1,025.0

(000)
BALANCE SHEET FORCECASTING

Forecasting what the Balance Sheet of an

enterprise will look like in the future
depends a lot on the future Sales.Let us
start the Current Assets of the Balance
Sheet,which include cash,marketable
securities,accounts
recievables,inventories(raw materials,work-
in process,and finished Goods),and other
current Assets.
 TABLE 7.10 PRO FORMA INCOME STATEMENT AND ADJUSTED PRO-
FORMULA INCOME STAEMENT FOR 2013
Pro Forma Adjusted Pro Comments
Income Forma Income
Statement statement

Sales 540,000 540,000

Cost of Good Sold 340,000 340,000
Gross Profit 200,000 200,000
Operating 186,000 186,000
Expenses
Less Interest 6,000 6,800 Additional
Expenses expenses of 800
pesos
Equals net profit 8,000 7,200
before taxes
Less taxes 2,000* 1,800 Taxes decreased
by 200 pesos
Equals Net Profit 6,000 5,400 Net effect 600
After taxes pesos