Week 5 Producing Budgeted Statements

Producing Budgeted, or Pro Forma Financial Statements

Once you have a Sales Forecast, the task is to extend the rest of the income statement and the balance sheet into the future accordingly.

To extend the income statement and balance sheet accounts into the future, you must make judgments about how each item on the financial statements behaves. For example, to forecast Amalgamated Hat Rack’s COGS for 2017, given your 2017 sales estimate of $3,386,500, you might proceed as follows:

	Historical 2016*	Estimated 2017
Sales Revenue	$3,200,000	$3,386,500 (Forecast)
COGS	$1,600,000	?

*The Historical 2016 numbers are taken from Amalgamated Hat Rack’s income statements on the lecture pages for Week 4.

Suppose through careful observation and analysis you determine that COGS tends to fluctuate with sales over the years, tending to remain a constant percent of sales. Therefore, you believe you can forecast COGS in the future by maintaining this trend (that is, by always keeping COGS the same percentage of sales that it is now).

In 2016 COGS was $1,600,000 / $3,200,000 = .50, or 50% of Sales.

Therefore, according to your assumption, COGS in 2017 ought to remain 50% of Sales:

2017 COGS = $3,386,500 x .50 = $1,693,250

Percent of Sales Method
For obvious reasons, this forecasting method is often called the percent of sales method. Using this technique, you can extend the whole income statement and the balance sheet into the future. Remember, you do it by making judgments about how each account on the financial statements behaves. If, in your judgment, the account varies directly with sales you can use the percent of sales method as outlined above. If the account does not behave that way, then you must make other judgments and forecast the account accordingly. (For example, you might forecast Notes Payable by assuming that all short-term debts will be paid off during the coming year. In that case projected Notes payable would be zero.)