Question

How do you prepare pro-forma financial statements and describe their relationship to the master budget components?

Answer 1

Answer:

To start creating a pro forma statement, one must begin with an income statement from the current year.

Step 1:

Calculate revenue projections for the business. Make sure to use realistic market assumptions to write an accurate pro forma statement. Research and speak to experts to determine what a normal annual revenue stream is, as well as cash flow and asset accumulation.

Step 2:

Estimate the total liabilities and costs. The liabilities are loans and lines of credit. The costs will be the lease, employee pay, insurance, licenses, permits, materials, etc. To create the first part of the pro forma one will use the revenue projections from Step 1 and the total liabilities and costs found here.

During this time, one has to put a lot of thought into each expense. This is an opportunity to evaluate if every cost is necessary, and what can be cut.

Step 3:

Estimate cash flows. This portion of the pro forma statement will project the future net income, sale of assets, dividends, issuance of stocks, etc. This is the second section of the pro forma financial statement.

Step 4:

Create the chart of accounts. This chart of accounts will make up the pro forma statement for a 3 to 5 year period. Year one will be broken down into monthly increments, while the following years ( years 2 and 3) will be broken down by quarter, and years 4 and 5 are broken down annually.

Remember to continually update the projections in your pro forma to ensure ongoing accuracy.

Financial statements and it's relationship to the master budget components:

A master budget contains all of the other budgets within a business. A successful budget depends on accurate predictions of future activity within each department or division. While companies with multiple divisions have a more complex master budget, all businesses share the same major components. The two main parts are the operational budget and the financial budget. There is a specific order of completion when preparing a master budget.

Operational Budget Relationships:

Sales revenues fund the other operational budgets. The sales budget and all other department budgets are closely related. The cost of producing an item, including direct costs and indirect costs, is a major consideration when setting the selling price of a line of merchandise. Yet the selling price must be competitive in the marketplace to make enough sales to fund the other budgets. Streamlining the process and minimizing waste is essential to increasing profits.

Financial Budget:

The financial budget has five parts. The schedule of expected cash receipts is based on predicted future sales revenues during each period. The amount for each month or quarter will vary in small businesses that are cyclical in nature. The schedule of expected cash payments reflects the amount of money the business plans to spend on purchases during each financial period. The cash budget, income statement and balance sheet all reflect budgeted amounts. If we compare them with the actual numbers at the completion of each quarter, then we can make any necessary adjustments.

Master Budget Order of Completion:

Some component budgets require financial data from other budgets before we can complete them. The correct order for completing the operational budget components is: sales, production, direct material purchases, direct labor, overhead, administrative and cost of goods manufactured. When completing the financial budget, one should begin with the schedule of expected cash receipts and then continue with the schedule of expected cash payments to suppliers, the cash budget, the budgeted income statement and budgeted balance sheet. Following this order will ensure that we have the necessary information for the next component.