Exhibit 8 supports section VI of your Strategic Audit.
What is a Pro Forma Income Statement?
It is a prediction of how the income statement figures would look like for the next five years for the firm you have chosen for the capstone. As in any financial prediction, it depends on assumptions. Assumptions are key to determining how the future would look like.
How to Create a Pro Forma Income Statement?
Section VI of your Strategic Audit includes three strategic alternatives, generally known as stability, growth, and retrenchment. You need to build a pro forma for each of those strategic alternatives, so need to have three different sets of assumptions for each alternative.
The easiest prediction assumes the near past will repeat into the near future. In other words, what happened financially in the previous five years will replicate into the next five years. This is the extreme case of stability, and all future income statement variables are assumed to evolve based on the averages of the last five years.
These assumptions are very strong, and in that sense, maybe very non-realistic. However, it is very easy to calculate, because you just need to know the average of the last five years. If costs went up 5% on average during the last five years, you assume costs will also go up 5% per year in the next five years.
Assumptions for growth and retrenchment strategic alternatives cannot be based on averages of past performance. Growth and retrenchment want clearly to differentiate from the past. You may start by looking at the averages of the ‘stable no strategy’ scenario, and from there to modify the assumptions for growth and retrenchment.
How to use TemplateSA-EXH8-ProForma and 5-Y Financials
The TemplateSA-EXH8-ProForma.xlsx can be downloaded from the attachments here and is a good reference to see how assumptions determine income statement items for the five years in the future, and how the common ratio percentages are calculated for those years too.
That template does not show how the averages were calculated because it does not include the Income Statement date from the last five years. Your 5-Y financials Excel workbook has that information, and the sheet named ‘Pro-Forma no strategy’ has the average formulas connected to the real information. After reviewing it and understanding all the formulas for the first year, copy/paste for the following four years. Do the same with the Common Size Percentages.
To create the Pro-Forma Growth, right-click on the sheet name Pro-Forma No Strategy (bottom of Excel screen) and copy it. Then, rename the copy as Pro-Forma Growth. All the formulas would work, but you must change the assumptions to fit the new growth strategy alternative.
To create the Pro-Forma Retrenchment, follow the same steps mentioned before.
Assignment Submission Procedures
Attach your updated 5-Y Financial Excel workbook with the three Pro Forma sheets. You may add comments to your instructor in the “Add Comments” field if you wish. Then click the Submit button.