- 1. The Financial Forecasts for the Business Plan Shad Valley
2007
2. Contact Info
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- http://foba.lakeheadu.ca/hartviksen
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- http://www.scotiabank.com/businessplan
3. Todays Agenda
- Purpose of Financial Forecasts
- Characteristics of Good Financial Forecasts
- How to forecast and how to recognize assumptions
- A tour of the financial forecasts required
- Purpose of each forecast and their interrelationships
- Data requirements and how they are generated
- Pro forma Financial Statements
4. What we Hope to Accomplish
- Understand the importance and use of:
- Learn how to develop loan amortization schedules and CCA
schedules
- Learn how to incorporate this forecast information into
financial forecasts
- Get you started on your own forecasts
- Develop some skills in the use of Excel spreadsheets
5. The Purpose of Financial Forecasts
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- Predict the financial consequences of our business plan
-
- Allow us to change our plans in advance to optimize the real
financial results after analyzing the forecast financial
statements.
-
- To demonstrate to financial partners the ability of the
business to give them an adequate return on investment.
6. The Purpose of Financial Forecasts What do Investors Look
For?
- Ability to generate cash flow early enough and in sufficient
quantity to ensure on-going financial solvency
- Time to positive cash flow
7. Characteristics of Good Forecasts
- Based upon good primary and secondary research
- Congruent with operating and marketing plans
- Can withstand stress testing
8. Where do you Start?
- When generating integrated financial statements you start
with:
- You will modify the annual sales forecast to a monthly sales
forecast for the first year
- Make projections of all expenses for the first year.
- Start with a guess about the amount of initial financing
required and where it is likely to be invested.
-
-
- The big difference between the cash budget and the pro forma
Income Statement is that you include depreciation in the Income
Statement and ignore it in the cash budget.
-
-
- The other big difference is that you use total interest expense
for the year in the income statement, but you use the total
payments in the cash budget.
9. Integrated Financial Forecasts Analyze forecasts, adjust
inputs and forecast again. Sales Forecast Cash Budget Initial
Investment Schedule Pro Forma Income Statement Pro Forma Balance
Sheet Detailed Expense Forecasts Loan Amortization Schedule Capital
Cost Allowance Schedule 10. Before we Get Started Lets Review Some
Things about Business Plans
- A Business Plan is a forecast of what you hope to do.and how
and when you hope to do it!
11. Characteristics of a Good Plan
12. Uses of A Business Plan
- Helps you understand the steps to implementing your idea and
what key factors you must monitor to ensure success.
- Support an application for financing
- Solicit potential financial partners
13. How a Business Plan is Read
- Determine the characteristics of the company and industry
- Determine the terms of the deal
- Read the latest balance sheet
- Determine the caliber of the people in the deal
- Determine what is different about this deal
- Give the plan a once-over lightly
14. Abbreviated Contents
- Title Page (with disclaimer)
- Market Research and Analysis
- Economics of the Business
- Design and Development Plans
- Manufacturing and Operations Plan
- Critical Risk, Problems and Assumptions
NOTE the location of the financial documents 15. IV.Economics of
the Business
- Gross and operating margins
- Profit potential and durability
- Fixed, variable and semi-variable costs
- Months to reach positive cash flow
16. XI.The Financial Plan
- Actual financial statements (if an already established
business)
- initial investment required
17. XII.Financing
- Proposed sources of financing
- investors forecast rate of return on invested capital
18. The Basic Financial Forecasts Shad Valley Lakehead 19. Types
of Financial Forecasts
- Initial Investment Schedule
- Pro forma Income Statements
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- Loan Amortization schedule
- Statement of Forecast Assumptions
20. Break-even Analysis Shad Valley 2007 21. Break - Even
Analysis (Cost/Volume/Profit Analysis)
- This is a planning and control technique.
-
- make informed decisions about pricing your product or service
and the cost to produce it.
-
- compare your actual results with those that you have
forecast.(For example, your restaurant may require you to sell
10,000 meals at $10.00 per meal = $100,000 in order to break even
annually.This works out to 192 meals a week or 28 per day.If on the
first day of operation you sell 30 mealsyou are on track to break
even!)
22. Break - Even Analysis (Cost/Volume/Profit Analysis)
- The break-even point can be found using the following
equation:
- Selling price/unit - Variable Cost/unit
23. Cost Behaviour
- You can classify fixed and variable costs according to how they
change in response to changes in sales volume.
-
- are costs that (within the relevant range) dont change in
response to changes in sales volume.
-
- Examples include depreciation expense, rent, salaries and other
overhead costs.
-
- are costs that (within the relevant range) change in response
to changes in sales volume.
-
- Examples include direct materials and direct labour costs
(wages paid by hour).
24. Relevant Range
- The relevant range is the range of output (units produced and
sold) that the cost and pricing assumptions can reasonably be
expected to hold.
$ of Sales and Costs # of units produced and sold Total Revenue
Total Costs Fixed Costs Relevant Range 25. Relevant Range
- If sales are expected to push the firm beyond its current
physical capacity, (beyond the relevant range) cost behaviour
assumptions must be revised.
$ of Sales and Costs # of units produced and sold Total Revenue
Total Costs Fixed Costs Relevant Range 26. Break - Even Analysis
(Cost/Volume/Profit Analysis) Number of units produced and sold $
of Sales and Costs Total Revenue Line 12 $20 $10 The slope of
therevenue line isdetermined by theprice that you setfor your
productor service. Sales revenuewhen price perunit is $10.00. 27.
Break - Even Analysis (Cost/Volume/Profit Analysis) Number of units
produced and sold $ of Sales and Costs Total Revenue Line 12 $20
$10 The slope of therevenue line isdetermined by theprice that you
setfor your productor service. Sales revenuewhen price perunit is
$5.00. 28. Break - Even Analysis (Cost/Volume/Profit Analysis)
Number of units produced and sold Total Revenue Line $7.50 $10
Total Variable Cost Contribution Margin per unit = $2.50 The slope
of therevenue line isdetermined by theprice that you setfor your
productor service. $ of Sales and Costs 12 If variable cost per
unit is less than price per unit,there is a positivecontribution
margin. 29. Contribution Margin
- For most small businesses, it is relatively easy to determine
the variable cost per unit.
- What you want to determine is how much it costs you in terms of
direct material and direct labour to produce your product or
service.
- Once you know the variable cost per unit, this becomes a good
guide to you in the pricing decision.Obviously, if you price your
product under your variable cost per unit, you will lose money each
time you sell one unit.The more you sell, the more money you
lose.
- Look at the following example..
30. Contribution Margin Example
- You plan to start a bagel shop.
- The average customer will purchase a dozen bagels, some cream
cheese and a coke.
- You have determined that your variable costs to produce this
average customer purchase as follows:
- 12 Bagels cooked (materials and electricity) 2.99
- Cream cheese and container 1.65
- Straw/napkins/bag and other condiments 0.75
- Direct labour costs (counter help & cook) 2.75
- Total variable cost per unit $8.99
- Given your analysis you initially price coke at $2.00 and a
dozen bagels with cheese for $8.50 giving you a contribution margin
of $1.51 per unit.Total cost to the customer is $10.50 plus PST and
GST or $12.08
31. Contribution Margin .
- You now find out that the Great Canadian Bagel sells coke for
$1.75 and a dozen bagels with cheese for $6.50 for a total cost to
the customer of $9.49 (including Gst and Pst)this is below your
estimated variable cost per unit!
- The Great Canadian Bagel is a franchise that benefits by the
fact that the franchisor has tremendous buying power (centrally
negotiates purchases and prices with suppliers for flour, cream
cheese and coke).This gives them a competitive advantage over
you...
- Variable Cost per unit Great Canadian Bagel
- 12 Bagels cooked (materials and electricity) 2.99 1.50
- Cream cheese and container 1.65 1.20
- Straw/napkins/bag and other condiments 0.75 0.50
- Direct labour costs (counter help & cook) 2.75 2.75
- Total variable cost per unit $8.99 $6.40
32. Contribution Margin .
- Conclusion:if you are to compete with the Great Canadian Bagel
purely on price, you will fail.
- Variable Cost per unit Great Canadian Bagel
- 12 Bagels cooked (materials and electricity) 2.99 1.50
- Cream cheese and container 1.65 1.20
- Straw/napkins/bag and other condiments 0.75 0.50
- Direct labour costs (counter help & cook) 2.75 2.75
- Total variable cost per unit $8.99 $6.40
- Selling Price to the Public per unit $10.50 $8.25
- Contribution margin per unit $1.51 $1.85
- Your variable cost per unit is higher than the Great Canadian
Bagels variable cost per unit.
- Your proposed selling price is 27% higher than your competition
yet your proposed contribution margin is 18% lower.
33. Contribution Margin Analysis
- Faced with this pricing and costing analysis, you have some
choices:
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- forget about going into this business
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- seek to negotiate arrangements where your direct operating
costs can be lowered
-
- devise a product or marketing strategy that would induce
consumers to purchase your products over the Great Canadian Bagel
product (higher quality product, perceived greater value that
justifies the higher price)
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- seek to locate your business somewhere there is no direct
competition.(Nipigon, Marathon, Atikokan, Sioux Lookout)
- Of course, further analysis will be required (before
proceeding) to determine whether you could actually make a profit
at the business.
34. Contribution Margin
- The contribution margin is the amount of money that is
available from the sale of each unit to cover the fixed costs of
the firm.
- Once those fixed costs are covered, any further units that are
sold will result in profit.
35. Break Even Point
- Is the point where total revenue equals to total costs
- Variable and Fixed costs are summed to equal total costs.
- Break even point in units =Annual Fixed Costs / contribution
margin
36. Break Even Chart $ of Sales and Costs # of units produced
and sold Total Revenue Total Costs Fixed Costs Break Even Point in
Units TR = TC 37. Annual Fixed Costs of the Bagel Business
- Let us assume for a moment that you have decided to locate your
proposed business in Nipigon where you are sure that there is no
competition, and it is unlikely competition would enter the market
after you arrive.
- You estimate that once established, you will face the following
fixed costs each year to run the business:
- Annual building lease costs (12 months @ $2,000/month)
$24,000
- Office expenses (bank charges, accountant etc.) 8,000
- Depreciation of equipment (ovens, microwave, etc.) 4,400
- Gross Salary for the manager34,000
- Employer contribution to CPP/EI and employer health tax
9,520
- Other fixed costs (advertising and promotion) 2,000
- TOTAL ANNUAL FIXED COSTS $81,650
38. Break Even Point of the Bagel Business
- The breakeven point, given your analysis to this point is:
- Break-even point in #s of meals annually =Annual Fixed
Costs
- This works out to 4,507 meals per month or 149 meals per
day.
39. Break Even Point of the Bagel Business
- Break-even point = 54,073 meals
- This works out to 4,507 meals per month or 149 meals per
day.
- This implies baking and selling 1,788 bagels per day with no
wastage.
-
- Do your ovens and facilities have the capacity to produce this
volume each day?
-
- If you are closed on Christmas, New Years or any other dayyou
will have to sell more on the other days on average.
-
- NOW - the big question.what is the market for your product in
that locationwho would buy bagels?How frequently?What is their
purchasing behaviour?Attitudes toward price?
40. Break Even Point of the Bagel Business
- Break-even point = 54,073 meals
- At an average price per sale of $10.50, that volume of meals
means annual sales revenue of:
- Annual Sales Revenue = Price per meal times # of meals
41. Initial Investment Schedule 42. Initial Investment
Schedule
- The purpose of the initial investment schedule:
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- Identify proposed sources of capital
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- Identify proposed initial uses of capital
43. The Monthly Cash Budget 44. The Monthly Cash Budget
- The purposes of the monthly cash budget:
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- Illustrate projected sources of cash timing and magnitude
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- Illustrated projected uses of cash timing and magnitude
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- Demonstrate the time to producing a positive cash flow
45. The Pro Forma Income Statement 46. The Pro Forma Balance
Sheet 47. Subsidiary Forecasts
- You will need to make a series of forecasts that will be
incorporated into your overall financial forecasts.
- Some of it will require outside data gathering for
example:
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- Employer contributions to CPP and EI
- The most common subsidiary forecasts are:
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- Loan amortization schedule
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- Capital Cost Allowance Schedule
48. Types of Small Business Loans
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- Business Development Bank of Canada
49. Fixed Term Blended Payment Loans This is a diagram of the
cash flows involved $10,000 Monthly fixed payments 50. Effective
Annual Rate Calculations
- You wish to borrow $10,000
- Assume you are quoted a fixed term, fixed payment loan at 2.5
percent above the prime lending rate
- The prime lending rate is currently 4.5%
- The loan amortization period is 1 year
51. Calculating an Effective Monthly Rate
- Since most loans require monthly payments, it is necessary to
determine themonthlyrate that would equal the
effectiveannualrate:
52. Calculating the Monthly Loan Payment
- Now we know all of the variables:
-
- We can calculate the loan payment:
53. Preparing a Loan Amortization Schedule 54. Use of the Loan
Amortization Schedule
- The loan payment each month is a cash outflow that must be
included in your cash monthly cash budget.
- The total interest expense for the year is included in thepro
formaincome statement.
- NOTE: -repayment of principal is not a taxdeductible
expense.
- - the total payment is a cashflow burdenborne by the firm
55. Effective Annual Rates of Return
- Most loan rates are quoted in APR terms (annual percentage
rate)
- However, APR financing does not take into account the effects
of compounding
- Most loans are compounded semi-annually.(ie. Interest is
calculated and credited every six months).This effectively
increases the rate of interest that the consumer faces.
56. The Nature of Depreciation
- Capital assets such as buildings and equipment and land are
very costly, but usually have a useful life of greater than one
year.
- Buildings and equipment tend to wear out over time(ie. They
have a useful life of perhaps 10, 20 or 30 years)
- The cost of the buildings and equipment is spread out over
their useful lives, and only the amount of wastage (wear and tear)
is deductible from income in that year for the purposes of
calculating taxes.
- CCRA predominantly uses one method of depreciationit is known
as Capital Cost Allowance.
57. CCA gives rise to a Tax Shield Benefit to the Company
- CCA is anon-cashdeduction from income that would otherwise be
subject to income taxation.
- As a result of the CCA deduction, taxable income is
reduced.
- This results in a savings in tax payable.
- The tax shield benefits is equal to:T(CCA)
- CCA = the dollar amount of CCA claimed
- A firm with a 40% corporate tax rate and a $2,000 CCA deduction
will save $800 in taxes.
4 K. Hartviksen 58. Example: Consider two firms that report
$10,000 in earnings before CCA and taxes, face a 40% tax rate.One
firm has no CCA to claim, the other can claim $2,000 in CCA
- Earnings Before CCA & Tax $10,000 $10,000
- Taxable Income $ 8,000 $ 10,000
- Net Income $ 4,800 $ 6,000
- Add back non-cash expense 2,000 0
- Cash flow from Operations $ 6,800 $ 6,000
5 K. Hartviksen Note that company A is better off by $800
because of the $2,000 non-cash deduction of CCA.That is the amount
of taxes saved. 59. CCA Rules
- Assets are grouped into pools or classes and depreciated as a
group
- CCA rates are found in the regulations to the Income Tax Act
and can be changed by Order-in-Council
- There is no need for an estimate of salvage value or useful
life
- 1/2 of the regular CCA rate for the class applies to the net
additions to the pool for that year.
- CCA cannot be used to create a tax loss.
7 K. Hartviksen 60. CCA Over Time - A Simple Example Assume you
acquire a depreciable asset with a cost base of $100,000 and there
are no other assets in this pool.The CCA rate for the pool is 10%.
Note you are allowed only 1/2 the regular CCA rate on the net
additions to the pool in the year of acquisition. 8 K. Hartviksen
61. CCRA Form 62. CCRA Form forecasting CCA out three years for one
asset class 63. NOTE Regarding Depreciation in your Financial
Forecasts:
- You never include depreciation (CCA) on a cash flow (cash
budget) forecast
- You use depreciation only in your pro forma income statement,
and on your pro forma balance sheet.
64. Initial Startup Capital Required
- The initial estimate can and probably will be revised depending
on your first iteration of the forecasts.
- Separate the estimate into two categories:
-
- Fixed assets (plant and equipment)
- You do this because when you look for financing for these
investments, the fixed assets can usually be pledged as collateral
for any borrowing, whereas the working capital needs usually has to
be financed out of the owners equity.
65. Initial Investment
- In your business plan you will have to prepare a schedule that
details the initial financial investment that is required to make
your business a success.
- It is best is you divide the schedule up into two
components:
-
- Working capital requirements
66. Initial Investment Required Example 67. The Cash Budget
- Incorporates your startup capital estimates
- Is strongly a function of your sales forecasts (that are
predicated on your market research and some assumptions about your
market penetration strategy)
68. Importance of Cash Flow
- Planning to have cash available to pay bills of the business as
they become due is a critical aspect of business survivalit is a
management skill.
- Understanding the cash flow cycle of a firm can help you manage
those elements that are critical to ensuring you can pay your
bills.
- Cash flow forecasting through a cash budget provides important
information to you and to your potential funding partners about
your operating financial needs and most particularly,
thetimingandmagnitudeof any projected cash deficits or
surpluses.
69. Cash and Materials FlowShareholders equity Debt Cash Taxes
Cash Sales Raw Materials Inventory Finished Goods Inventory
Work-in-processInventory 70. The Cash Budget
- Cash budgets are most often prepared on a monthly basis.
- Most funding partners expect to see three years of
projects.Some may require as many as seven years.
- If your business expects to encounter any seasonality in the
sales cycle, you will find some interesting effects that may
dramatically affect the amount of start-up financing that you
require.
- If there is seasonality effects, you will have to carefully
manage your cash flows, inventories and accounts receivable to
remain solvent.
71. Cash Budgets
- allow us to forecast the cash flows of a firm over time
(between balance sheet dates).
- identifies the timing and magnitude of expected cash surpluses
and deficits - thereby providing the manager with the opportunity
to prepare, in advance, to finance expected deficits, or to invest
surpluses.
- may be used as the basis for pro forma financial
statements.
72. General Form - Cash Budget 73. Assumptions of Cash
Budgets
- that cash inflows and outflows occur evenly throughout the
month.
-
- disbursements often are predictable
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- wages/salaries due on 15th and 30th
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- payments to suppliers on 15th or 30th, etc.
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- cash receipts depend on how we manage accounts
receivable....depending on how we do this they may largely occur
between the 20th and 30th of the month...
-
- what is the impact of the foregoing?
-
- how can we overcome this?
74. General Form - Cash Budget 75. General Form - Cash Budget
76. Cash Balance $ Cash JanFebMarAprMayJunJulAug 77. Analyzing your
financial forecasts Lakehead Shad Valley 78. Ratio Analysis
- This is a technique used by investors and bankers (lenders)
alike to assess the financial strength of your proposed
business.
- Once your business begins, ratios will be used to examine how
well you are managing your business.
79. Ratio
- Is one number divided by another!
- Purpose is the provide some insight into the complexity of
financial information.
- Current Ratio = Current Assets
80. Categories of Ratios
81. Liquidity Ratios
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- to examine the ability of the business to pay its bills on
time.
- A firm that cant survive in the short-term wont have to worry
about the long-term!
82. Liquidity Ratios
- Current Ratio = Current Assets
- Quick Ratio = Current Assets - Inventories
83. Asset Management Ratios
-
-
- to give some insight into how well the business is being
managed.
84. Asset Management Ratios
- Inventory Turnover = Sales
85. Asset Management Ratios
86. Debt Management Ratios
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-
- to examine the impact that the chosen methods of financing are
having (likely to have) on the financial health of the
business.
-
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- Lenders will also be concerned with your liquidity ratios
because those ratios assess your firms ability to pay the bills
when they come due.
87. Debt Management Ratios
- Total Assets = Total Debt
- earned = Operating Income
88. Profitability Ratios
-
-
- to examine the historical (or prospective rate of return in the
case ofpro formafinancial statements) rates of return earned on
invested capital.
89. Profitability Ratios
90. Profitability Ratios
91. Seasonality of Sales
- most firms experience a seasonal variation in sales
volume...times of the year when sales increase, and times of the
year when sales volumes are low or non-existent.
- there are financial implications for firms that experience a
marked seasonal sales cycle
-
- what is the best time in the seasonal sales cycle to have the
fiscal year end?
-
- how do we finance the seasonal build-up in inventory
levels?
-
- what happens to the balance sheet accounts at different points
in the seasonal sales cycle?
-
- how comparable are two firms in an industry with a marked
seasonal sales cycle if they have differ fiscal year ends?
92. Balance Sheet Accounts over time 93. Selecting the Fiscal
Year End
-
- for smaller, owner/managed enterprises, there are greater
tax-planning opportunities if the corporate fiscal year end is set
sometime after the calendar year end
-
- the firms financial position
-
- firms will look most healthy if the fiscal year end is set
sometimeafter the seasonal sales peak....long enough afterward to
see receivables collected.
-
- auditors are busy around the calendar year end...with firms and
individuals that have selected Dec 31 as their year end.
-
- auditors are busy from February through May with income
tax
94. Ratio Analysis
- a ratio is just one number over another number.If the ratio is
poor when compared to something else, it could be a result of the
numerator, or the denominator, or both.
- a ratio is just a number.It must be compared to something else
if it is to begin to take on some meaning.Common comparators
include:
-
- historical ratios for the firm itself
-
- other current ratios for the same firm
- it is important to take the context into account when
interpreting the financial performance of the firm...what industry
is the firm in?how rapidly has the firm been growing? what is
happening in the industry?
- ratio analysis is a starting point in analyzing the firm.It
must be supplemented by analysis of the overall economy, the
industry, etc.
95. Income Statement Ratios
- Absolute Common Size Industry Avg.
- Sales $250,000 100.0% 100%
- Cost of Goods Sold 173,000 69.2% 70%
- Gross Margin 77,000 30.8% 30%
- Admin Expenses 50,000 20.0% 10%
- Interest Expense 5,000 2.0% 5%
- Net Income $22,000 8.8% 15%
- Profit Margin on Sales 8.8% 15%
- You can see from the common size data, that this firm differs
from the industry in overhead costs and in interest expense.Without
further information it is difficult to draw any specific
conclusions, however, you should note, that direct operating costs
are in line with the industry.Why is selling and admin. expenses
double that of the industry?The firms fixed financing costs are
low...is it just low cost or are they using less debt than others
in the industry?
96. Use of Ratios
- Evaluate your past financial performance
- Evaluate your financial forecasts
97. Role of Ratios in Your Business Plan
- Your business plan forecasts your firms future financial
performance.
-
- Conduct ratio analysis on your forecast position
-
- determine whether you should pursue your plans
98. Role of Ratios in Your Business Plan Prepare Pro Forma
Financial Statements based on your business plans Analyze your
forecasts using ratio analysis Once you are satisfied with your
forecastsproceed to raise the capital and implement the plan Revise
plan ifnecessary 99. The Articulation of forecast Income Statements
and Balance Sheets
- Articulation refers to the fact that the forecast income
statements and balance sheets are integrally linked.
-
- Assets like building and equipment are stated on the balance
sheet at their net value (net of depreciation)
-
- The retained earnings account on the balance sheet will be the
accumulated retained earnings over time as found historically on
the income statements.(The difference between last years R/E
balance and next years, is the amount of income after tax that is
retained in the firm.)
100. Questions? Good Luck