B.5. Top-Level Planning Flashcards

Pro forma financial statements are used to see what the company’s financial statements will look like if something under consideration or forecasted actually happens.

Pro forma financial statements are prepared for specific scenarios and are not the same as the master budget, although one or several versions of pro forma financial statements may be prepared as a part of the formal planning process that precedes development of the master budget.

Managers use pro forma financial statements when considering a major decision, to project the decision’s effect on earnings, the company’s cash position, its need to borrow, whether it will be able to make its scheduled loan payments, whether it will remain in compliance with its debt covenants, and so forth.

Pro forma statements can be prepared for the whole company or specific departments, unlike master budget statements, which are prepared individually for every department and then consolidated into budgeted financial statements for the whole company.

Accurate sales forecasting helps avoid financial strain from unsold inventory or unused capacity and ensures preparedness for market changes.

Spontaneous liabilities increase naturally, such as increases in accounts payable caused by increased purchases of inventory to support increased sales, while external financing requires intentional actions like applying for loans or issuing securities.

Higher sales growth and a higher capital intensity ratio increase the need for external financing, while higher spontaneous liabilities, net profit margins, and retention ratio reduce it.

The FFS method is flexible and suitable for medium- and long-term forecasting, focusing on the difference between total assets and total liabilities plus equity to determine additional funds needed.