Question

Karen Lamont is in the process of starting a new business ans wants to forecast the first years income statement and balance sheet. She has made a number of assumptions

1 million in sales the first year

operating and gross profit margins will be 20 percent and 50 percent.

accounts recivable 12%

invetory as sales 15%

accounts payable 7%

accruals 5%

bank loaned her 300,000 and 100,000 is short term debt and 200,000 is long term debt. Both interest rates are 8%

firms tax rate is 30%

Lamont will need to purchase 350,000 in plant/equipment and she will peovide any other financing needed

QUESTIONS ARE:

1. Based on lamonts assumptions, prepare a pro forma income statement and balance sheet?

2. If her estimates are correct, what will be the firms current ratio and debt ratio? Explain the meaning iof these ratios?

Answer 1

1.

Income Statement for Year 1:

Sales	$1000000
Less: COGS	500000
Gross Profit	500000
Less: operating costs	300000
Operating Profits	200000
Less: Interest (600000*8%)	48000
Income before tax	152000
Less: Taxes @ 30%	45600
Net Income (tranferred to RE)	106400

Balance Sheet at the end of Year 1:

Liabilities	Amount $	Assets	Amount $
AP	35000	Cash	146400
Arruals	25000	AR (12% of 1m)	120000
ST Loan	100000	Inventory (15% of 1m)	150000
Current Liabilities	160000	Current Assets	416400
LT Loans	500000	Plant and equipment	350000
RE	106400
Total Liabilities	766400	Total Assets	766400

2.

a) Current ratio = CA / CL = 416400 / 160000 = 2.60

As explained by current ratio, the convenience to fulfil the short term obligations. In our case, the company has $2.60 to fulfil $1 of liability / obligations.

b) Debt ratio = Total Debt / Total Assets = 660000 / 766400 = 0.86

The debt ratio tells us the debt content in the total Assets. In our case, the company has 86% of the total assets financed by the debt. It makes the company more risky.

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