Chapter 4: Financial Forecasting

In the development of the pro forma financial statements, the last step in the process is the development of the capital budget. pro forma balance sheet. cash budget. pro forma income statement.

pro forma balance sheet.

In the percent-of-sales method, an increase in dividends will increase required new funds. will decrease required new funds. has no effect on required new funds. More information is needed.

will increase required new funds.

In using a systems approach to financial planning, it is necessary to develop a pro forma income statement. cash budget. production plan. All of the options are true.

All of the options are true.

In general, a firm with higher amounts of sales on credit has higher needs to borrow. more rapidly collection of credit sales. more ability to buy raw materials on credit. lower needs to borrow.

higher needs to borrow.

A rapid rate of growth in sales may require -sales forecasts to be made less frequently. -the firm to be more lenient with credit customers. -increased borrowing by the firm to support the sales increase. -higher dividend payments to shareholders.

increased borrowing by the firm to support the sales increase.

The difference between total receipts and total payments is referred to as cash balance. net cash flow. beginning cash flow. cumulative cash flow.

net cash flow.

Required production during a planning period will depend on the beginning inventory of products. sales during the period. desired level of ending inventory. All of the options are true.

All of the options are true.

Pro forma financial statements are -often required by prospective creditors. -the most comprehensive means of financial forecasting. -All of the options are true. -projections of financial statements for a future period.

-All of the options are true.

In forecasting a firm's cash needs for some future period -the percent-of-sales method is a "broad-brush" approach. -cash budgets are more exact than the percent-of-sales method. -a cash budget approach can deal effectively with both level and seasonal production schedules. -All of the options.

-All of the options.

If the actual A/R at the end of February was $12,000 and projected sales in March are $50,000, where 70% of sales are on credit, 60% of credit sales are collected in the month of the sale, and 40% are collected in the month after the sale, what is the projected A/R balance on the pro forma balance sheet for the end of March? $14,000 $48,000 $20,000 $35,000

$14,000 Explanation A/R Bal. end of March = A/R from March sales = (40% of March credit sales) = ($35,000 × 0.4) = $14,000, all of February's AR balance should be collected in March.

If projected net cash outflow for November is ($10,000), the beginning cash balance is $4,000, the minimum cash balance is $3,000, and the beginning loan balance is $8,000, what will be the cumulative loan balance at the end of November? $22,000 $17,000 Correct $5,000 $14,000

$17,000 Explanation Net cash flow:$(10,000) + Beginning cash balance: 4,000 Cumulative cash balance:(6,000) Loan (Repayment): 9,000 Cum. Loan Bal.: 17,000

BHS Inc. determines that sales will rise from $400,000 to $550,000 next year. Spontaneous assets are 60% of sales, and spontaneous liabilities are 30% of sales. BHS has an 8% profit margin and a 40% dividend payout ratio. What is the level of required new funds? $18,600 $138,600 $3,600 No new funds are needed

$18,600 Explanation New funds required = A/S1(∆S)−L/S(∆S)−PS2(1−D) = 0.60($150,000) − 0.30($150,000) − 0.08($550,000) (1 − 0.40) = $18,600

True/False: If Wiggle Corp has beginning inventory of 100 units, projected sales of 400 units, and desired ending inventory of 200 units, production must be planned for 300 units.

False

True/False: The generation of sales and profits ensures that there will be adequate cash on hand to meet financial obligations as they come due.

False

A firm has targeted a 20% growth in sales this year. Last year's cash as a percent of sales was 10%, accounts receivable 30%, and inventory 25%. What percentage growth in current liabilities is required to support the growth in sales under the percent-of-sales forecasting method? 32% 13% 8% Not enough information to determine

13% Explanation Percentage growth in current liabilities = Percentage growth in current assets = 0.20 × (0.10 + 0.30 + 0.25) = 0.13

True/False:Growth in sales volume prevents a shortage of cash funds.

False

In developing the pro forma income statement, we follow four important steps: 1) Compute other expenses. 2) Determine a production schedule. 3) Establish a sales projection. 4) Determine profit by completing the pro forma income statement. What is the correct order for these four steps? -3,2,4,1 -1,2,3,4 -2,1,3,4 -3,2,1,4

3,2,1,4

If Excel Inc. has projected sales of $30,000 in January, $20,000 in February, and $20,000 in March, where 20% of sales are cash sales and the remaining credit sales are collected the month after, what are the cash receipts in March? $16,000 $21,400 $20,000 $10,300

$20,000 Explanation Cash Receipts Schedule January Sales: $30,000 February Sales:$20,000 March Sales: $20,000 Cash sales (20%): 4,000 Collections (80% of previous month's sales): 16,000 Total cash receipts: $20,000

A firm has forecasted sales of $4,500 in April, $3,000 in May, and $5,000 in June. All sales are on credit. 30% is collected in the month of the sale, and the remainder in the following month. How much cash is collected in June? $1,500 $5,250 $4,050 $3,600

$3,600 Explanation Cash from June = ($5,000 × 0.3) + (3000 × 0.7) = $3,600

A firm has beginning inventory of 400 units at a cost of $12 each. Production during the period was 700 units at $13 each. If sales were 800 units, what is the value of the ending inventory using LIFO? $2,750 $3,600 $3,300 $3,850

$3,600 Explanation Ending Inventory = 300 units @ $12 each = $3,600

A firm has beginning inventory of 450 units at a cost of $10 each. Production during the period was 500 units at $12 each. If sales were 700 units, what is the cost of goods sold (assume FIFO)? $8,000 $8,100 $7,900 $7,500

$7,500 Explanation Old inventory (450 units at $10):$4,500 Plus new production (500 units at $12):$6,000 Available:$10,500 Less ending inventory (250 units at $12):$3,000 Cost of goods sold:$7,500

XYZ Co. has forecasted June sales of 400 units and July sales of 700 units. The company maintains ending inventory equal to 125% of next month's sales. June beginning inventory reflects this policy. What is June's required production? 750 units 0 units 775 units 400 units

775 Units Explanation +Projected sales: 400 units +Desired ending inventory: 875 (1.25 × 700) −Beginning inventory: 500(1.25 × 400) Units to be produced:775

Which of the following is most likely to increase the final number for notes payable for short-term borrowing needs in the pro forma balance sheet? A decrease in inventory. An increase in retained earnings. A decrease in accounts payable. A decrease in accounts receivable.

A decrease in accounts payable.

Philip Morris expects the sales for his clothing company to be $550,000 next year. Philip notes that net assets (Assets − Liabilities) will remain unchanged. His clothing firm will enjoy a 12 percent return on total sales. He will start the year with $150,000 in the bank.What will Philip's ending cash balance be?

Ending Cash balance: $216,000 Explanation Philip Morris Beginning cash:$150,000 No asset buildup: 0 Profit: 66,000 Ending cash:$216,000 Return on sales = 0.12 × $550,000 = $66,000

True/False: A firm that is currently operating at 100% of capacity has an increase in sales. For every percentage increase in sales, the same percentage increase will be needed in current assets and current liabilities.

False

True/False: Generally, the pro forma income statement and balance sheet must be created before the cash budget is completed.

False

True/False: Lower profit margins resulting from increased competition would mean a lower need for external funds.

False

True/False: The finance department should work independently without input from other departments because there may be significant biases when creating pro forma financial statements.

False

True/False: Total production costs on the production schedule should be equal to cost of goods sold in the pro forma income statement.

False

True/False: A cash budget is unnecessary since we know how many units will be sold and produced every month, which is assumed to be the cash inflows and outflows.

False

True/False: An increase in accounts receivable and/or a decrease in accounts payable will usually reduce the amount of new external funds required.

False

True/False: An increase in sales and/or profits means there is also an increase in cash on the balance sheet.

False

True/False: Profit is generally adequate to finance significant growth.

False

True/False: The cash budget approach to financial forecasting assumes that balance sheet accounts maintain a constant relationship to cash.

False

True/False: The percent-of-sales method provides the most accurate and detailed method of forecasting necessary funds.

False

True/False: Compared to a firm operating at 100% of capacity, firms that are operating at less than full capacity will require greater new external funds when sales increase.

False

When using the percent-of-sales method in forecasting the funds needed, which of the following is not true? -Required new funds increase as sales decrease. -Required new funds decrease as profit margin increases. -Required new funds increase as assets increase. -As the tax rate increases, the required new funds increase.

Required new funds increase as assets increase.

The Alliance Corp. expects to sell the following number of units of copper cables at the prices indicated, under three different scenarios in the economy. The probability of each outcome is indicated. Outcome A Probability:0.70 Units:225 Price:$20 Outcome B Probability:0.10 Units: 370 Price: $35 Outcome C Probability:0.20 Units: 510 Price: $45 What is the expected value of the total sales projection?

Total expected value: $9,035 Explanation Total value = Units × PriceExpected value = Probability × Total value

True/False: Level production schedules usually have the advantage of reducing overall production costs.

True

True/False: Pro forma income statements follow the creation of the sales forecast and production plan.

True

True/False: The calculation of cash receipts requires a breakout of cash and credit sales and cash collections history.

True

True/False: The value of ending inventory should be equal to beginning inventory plus total production costs minus cost of goods sold, all from the same time frame.

True

True/False: A higher growth rate in sales will often require more external funds.

True

True/False: Companies generally prefer to maintain some minimum cash balance.

True

True/False: Pro forma income statements and balance sheets refer to projected financial statements.

True

True/False: Sales projections and the ability to accurately predict the future have a large impact on cash flow expectations.

True

True/False: The primary purpose of the cash budget is to allow the firm to anticipate the need for outside funding or excess funds to be invested.

True

True/False: A lower dividend payout ratio will decrease the firm's need for borrowing.

True

True/False: It is helpful to break down the income statement into smaller monthly periods to enable evaluation of seasonal patterns of cash inflows and outflows.

True

True/False: The percent-of-sales method for financial forecasting assumes that balance sheet accounts maintain a relatively constant relationship to sales.

True

Delsing Plumbing Company has beginning inventory of 16,500 units, will sell 55,000 units for the month, and desires to reduce ending inventory to 25 percent of beginning inventory. How many units should Delsing produce?

Units to be produced: 42,625 Explanation Delsing Plumbing Company Projected unit sales:55,000 Desired ending inventory:4,125 Total units required:59,125 Beginning inventory:−16,500 Units to be produced:42,625 Desired ending inventory = 0.25 × 16,500 = 4,125 units

The need for an increase or decrease in short-term borrowing can be predicted by ratio analysis. trend analysis. a cash budget. an income statement.

a cash budget.

Eli Lilly is very excited because sales for his nursery and plant company are expected to double from $600,000 to $1,200,000 next year. Eli notes that net assets (Assets − Liabilities) will remain at 50 percent of sales. His firm will enjoy an 8 percent return on total sales. He will start the year with $120,000 in the bank and is bragging about the Jaguar and luxury townhouse he will buy. a. Compute his likely cash balance or deficit for the end of the year. Start with beginning cash and subtract the asset buildup (equal to 50 percent of the sales increase) and add in profit. (Negative amount should be indicated by a minus sign.) b. Does his optimistic outlook for his cash position appear to be correct?

a. Ending Cash Balance: ($84,000) b. No Explanation a. Eli Lilly Beginning cash:$120,000 Asset buildup:(300,000) Profit: 96,000 Ending cash: $(84,000)Deficit Asset buildup = 0.50 × ($1,200,000 − 600,000) = $300,000 Return on sales = 0.08 × $1,200,000 = $96,000 b.No, he will actually end up with a negative cash balance.

The Bradley Corporation produces a product with the following costs as of July 1, 20X1: Material:$4 per unit Labor: 4 per unit Overhead: 2 per unit Beginning inventory at these costs on July 1 was 3,250 units. From July 1 to December 1, 20X1, Bradley Corporation produced 12,500 units. These units had a material cost of $5, labor of $4, and overhead of $5 per unit. Bradley uses LIFO inventory accounting. a. Assuming that Bradley Corporation sold 14,000 units during the last six months of the year at $19 each, what is its gross profit? b. What is the value of ending inventory?

a. Gross profit: $76,000 b. Ending inventory: $17,500

At the end of January, Mineral Labs had an inventory of 775 units, which cost $12 per unit to produce. During February the company produced 900 units at a cost of $16 per unit. a. If the firm sold 1,500 units in February, what was the cost of goods sold? (Assume LIFO inventory accounting.) b. If the firm sold 1,500 units in February, what was the cost of goods sold? (Assume FIFO inventory accounting.)

a. cost of goods sold: $21,600 b. cost of goods sold: $20,900

Sprint Shoes Inc. had a beginning inventory of 9,250 units on January 1, 20X1. The costs associated with the inventory were: The Sprint Shoes Inc. produces a product with the following costs as of July 1, 20X1: Material:$15.00 per unit Labor:8.00 per unit Overhead:7.10 per unit During 20X1, the firm produced 43,000 units with the following costs: Material:$17.50 per unit Labor:8.80 per unit Overhead:10.30 per unit Sales for the year were 47,350 units at $44.60 each. Sprint Shoes uses LIFO accounting. a. What was the gross profit? b. What was the value of ending inventory?

a. gross profit: $407,075 b. ending inventory: $147,490

In order to estimate production requirements, we -add beginning inventory to desired ending inventory and divide by two. -add beginning inventory to desired ending inventory and subtract projected sales in units. -subtract projected sales in units from desired ending inventory and add beginning inventory. -add projected sales in units to desired ending inventory and subtract beginning inventory.

add projected sales in units to desired ending inventory and subtract beginning inventory.

Firms that successfully increase their inventory turnover ratio will, among other things, -be able to reduce their borrowing needs. -be able to reduce their dividend payments to stockholders. -find it more difficult to be given credit by their resource suppliers. -have a greater need for high balances in their cash accounts.

be able to reduce their borrowing needs.

In developing data for accounts receivable for the pro forma balance sheet, the analyst is most likely to turn to the pro forma income statement. cash budget. prior balance sheet. statement of retained earnings.

cash budget.

Net cash flow is equal to income after taxes minus depreciation. income after taxes minus dividends. cash receipts minus cash payments. cash receipts minus cash payments minus depreciation.

cash receipts minus cash payments.

The pro forma income statement is important to the overall process of constructing the pro forma balance sheet because it allows us to determine a value for change in retained earnings. gross profit. interest expense. prepaid expenses.

change in retained earnings.

In the construction of the cash payments schedule, the major cash payment is generally the general and administrative expense. costs associated with manufacturing inventory. interest and dividends. payments for new plant and equipment.

costs associated with manufacturing inventory.