MODULE 2 INTRODUCTION TO FORECASTING

WEL Financial Intelligence

Module 2 - Forecasting

Proforma Income Statement - this records sales and expenses for a given time period according to accounting standards.

Balance Sheet – Financial snapshot of the venture. Shows assets, liabilities and owners equity

Anatomy of a Balance Sheet

Balance Sheet

shows the balance between the venture Assets and Liabilities

plus the Owner’s Equity

Assets = Liabilities + Owner’s Equity

“Snapshot” of the venture

at a particular point in time

Current Assets(Easily turned into cash)

Cash & petty cash

Accounts recv’ble

Inventory/supplies

Prepaid expenses

Fixed Assets(Fairly permanent investments needed for operations)

Land, buildings

Prod & office equip’t.

Furniture

Vehicles

Current Liabilities(Debts and financial obligations that need to be paid within 12 months)

Accounts payable

Notes payable

Payroll

Taxes payable

Long-term Liabilities(Balances that come due after the current operating year)

Mortgages

Bank loans

Equip’t loans

Owner’s Equity (aka: “Net Worth”)

(Determined by subtracting the Total Liabilities from the Total Assets)

What owner has left if she liquidated all assets and paid off all debts.

Total Liabilities

+ Owner’s Equity must always

= Total Assets

Assets = Liabilities + Owner’s Equity

Note: This figure will differ based on legal structure

Anatomy of a Balance Sheet

Current Assets

Cash 1,000

Accts Rec 2,000

Inventory 5,000

Prepaid

Insurance 250

Total 8,250

Fixed AssetsLease Improv. 2,000

Equipment 5,000

Vehicles 10,000

Total 17,000

Total Assets 25,250

Current Liabilities

Overdraft 1,600

Credit Cards 2,500

Payroll 1,325

Taxes pay. 825

Total 6,250

Long-term LiabilitiesEquip. Loan 1,800

Vehicle Loan 8,000

Total 9,800

Total Liabilities 16,050

Owner’s Equity (aka: “Net Worth”)

Owner Capital 15,000

Retained Earnings (5,800)

Total Equity 9200

Total Liabilities and Equity

25,250

Assets = Liabilities + Owner’s Equity

Sample Balance Sheet

Balance Sheet Terms

Assets:

Things of value that the business owns. Assets are grouped into two categories:

Current Assets – these include cash, inventory, prepaid expenses and accounts receivable (money that the business is owed).

Fixed or Long-term Assets – items with a useful life over one year. The depreciation or decrease in value of assets is accounted for by way of depreciation expenses.

Balance Sheet Terms

Liabilities:

Debts or money that the business owes. They are grouped into two categories:

Current Liabilities – These are financial obligations that the business must meet within a year such as accounts payable and taxes.

Long-term liabilities – Any liability for which payment continues longer than one year. Examples include mortgages, bank loans, and equipment leases.

Balance Sheet Terms

Equity:

Equity – represents the owner’s equity, which is the “net worth” of the business.Capital – This will vary based on the legal structure however will include the “capital” of the company which is commonly cash given in exchange for shares of the company.

Retained Earnings - This is the cumulative earnings (or losses) of previous years.

ProForma Income Statement

Income Statement

shows sales/revenue and expenses over a period of time

Also known as P&L

(Profit and Loss Statement)

Used toMeasure resultsFind financial problemsIdentify profit centers to know where to concentrate resources

Figure taxes, borrow money and sell stock

Anatomy of Income Statement + Revenue (input of cash)

+ Gross sales ̶� Less Returns and allowances

= Net sales– Cost of goods sold (“variable” expenses: Labor, Direct, Other)

=Gross profit (revenue – cost of producing prod/serv)

– General and administrative (“fixed” expenses)Admin., Marketing, office, utilities, equip. maintenance, etc.

=Net operating income

+ Total other income (gain (loss) on sale of assets; interest)

=Net income (loss)

Sample of Income Statement

Acme Store Inc. Jan. 31, 2007 (in Dollars)

Gross sales $20,000 Less Returns and allowances 400

Net sales 19,600

Cost of goods sold 8,500Gross profit 11,000

General and administrativeRent 5,000Admin& Office Labour 2,300Utilities 1,800Maintenance & Supplies 300 9.400

Income (before taxes) $1,600

Income Statement Terms

Income Statement - The revenue and associated expenses for the sales of goods and/ or services for a period of time. Cost of Goods Sold (COGS) - Are the costs that a business incurs as a result of producing its product or service.

Gross Profit - The income earned after COGS have been deducted from revenue.

Pricing Strategies

New ventures need to forecast sales and revenues as part of the planning process. A key factor that drives this is the pricing strategy.

Effective pricing strategies are the result of something between an exact science based on logical factors and an intuitive insight based on instinct.

The simplest method for pricing products or services is that which results in maximum net revenue.

Pricing Strategies - BEP

Break Even Point (BEP)

It is critical to understand a company’s BEP as part of the forecasting process.

The level of operation (sales dollars or production quantity) at which a company neither earns a profit nor incurs a loss.

Fixed and Variable Expenses

In order to determine BEP, expenses must be categorized as fixed and variable:

Fixed expenses – expenses that do not vary with the volume of sales or production (rent, depreciation, interest rate)

Variable expenses – expenses that vary directly with changes in the volume of sales or production (raw materials cost, sales commissions, etc.)

Pricing Strategies

It is critical to understand at what points sales cover costs, and the venture starts to make a profit.

C=$ cost

a

sales

Variable expenses

Number of units

Fixed Costs

profit

loss

$$

X=units produced or sold

Pricing Strategies

Profit Planning - An example:Store buys and sells a single product

Selling price is $5/unit;

Purchase cost is $3/unit

Fixed cost is $100/period

Contribution Margin is ($5-$3)/$5 = 40%

How the profit varies as volume of sales varies?

Pricing Strategies

Break- Even Point :

Break-even sales ($) =

= Fixed costs / contribution margin (%)

= $100 / 0.4 = $250

Break-even volume (units)

= Fixed costs / margin per unit

= $100 / ($5 - $3) = 50 units

Adding in a Profit

What should be the level of sales for $100 profit?Sales ($) Fixed costs + Desired net income

contribution margin = ($100 +$100)/ 0.4 = $500

Volume (units) Fixed costs + Desired net income

per unit contribution margin ($100 +$100)/ 2 = 100

Markup

The difference between the cost of product or service and its selling price is the Markup.

Dollar markup = Retail price – Cost of merchandise % markup = Dollar markup / Cost of unit

Example: If a shirt costs $15 and the manager plans to sell it for $25

Dollar markup = $25 - $15 = $10 % markup = $10 / $15 =66.67%

Summary Module 2

This section has provided an overview of key financial documents including:Balance Sheet

Assets = Liabilities + Owners Equity

Proforma Income Statement

Sales - Pricing strategies and sales forecasts

Expenses - Variable & Fixed Expenses

Profit - Break Even Analysis

Assignment

Create an opening balance sheet for your venture

Use Excel template: “Key Financial Documents” (sheet E)

Create an income statement for your venture

Use Excel template: “Key Financial Documents” (sheet D)

Appendix

Additional slides if required

Initial Markup

Average markup required on all merchandise to cover the cost of items, all incidental expenses and a reasonable profit

Initial Dollar Markup =

Oper. Expenses+ Reductions + Profits

Net Sales + Reductions