Question

Pro forma retained earnings - ex. #2

The bottom line on the pro forma P&L for the fiscal year that has just begun is $500,000. The top line is $3.5 million.

The current balance in retained earnings is $2,100,000.

A dividend payout ratio of 40% is anticipated.

a) [review] What is the net profit margin?

b) [review] Explain the answer to a) above.

c) Forecast retained earnings at the end of the fiscal year that has just begun.

d) Which pro forma financial statement will show the forecasted retained earnings figure calculated in c) above?

Answer 1

(a) Bottom Line = $ 500000 and Top Line = $ 3.5 million

Net Profit Margin = (Bottom Line / Top Line) x 100 = (500000 / 3500000) x 100 = 14.2857 % ~ 14.29 %

(b) Bottom Line is the last line in the income statement and is equal to a firm's Net Income whereas Top Line is the topmost line in the income statement and is equal to a firm's Revenue (Sales). Net Profit Margin is the amount of net income generated per unit of revenue. Hence, Net Profit Margin is equal to Net Profit divided by Total Revenue.

(c) Net Income = $ 500000 and Dividend Payout Ratio = 40 %

Dividend Paid = 0.4 x 500000 = $ 200000

Increase in Retained Earnings = Net Income - Dividend Paid = 500000 - 200000 = $ 300000

(d) Retained Earnings is present in the pro-forma financial statement called Balance Sheet. In the Balance Sheet, the Retained Earnings figure can be found under the heading "Shareholder's Equity/Owner's Equity".