Top executive officers of Zottoli Company, a merchandising firm, are preparing t
ID: 2361509 • Letter: T
Question
Top executive officers of Zottoli Company, a merchandising firm, are preparing the next year's budget. The controller has provided everyone with the current year's projected income statement. Current Year Sales revenue $2,000,000 cost of goods sold $1,400,000 gross profit $600,000 selling and admin. expenses $260,000 Net income $340,000. Cost of goods sold is usually 70 percent of sales revenue, and selling and administrative expenses are usually 10 percent of sales plus a fixed cost of $60,000. The president has announced that the company's goal is to increase net income by 15 percent. Required: The following items are independant of each other. a.) What percentage increase in sales would enable the company to reach it's goal? Support your answer with a pro forma income statement b.) The market may become stagnant next year, and the company does not expect an increase in sales revenue. The production manager believes that an improved production procedure can cut cost of goods sold by 2 percent. What else can the company do to reach it's goal? Prepare a pro forma income statement illustrating your proposal. c.) The company decides to escalate its advertising campaign to boost consumer recognition, which will increase selling and administrative expenses to $340,000. With the increased advertising, the company expects sales revenue to increase by 15 percent. Assume that cost of goods sold remains a constant proportion of sales. Can the company reach it's goal?Explanation / Answer
Pro Forma Income Statements A pro forma income statement is similar to a historical income statement, except it projects the future rather than tracks the past. Pro forma income statements are an important tool for planning future business operations. If the projections predict a downturn in profitability, you can make operational changes such as increasing prices or decreasing costs before these projections become reality. Pro forma income statements provide an important benchmark or budget for operating a business throughout the year. They can determine whether expenses can be expected to run higher in the first quarter of the year than in the second. They can determine whether or not sales can be expected to be run above average in June. The can determine whether or not your marketing campaigns need an extra boost during the fall months. All in all, they provide you with invaluable information—the sort of information you need in order to make the right choices for your business. How do I create a pro forma income statement? Sit down with an income statement from the current year. Consider how each item on that statement can or will be changed during the coming year. This should, ideally, be done before year’s end. You will need to estimate final sales and expenses for the current year to prepare a pro forma income statement for the coming year. Pro forma gross profit Let’s assume that you expect sales to increase by 10 percent next year. You multiply this year’s sales of $1,000,000 by 110 percent to get $1,100,000. Then, in this case, you assume there will be no increase in the cost of each item you are selling, but you will need 10 percent more items to sell in order to achieve your sales goals. So, you multiply this year’s cost of goods sold (let’s assume a figure of $500,000), by 110 percent to get $550,000. To figure your pro forma gross profit for next year, subtract the pro forma cost of goods sold from the pro forma sales. $1,100,000 minus $550,000 equals your gross profit, or $550,000. Pro forma total expenses Let’s assume salaries and other expenses will increase by 5 percent. So, you multiply your historical salaries of $200,000 and your historical expenses of $100,000 by 105 percent each. Your pro forma salaries for next year will be $210,000 and your pro forma expenses will be $105,000. You then figure your pro forma total expenses by adding pro forma salaries and pro forma other expenses together. In our sample case your pro forma total expenses will be $315,000. Pro forma profit before taxes Pro forma profit before taxes is figured by subtracting the pro forma expenses from the pro forma gross profit, or $315,000 from $550,000 for a pro forma profit before taxes of $235,000. Pro forma taxes Pro forma taxes are figured by taking your estimated tax rate, in this case 30 percent, and multiplying it by the pro forma profit before taxes of $235,000. This produces a pro forma tax bill of $70,500. Pro forma profit after taxes Pro forma profit after taxes is figured by subtracting the pro forma tax bill of $70,500 from the pro forma profit before taxes of $235,000. Your pro forma profit after taxes, in this case, would be projected at $164,300. Remember that pro formas are essentially best guesses. You should continually update your projections by recalculating your pro formas using any new and actual financial information you have as a base. Doing this on a monthly or quarterly basis will help to assure that your projections are as close to being accurate as possible.