Chapter 9 - Prospective analysis. We study forecasting and pro forma analysis of financial statements in this chapter. We provide a detailed example of the forecasting process to project the income statement, the balance sheet, and the statement of cash flows. We describe the relevance of forecasting for security valuation and provide an example using forecasted financial statements to implement a valuation model. We discuss the concept of value drivers and their reversion to long-run equilibrium levels. | Financial Statement Analysis . Subramanyam Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9 CHAPTER Prospective Analysis Prospective Analysis Security Valuation - free cash flow and residual income models require estimates of future financial statements. Management Assessment - forecasts of financial performance examine the viability of companies’ strategic plans. Assessment of Solvency - useful to creditors to assess a company’s ability to meet debt service requirements, both short-term and long-term. Importance The Projection Process Projected Income Statement Sales forecasts are a function of: 1) Historical trends 2) Expected level of macroeconomic activity 3) The competitive landscape 4) New versus old store mix (strategic initiatives) The Projection Process Target Corporation Income Statements The Projection Process Steps: Project sales Project cost of goods sold and gross profit margins using historical averages as a percent of sales Project SG&A expenses using historical averages as a percent of sales Project depreciation expense as an historical average percentage of beginning-of-year depreciable assets Project interest expense as a percent of beginning-of-year interest-bearing debt using existing rates if fixed and projected rates if variable Project tax expense as an average of historical tax expense to pre-tax income Projected Income Statement The Projection Process Target Corporation Projected Income Statement The Projection Process Target Corporation Projected Income Statement The Projection Process Steps: Project current assets other than cash, using projected sales or cost of goods sold and appropriate turnover ratios as described below. Project PP&E increases with capital expenditures estimate derived from historical trends or information obtained in the MD&A section of the annual report. Project current . | Financial Statement Analysis . Subramanyam Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9 CHAPTER Prospective Analysis Prospective Analysis Security Valuation - free cash flow and residual income models require estimates of future financial statements. Management Assessment - forecasts of financial performance examine the viability of companies’ strategic plans. Assessment of Solvency - useful to creditors to assess a company’s ability to meet debt service requirements, both short-term and long-term. Importance The Projection Process Projected Income Statement Sales forecasts are a function of: 1) Historical trends 2) Expected level of macroeconomic activity 3) The competitive landscape 4) New versus old store mix (strategic initiatives) The Projection Process Target Corporation Income Statements The Projection Process Steps: Project sales Project cost of
