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Similar to a pro forma income statement, the pro forma balance sheetA projected balance sheet. is a projection of a balance sheet. While the percentage-of-sales method could be used for the balance sheet as well, a more sophisticated and accurate approach would be to analyze each line of the balance sheet. A properly forecasted balance sheet uses best judgement to predict future sales and expenses. For example, our company may need to hold a certain amount of cash to meet basic expenses. Or a company at capacity might need to add assets to continue sales growth. A common size balance sheetA balance sheet with entries expressed as a percentage of total assets., which shows each balance sheet item as a percentage of total assets, may help guide us in making these decisions. This infomation enables an individually tailored and more accurately forecasted balance sheet.
Pet Product’s Forever Inc. has the following balance sheet. They know certain things about their next year which will play a role in determining the pro forma balance sheet.
Figure 5.4 Pet Products Forever Inc. Balance Sheet (Thousands) 2012
Figure 5.5 Pet Products Forever Inc. Common Size Balance Sheet (Thousands) 2012
Pet Products Forever has certain financial goals and knowledge about the upcoming year.
Given this information we construct the following balance sheet.
Figure 5.6 Pet Products Forever Inc. Pro Forma Balance Sheet First Pass (Thousands) 2013
Note that retained earnings has increased by our earnings less our divindends paid ($11 thousand − $4 thousand = $7 thousand). Since accounts receivable and payable both scale with sales, and sales increased by 10%, each of these has increased by 10% as well.
After our first pass, our balance sheet doesn’t balance! If our total assets are larger than our total liabilities and equity, we need to raise money somehow, either by increasing financing (that is, borrowing more, reducing dividends, or issuing equity) or reducing assets. Smaller total assets means returning cash to our investors (by reducing debt or increasing dividend payout) or parking the cash on our balance sheet (in cash or other short term investments).
Since after the first pass the total assets are smaller, we can choose to increase cash held to balance the books.
Figure 5.7 Pet Products Forever Inc. Pro Forma Balance Sheet Second Pass (Thousands) 2013
Pro Forma balance sheets provide a look into a company’s future.
Using the original Pet Products Forever balance sheet from 2012, construct a pro forma balance sheet using the following information: