What are the basic benefits and purposes of developing pro forma statements and a cash budget?
1. What are the basic benefits and purposes of developing pro forma statements and a cash budget?
a. Pro forma income statements, balance sheets and statements of cash flows are commonly understood as financial projections.
The purpose of financial projections of a new or an existing enterprise is to indicate the venture’s potential, present a timetable for financial viability and lay a benchmark to measure the effectiveness of management’s performance along the financial axis. It can also serve as an operating plan using financial benchmarks. Entrepreneurs need answers to questions that link strategic business decisions to financial plans and choices. What is likely to happen? When? What can go right along the way? What can go wrong? What has to happen to achieve business objectives and to increase or preserve options? Financially savvy entrepreneurs know that such questions trigger a process that can lead to creative solutions to their financial challenges and problems. Well-developed financial projections benefit the company because they are the key to this financial vigilance.
In fact, Pro forma income statements are the plan-for-profit part of financial management and can indicate the potential financial feasibility and the time frame of a new venture. Since usually the level of earnings or profits, particularly during the start-up years of a venture, will not be sufficient to finance operating asset needs, and since actual cash inflows do not always match the actual cash outflows on a short-term basis, a cash flow forecast that will indicate these conditions and enable management to plan cash needs is recommended. Further, pro forma balance sheets are used to detail the assets required to support the projected level of operations and, through liabilities and capital, to show how these assets are to be financed. The projected balance sheets can indicate if debt-to-equity ratios, working capital, current ratios, inventory turn over and the like are within acceptable limits required to justify future financings that are projected for the venture. Finally, a break even chart and a corresponding sensitivity analysis showing the level of sales and production that will cover all costs, including those costs that vary with production level and those that do not, is essential.
More on Pro forma Statements
Projected financial statements are typically developed with assumptions that are monthly for the first year and quarterly for the next few years into three-year or five-year term operating plans. Managers will typically break down the revenue item on the income statement into various revenue channels whether product or service. Based on pricing, which the market will bear, and the number of units that could be sold, product and service unit sales …
This solution identifies and discusses the basic benefits and purposes of developing pro forma statements and a cash budget.
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