Question

Describe the Pro Forma statement and the percent of sales method for future cash needs.

What are the pros and cons of each method?

Which method would you prefer to use and why?

Answer 1

Pro-forma Statement

Pro-forma statement is projected or future financial statement that represents the result of various actions and policies that the company/firm is planning to adopt in future.

Pro-forma statement is based on certain assumptions and projections. Pro-forma statement means projected balance sheet, income statement and statement of cash flows.

Percentage of sales method

Percentage of sales method is used to predict the future sales growth. Then this information is used to predict the future cash needs of the company to achieve that sales growth.

Advantages of percentage of sales method:

1. It is easy to develop as current year sales are used to forecast future sales.

2. It is relatively correct for the items correlated with sales.

Disadvantages of percentage of sales method:

1. Expenses which are fixed in nature are difficult to predict with the change in sales percentage.

2. Some the variable expenses does not change in uniformity with change in sales percentage, thus it is difficult to predict that expenses.

Pros of Pro-forma Statement

Pro-forma statement is based on strategic planning, thus it take into account all the strength and weakness of the various action. Pro-forma statement of cash flow show the cash needs of the company based on all the factors.

Cons of Pro-forma Statement

Pro-forma statement is based on estimates, assumptions and projection of “as if” data. If the “as if” data is not correct, all the estimates will be wrong.

I will prefer to use Pro-forma statement as it more detailed and is not based on only one factor that is sales.