Pro Forma Income Statement

1. Pro Forma Income Statement • Projected or “future” financial statements. The idea is to write down a sequence of financial statements that represent expectations of what the results of actions and policies will be on the future financial status of the firm. • Income statement measures a company's financial performance over a specific accounting period. Financial performance is assessed by giving a summary of how the business incurs its revenues and expenses. Also known as statement of “revenue and expenses”

2. Components of Income Statement • Net Sales (a.k.a. sales or revenue): These all refer to the value of a company's sales of goods and services to its customers. • Cost of Goods Sold : For a manufacturer, cost of sales is the expense incurred for raw materials, labor and manufacturing overhead used in the production of its goods. • Gross Profit (a.k.a. gross income): represents the difference between net sales and the cost of sales. Gross profit provides the resources to cover all of the company's other expenses. Obviously, the greater and more stable a company's gross margin, the greater potential there is for positive (net income) results. • Operating Expenses: includes all the operational expenses of the company. (e.g. salaries and wages of staff, advertisement cost)

3. Cntd.. • Interest expense: Companies often borrow money in order to build plants or offices, buy other businesses or purchase inventory. The borrowed money is converted as an expense on the income statement. E.g. the interest a company pays to banks is an expense. As a result, interest expense must be accounted for on the income statement.

4. Basic Format Sales (or Revenue) Less Cost of Goods Sold Equals Gross Income (or Gross Earnings) Less Operating Expenses Equals Operating Income Less Depreciation Equals EBIT Less Interest Expense Equals EBT Less Taxes Equals Net Income (Net Earnings, EAT, Profits)

5. Break-even • Break Even: Cost=revenue • The break-even point in any business is that point at which the volume of sales or revenues exactly equals total expenses -- the point at which there is neither a profit nor loss. The amount that you have invested • Another definition: the level of sales or production at which the total costs and total revenue of a business are equal.

6. Cntd.. • B.E in quantity: the quantity of products you need to sell in order to break even. fixed cost/ (selling price – variable cost) • B.E in price (Rs): fixed cost/(1- variable cost/selling price)

7. Example • For example if your fixed cost for producing tables is 100. The variable cost (materials, labor, etc ) is 50. If you choose a selling price of for each table to be 70, then: • Then you B.E in quantity= 100/ (70-50)=5

8. CAPEX and OPEX • CAPEX: Capital Expenditure, initial investment, funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment. • (CAPitalEXpenditures) Refers to the cost of developing a product or system. OPEX (operating expenditures) are the ongoing costs for running it. For example, the purchase of a printer is the CAPEX, and the annual paper and ink cost is the OPEX. For larger systems, OPEX may also include the cost of human operators and facility expenses such as rent, electricity, heating and air conditioning.

9. Components of OPEX • Operating expenses include: • accounting expenses • maintenance and repairs • advertising • office expenses • supplies • attorney fees and legal fees • utilities, such as telephone • insurance • property management, including a resident manager • property taxes • travel and vehicle expenses

10. NPV (net present value) • Definition of 'Net Present Value - NPV‘: The difference between the present value of cash inflows and the present value of cash outflows. • NPV is used in capital budgeting to analyze the profitability of an investment or project.  • NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield.  

11. Formula

12. Additional explaination. • NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account. If the NPV of a prospective project is positive, it should be accepted. However, if NPV is negative, the project should probably be rejected.

13. For example • if a retail clothing business wants to purchase an existing store, it would first estimate the future cash flows that store would generate, and then discount those cash flows into one lump-sum present value amount, say $565,000. • If the owner of the store was willing to sell his business for less than $565,000, the purchasing company would likely accept the offer as it presents a positive NPV investment. Conversely, if the owner would not sell for less than $565,000, the purchaser would not buy the store, as the investment would present a negative NPV at that time and would, therefore, reduce the overall value of the clothing company.

14. IRR (Internal rate of return) • The discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. • Generally speaking, the higher a project's internal rate of return, the more desirable it is to undertake the project. • As such, IRR can be used to rank several prospective projects a firm is considering. Assuming all other factors are equal among the various projects, the project with the highest IRR would probably be considered the best and undertaken first. • IRR is sometimes referred to as "economic rate of return (ERR)".

15. You can think of IRR as the rate of growth a project is expected to generate. • While the actual rate of return that a given project ends up generating will often differ from its estimated IRR rate, a project with a substantially higher IRR value than other available options would still provide a much better chance of strong growth. • IRRs can also be compared against prevailing rates of return in the securities market. If a firm can't find any projects with IRRs greater than the returns that can be generated in the financial markets, it may simply choose to invest its retained earnings into the market

16. IRR through Interpolation • IRR = Lowest Discount Rate + [NPV at Lower rate * (Higher Rate - Lower Rate) / (NPV at Lower Rate - NPV at Higher Rate)]

17. For eg:- Say there are two discount rates for instance 10% & 20% and also let us say  NPV at 10% is +29,150 and at 20% is -19,350. Then IRR would be as follows : IRR = 10% + [ 29,150*(20%-10%)/(29,150+19,350)] IRR = 16.01% NOTE : - This formula is useful when there is unequal Cash Inflows.

18. When there is equal Cash Inflows : • (a) Long Life Project : - • When life is at least twice that of payback period. • Steps : • 1. Calculate Payback Factor • 2. Look into PV(present value) Tables • (b) Short Life Project: -  • When life is less than the twice of payback period. • Steps: • 1. Find two discount rates within which this value lies in the table. • IRR = Lower Discount Rate + [ (PV annuity Factor at Lower Rate - Payback Factor) / (PV annuity factor at Lower Rate - PV annuity Factor at Higher Rate)] • Payback Factor = Cash Outflow / Annual Cash Flow after tax