Spring 2009 NBA 5060

Lecture 8 – Pro Forma Financial Statements & Forecasting I

1. Pro forma financial statements

2. Some Coaching Tips

3. A structured forecasting approach

• Step 1: Forecasting Sales
• Step 2: Forecasting the rest of the income statement
• Step 3: Forecasting the balance sheet
• Step 4: Computing the statement of cash flows and free
cash flows to equity
• Step 5: Terminal year assumptions
• Step 6: Economic reality checks and an iterative process

For next class, we will complete our discussion of forecasting and develop
forecasts for CBRL. Consider how you would forecast CBRL’s income
statement and balance sheet.

Lecture 8 Page 1 of 8
Pro Forma Financial Statements
Motivation

• The key component for any serious security analysis

• Limited by the reliability of key assumptions and the inherent

uncertainty of future events

Integration from first half of the course – to assist in the

forecasting task, you should make use of:

Business Analysis:

• Have a good understanding of the macro factors that drive

sales in the industry, cyclicality, etc.
• Recent trends, cycles, structural changes over time,
technology risks
• Entry barriers protecting ROA, sustainability of competitive
advantage, etc.

Accounting Analysis:

• Flag the historic financial statements for any non-recurring

transactions to avoid extrapolating into the future.
• Watch for unorthodox accounting policies that can adversely
impact future profits (e.g. capitalizing store opening costs).

Financial Analysis:

• Use prior year F/S as a starting point.

• Be aware of industry norms. You can get industry
benchmarks from, for example, Multex investor – or Yahoo!
Finance.
• Use ROAs, ROEs, turnover ratios and profit margins as
reality checks for your future forecasts.

Lecture 8 Page 2 of 8
Coaching tips in constructing pro forma financial
statements

1. The future is inherently uncertain

2. Sound analysis is the key

3. Exploit the structure and articulation of the financial statements

4. Reality checks and iteration

Lecture 8 Page 3 of 8
Pro forma financial statements – A structured approach

Forecast Sales

Lecture 8 Page 4 of 8
Step 1: Forecasting sales

How sales growth behaves over time

Forecast Margins Forecast Turnovers

Depreciation Property, Plant,

Expense & Equip

Interest Forecast
Expense Leverage

Other income Other assets

and expense and liabilities
Sales growth rates display strong mean reversion. Why?

Pro forma Pro forma

Income Statement Balance Sheet

Pro forma
Statement of Cash Flows

Distributions to Equity Holders

Lecture 8 Page 5 of 8
General forecasting considerations

Top-down approach

Macro forecast  Industry Sales Forecast  Firm Sales Forecast

This approach assumes the following conditions:

This approach is less useful when:

Lecture 8 Page 6 of 8
Firm-specific influences on sales growth

A significant predictor of future revenue:

From Cracker Barrel’s 10-K

Item 1. Business
We plan to open 12 new stores in 2009, two of which already were open as of September
24, 2008.

Item 7. Management’s Discussion & Analysis

We estimate that our capital expenditures (purchase of property and equipment) during
2009 will be up to $98,000. This estimate includes costs related to the acquisition of sites
and construction of 12 new Cracker Barrel stores and openings that will occur during
2009, as well as for acquisition and construction costs for locations to be opened in 2010,
capital expenditure maintenance programs and operational innovation initiatives.

Other considerations:

Lecture 8 Page 7 of 8
Sales growth over the longer term

How many years should you forecast? Theoretically, the value of the
equity depends on an infinite stream of expected future cash flows.
Practically, we’re limited in forecasting to just a few years.

The forecast horizon should be long enough for the firm to reach
“steady-state.” What does this mean?

Typically, most time is spent forecasting the near-term sales growth

expectations (e.g., from 1 to 5 years out). Use an equilibrium
assumption for the last year and extrapolate the intervening years.

Sales growth rate for the last year:

Extrapolating between early years and the last year:

Linear trend

B C D E F G H I J K
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
0.187 0.173 0.159 0.145 0.131 0.116 0.102 0.088 0.074 0.060

Example =B5+(($K$5-$B$5)/(COUNT($C$4:$K$4)))

Exponential/quadratic trend

B C D E F G H I J K
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
0.187 0.104 0.076 0.065 0.062 0.061 0.060 0.060 0.060 0.060

Example =B5+(($K$5-B5)*0.65)

Lecture 8 Page 8 of 8