CHAPTER 7

PREPARING, ANALYZING,
AND FORECASTING
FINANCIAL
STATEMENTS:
QUANTIFYING THE
BUSINESS PLAN
The intention of this reading is not about teaching entrepreneur how
to be an expert accountants. Rather, it is simply about trying to
understand, construct, and enterpret financial statements.more
specefically, it is meant to translate the business plan into
numerical format composed of financial statement.these financial
statement summarize what is going to happen to the business plan
is carried out well.let us begin by assuming that an entrepreneur
has set up ABC Corporation
A corporation separate legal personality created by law.it can sue and
be sued.
At the beginning,ABC corporation has nothing.However,
Stockholders will be giving cash to the corporation.
Second ABC corporation may need more money and goes ahead to
borrow this from banks or rather financial institution
If we assume that ABC corporation is manufacturing concern, then
there will be a third source of funds and these raw materials
suppliers.the suppliers wo would give raw materials and \or
suppliers to ABC corporation and they will be paid later.
From the cash of corporation, it may want to invest in
land,building,machinery,equipment,furniture,fixtures and vehicles.
It will then try to activate the factory by converting
the raw materials into finishing goods. While in
the factory, however, the corporation would need
power and water, which they would pay from their
cash. So cash will be spent to buy power and
water, which would be used in the factory
Cash will also be used to pay for labor and
supervisors, which again would be used inside
the factory.
When the goods are completed, they become
finished goods inventory
Meanwhile, the accountant will concoct an account
called depreciation.
These are the other operating expenses that the corporation
would have to pay for in cash. These are the salaries, the
supplies, the electricity, and other expenses (e.g., travel,
and representation, rental, etc.)
Notice that there are two types of costs. The cost of making
the product becomes the product cost. The finished goods
when sold become the cost of goods sold. Then, there are
the period costs, which are the selling, general, and
administrative expenses.
Next, ABC corporation pays, in cash, non-operating
expenses, which are really the interest expenses and other
financial and other financial changes owed to the banks
Next ABC Corporation would have to pay cash to the
government for taxes.
Once the company sells the finished goods to the customers,
they become cost of goods sold. In exchange, sales or
revenues are gotten from the customers.
Some customers will pay cash, so the sales and
revenues go back to the cash account. Some
customers would avail of credit. Unpaid sales
become accounts receivable. And when the
customers finally pay, the amount of accounts
receivables transforms back into cash
ABC Corporation might have investments in
marketable securities, in which case they might
have non-operating income. And this non-
operating income comes back in the form of cash
Figure 7.1(D) shows the complete flow of funds
from the first business transaction to the last (
and all the others subsequence transaction)
DISCERNIMG FOUR FINANCIAL
STATEMENTS
The figure 7.1(D) is called funds flow.
Funds going from one container or one circle to
another container or another circle comprise the
funds flow except for the account called
depreciation, which is a figment of the imagination
of the accountant depreciation is not really part of
the funds flow
The funds flow is the first financial statement that
we have encountered.
The second financial statement is on the right side of figure
7.1 (D). If you will notice these re the sales and non-
operating income, which actually enter back to the
company. However, there are expenses and costs that
permanently exit the company.
The third financial statement that we can see from figure
7.1(D) that is the cash flow. Just focus on the cash
container or circle. There are arrows pointing to the circle.
These are the cash inflows.
There are arrows emanating of the cash circle. These are the
cash outflow.
The cash inflow and outflows constitute the cash flow
If we have the cash flow are greater than cash outflow, we
have a net cash inflow. However, if the cash outflows are
greater than the cash inflows, then we will have a net cash
outflow.
So, the third financial statement we have encountered is the
CONSTRUCTING FINANCIAL
STATEMENTS
We have already noted from figure 7.1 (D) that the
funds from one container to another.
The sourcing and usage or application of funds in
the financial transaction. So in every, entry there is
a source of funds there is a use of funds.
This is called double entry accounting, which is the
basis for the entire construction of the financial
statement.
Focusing on a few accounts of the funds flow
statement, specially loans, cash, and inventory, as
a examples, as example, we can follow how these
containers of funds relate to one another
Let us begin with the loan. ABC corporation borrows
1 million pesos from the bank. So there is an
increase in loan 1 million pesos while the same
time, ABC Corporation increases its cash by 1
million pesos. There is a source of funds from
loans of 1 million and a use of funds in cash for
the same 1 million pesos. From the 1 million pesos
in cash, ABC corporation might take out 0.5
million pesos from the cash container and this
gets entered into the inventory container which is
again a use of funds
Note that we have constructed T accounts for
each container, the T account divide the left
side from the right side of the fund
container.
For consistency, the account sources funds
from a container by making it exit on the
right side of container. When funds are
transformed to another container, these
funds enter on the left side of the container,
as shown below
The accounts made a rule. The right side of each container
(exit) is a source of funds.
The left side of each container (entry) is a use of funds.
There are also pattern that we are able to discern. All
increase in liabilities are sources of funds, and all
decreases in liabilities are uses of funds.
To sum up, All increase in liabilities and all decreases assets
are source of funds . They are recorded on the right side of
the containers. The technical term given by the accountant
for right side exits are credits.
All decreases in liabilities and all increase in assets are uses
funds.
Uses of funds are recorded on the left container.
The technical term for recording on the left side debits.
Hence, the accountant always has two accounting entries:
a credit followed by a debit or a debit followed by a credit.
In figure 7.2 (a) and figure 7.2 (B), we see these containers. We can divide the containers into two sides:
the right side and the left side. This division creates the accountants T accounts. On the right side
are the sources of funds or the credits. On the left side are the uses of funds or the debits.
The accountant will then create a chart of accounts.Each account represents a container of funds In
this case ,the containers are the accounts for cash,accounts receivable, inventory,fixed assets,and
other assets.In the liabilities side,we have the stockholders equity,short term debt ,long term debt,
supplier's credit,and accrued expenses.
ABC Corporation will source cash from the stockholder's equity.This is recorded as source of funds in the
stockholder's equity and enters cash as the use of funds.
ABC Corporation may also get long-term loans and short-terms from the banks.This loans are the
sources of funds and put into use in the form of cash.
From the cash ,the company may withdraw also some cash amount and it exits on the right side as a
source of funds.The company may buy inventory,Fixed assets,and other assets with the cash.Cash
would be the source of funds while the purchased assets would be the uses of funds.
The company may also use the cash to pay for supplier's credit ,to pay for short term debt and to pay for
long term debt.
Let us now put some numbers in this financial
statement
ANALYZING FINANCIAL
STATEMENTS’
Financial statements are nothing but abstraction of
all the business transactions going on in an
enterprise. Analyzing or intepreting financial
statements can give very powerful insights into
how an enterprise in conducting itself. One of the
most easily understood financial statements is the
income statement, also called the profit and loss
statement.
INCOME STATEMENT ANALYSIS
The top line of the income statements is Sales. One
can compare the Sales figures of an Interprise
over the years to see whether it is growing or not.
This comparative analysis over several years (or
months) is called time series analysis or a
horizontal analysis ( since the sales figure are
usually put along horizontal plane in a piece of
paper). The growth rate from year to year can be
computed on a percentage basis as a show in
table 7.4.
 Figure 7.4. Time Series or Horizontal Analysis

Year 2011 2012 Annual 2013 Annual

percentage percentage
growth growth
2011-2012 2012-2013

Amount 3,000,000 3,300,000 10% 3,960,000 20%

Below the gross profit is the line up of
operating expenses, also known as
selling, general, and Administrative
(SGA) expenses. The various expenses
items that are not directly part of the
costs involved in making the product
or delivering the service are include
here. The typical operating expenses
accounts are as follow:
• Salaries Wages
• Sales Commissions
• Rental or office leases
• Advertising and Promotion
• Professional Fees
• Travel and Transportation
• Training and education
• Employees’ Benefits
• Light, Water and Power
• Office supplies
• of office
• Representation expenses
• Miscellaneous or other expenses
Balance sheet analysis
The balance sheet items are logically arranged by
the accountant for convenient analysis.
 Current Assets
Current ration =
Current Liabilities

Cash, Marketable Securities, and accounts recievables

Quick ratio =
Current Liabilities
 total liabilities
Total debt- to- owners equity ratio =
owners equity

Long- Term Debt

Long – term debt- to- Owner equity ratio =
Owners ‘ equity
The third group of ratios is the pfofitability ratios. The net profit after taxes of the enterprise
are related to the sales , assets and owners equity of the enterprise.the ratio of net
profit after taxes to sales provides the return on sales (ROS). The ratio of net profit after
taxes to assets gives the return on assets (ROA). The ratio of the net profit after taxes to
owners equity yields return on equity (ROA).
 NET PROFIT AFTER TAXES
Return on Sales =
SALES

NET PROFIT AFTER TAXES

Return on assets (ROA) =
ASSETS
Forcasting Financial Statements
The art of financial forecasting is popular among
entrepreneurs who know their business inside out.It
enables them to ask the following questions,among
many prior to a financial exercise:
• What will happen to the market conditions
tomorrow?
• What will competition do?
• What product and services will come out?
• What technology is in store for us?
• What will interest rates be like?
• How will the e on grow?
• What regulations might the government impose?
Income Statement Forecasting
There are usually a very close relationship Sales and
Cost of Sales (or Cost of Goods Sold).Many companies,In
determining their selling prices,coviently add a specific
percentage mark-up or margin to the cost of Sales,thus
establishing a predictable ratio between the two items.If
an enterprise decides to slap a hundred percent mark-up
on its cost sales,the sales figure will double the cost of
Sales.
 TABLE 7.8 FORECASTING SALES AND COST OF SALES FOR XYZ (PESO IN
THOUSANDS)
Year 2011 % 2012 % 2013 % 2014 % 2015 %

Sales forecast

Past sales (000) 1000.0 100.0 1,100. 100.0 1,210. 100.0 100.0 100.0
0 0

Sales Forecast 1,331.0 1,464.0

(000)

Past cost sales 700.0 70.0 781.0 71.0 835.0 69.0

(000)

Cost sales
Forecast

In percentage 70.0 70.0

Terms

In peso value 932.0 1,025.0

(000)
 BALANCE SHEET FORCECASTING

Forecasting what the Balance Sheet of an enterprise

will look like in the future depends a lot on the future
Sales.Let us start the Current Assets of the Balance
Sheet,which include cash,marketable
securities,accounts recievables,inventories(raw
materials,work-in process,and finished Goods),and
other current Assets.
 TABLE 7.10 PRO FORMA INCOME STATEMENT AND ADJUSTED PRO-
FORMULA INCOME STAEMENT FOR 2013
Pro Forma Income Adjusted Pro Forma Comments
Statement Income statement

Sales 540,000 540,000

Cost of Good Sold 340,000 340,000

Gross Profit 200,000 200,000

Operating Expenses 186,000 186,000

Less Interest 6,000 6,800 Additional expenses

Expenses of 800 pesos

Equals net profit 8,000 7,200

before taxes

Less taxes 2,000* 1,800 Taxes decreased by

200 pesos
Equals Net Profit 6,000 5,400 Net effect 600 pesos
After taxes