Chapter 11—Forecasting Financial Requirements
TRUE/FALSE
1. The projection of profits, asset requirements, financing requirements and cash flows are essential in
determining whether a venture is economically viable.
2. Financial forecasts are required by lenders since they will want to know how they will be paid back;
investors will use the forecasts to value the company.
3. Pro forma financial statements are statements that have been prepared in the proper format by a CPA.
4. Profits reward an owner for investing in a company and constitute a minor source of financing for
future growth.
5. The cost of goods sold can be either fixed or variable.
6. Many small firms have a tendency to underestimate the amount of capital the business requires when
beginning operations.
7. The term net working capital equals current assets less total liabilities and is a measure of a company’s
liquidity.
8. High-tech businesses (such as computer manufacturers) generally require fewer assets than service
businesses.
9. Marcia like to use other people’s money when financing her business. In this way she “does more
with less” by controlling resources without actually owning them.
10. To project pro forma financial statements, speaking to others in the industry and researching industry
averages are good starting points.
11. Bettina plans to draw an income from her new business but her personal living expenses are not
needed in the financial plan unless these expenses are part of the capitalization of the business.
12. The percentage-of-sales technique is an effective method for a new company to estimate asset
requirements because asset-to–liabilities ratios tend to be relatively constant within an industry.
13. Because Liam’s new restaurant had a high volume of sales, his inventory needs increased illustrating
that a firm’s asset needs are the primary force driving sales.
14. The conventional measure of liquidity is the current ratio, which compares the current assets to total
liabilities on a relative basis.
15. Spontaneous debt financing results when accounts payable increase in proportion to a firm’s profits.
16. Profits that are retained within the company rather than being distributed to the owners are referred to
as retained income.
17. A line of credit is a short-term loan used in a business to help with financing fixed assets.
18. Cash flow can be projected in two ways: using the income statement to project cash flows or preparing
a cash budget.
19. The cash budget is concerned only with dollars received and dollars paid out.
20. After pro forma statements are prepared, they should be checked against actual results every quarter so
projections can be modified.
21. Financial projections should be limited to the income statement to prevent information overload on
lenders and investors.
22. Mario has high hopes for his new business, anticipating a very large profit margin. For the
preparation of his forecasts, he should use industry averages regardless of his hopes.
23. An entrepreneur should always project at least two scenarios for financial forecasting and budgeting:
best case, worst case, and most likely case..
24. To be realistic, an entrepreneur should project profits only one year into the future.
MULTIPLE CHOICE
1. Which source of information would be the most inclusive for an entrepreneur determining information
to complete the financial statements?
a.
Attend trade shows
b.
Contact the industry association
c.
Examine RMA Annual Statement Studies
d.
Talk to others in the industry
2. Tomas would like to know whether his new business will be profitable, how much financing he will
need, and whether he will have adequate cash flows. Tomas can get this information from:
a.
pro forma financial statements.
b.
historical financial statements.
c.
pro bono financial statements.
d.
quid pro quo financial statements.
3. Projecting financials may present a challenge because in a startup business,
a.
things seldom goes as planned.
b.
things always go as planned.
c.
expenses are too complex.
d.
expenses are simple.
4. Roland has already projected his company’s sales. The next step in forecasting his company’s income
is to project:
a.
operating expenses.
b.
interest expense.
c.
taxes.
d.
cost of goods sold.
5. Yvonne is planning a coffee shop. The cost of producing the coffee should be included in the
________ section of the pro forma financial statement.
a.
variable expense
b.
amount of sales
c.
cost of goods sold
d.
operating expense
6. Where should Rhonda put the administrative expenses for her business when she prepares the financial
forecasts?
a.
Administrative costs are subtracted from amount of sales.
b.
In the operating expenses section
c.
Administrative costs are included in cost of goods sold
d.
In the interest expense section
7. Verlin wants to avoid a common mistake often made by new entrepreneurs. What advice would you
give him?
a.
Spend as little as possible.
b.
Carry no inventory.
c.
Make sure he has adequate financing.
d.
Do without anything that is not absolutely essential.
8. Marcia uses other people’s money whenever possible to finance her business. She prefers to
minimize and control rather than maximize and own. This practice is known as:
a.
high-stepping.
b.
bootstrapping.
c.
unethical business practice.
d.
taking advantage of others.
9. Willar expects his new business to support him and his family. This means his asset and financing
requirements will:
a.
increase.
b.
decrease.
c.
remain the same.
d.
depend on the size of his family.
10. Which action will be a concern for a prospective investor?
a.
Having too much cash in a bank account
b.
Searching for information with a trade association
c.
Inadequate provision for personal expenses of the entrepreneur
d.
Obtaining a line of credit before beginning operations
11. Willard may be able to forecast his asset needs using the ____________ technique.
a.
percentage-of-inventory
b.
percentage-of-equity
c.
percentage-of-debt
d.
percentage-of-sales
12. The assets-to-sales relationship tends to be relatively constant within an industry, allowing for a(n)
_____ technique to be utilized in projecting asset requirements.
a.
percentage-of-sales
b.
bootstrap forecasting
c.
asset turnover ratio
d.
discounted sales
13. The greater a firm’s sales, the greater need for financing because of greater _____ requirements.
a.
asset
b.
employee
c.
marketing
d.
operational
14. Fixed assets include
a.
inventory.
b.
equipment.
c.
working capital.
d.
office supplies.
15. D&R Products forecasts that it will require $10,000 for equipment and depreciation will be over 5
years. The $10,000 will be reflected in the balance sheet as _____.
a.
inventory
b.
gross fixed assets
c.
net fixed assets
d.
accounts payable
16. A firm should finance its growth in such a way as to maintain adequate
a.
liquidity.
b.
inventory.
c.
sales.
d.
volume.
17. Alex wants to make sure he has enough liquid assets to pay his current bills. To do this, he should
calculate his firm’s:
a.
debt ratio.
b.
cash flow statement.
c.
current ratio.
d.
asset turnover ratio.
18. Zeno had a great idea but no cash so he asked the bank for a loan to finance the entire operation. It
seems he forgot that a bank would never provide _______ % of the firm’s financing.
a.
25
b.
50
c.
75
d.
100
19. D&R Products forecast a first year asset requirement of $143,500; therefore, the total debt requirement
is
a.
$143,500.
b.
a set percentage of sales.
c.
equal to the current ratio.
d.
dependent on the owner’s equity amount.
20. As her accounts payable and accrued expenses rose along with her firm’s sales, Ariel noticed that
________ occurs.
a.
spontaneous debt financing
b.
trade credit financing
c.
escalating debt
d.
asset-based financing
21. For the typical small firm, the primary source of equity capital for financing growth is
a.
operating profits.
b.
outside investors.
c.
spontaneous debt financing.
d.
retained earnings.
22. As Willard’s business grows and prospers, his company’s total assets requirements will equal
___________.
a.
total sources of financing less owner’s investment and retained earnings
b.
spontaneous debt financing plus bank loans plus owner’s investment less retained earnings
c.
total sources of financing less net assets and owner’s investment
d.
spontaneous debt financing plus bank loans plus owner’s investment plus retained
earnings
23. David has a company decorating houses for the holidays. He has secured a $25,000 line of credit
from his bank. For which purpose is David more likely to use this credit line?
a.
a warehouse to store decorations until they are sold
b.
labor to install the decorations in November
c.
a truck with a ladder to put up lights
d.
a full-time, year-round office person to answer phones and take orders
24. Jill’s business has current assets of $50,000 and current liabilities of $25,000. Which statement is true
about the company’s current ratio?
a.
The ratio is 50% and is acceptable for most industries.
b.
The ratio is 2 and is acceptable for most industries.
c.
The ratio is $25,000 and is not acceptable for most industries.
d.
Current ratio can not be determined from the information given.
25. Even though Miriam projected an annual positive cash flow, she may run out of cash if:
a.
customers use debit cards for their purchases.
b.
her sales are seasonal.
c.
sales exceed her projections.
d.
she finds a less expensive supplier.
26. A golf club should break down its annual cash budget into shorter time units because
a.
of the seasonality of its sales.
b.
one year is too far into the future to predict.
c.
the marketing plans may change during the year.
d.
production breakdowns may alter the company’s situation.
27. No single planning document is more important in the life of a company than the
a.
income statement.
b.
cash budget.
c.
balance sheet.
d.
corporate charter.
28. A simple listing of expected cash inflows and outflows provides the entrepreneur with a(n)
a.
income statement.
b.
cash budget.
c.
pro forma balance sheet.
d.
net equity computation.
29. Jake has prepared pro forma financial statements for his landscaping business. At the minimum, how
often should he check results and make modifications as needed?
a.
annually
b.
quarterly
c.
monthly
d.
weekly
30. Miriam wants to make sure she does not run out of cash so she is preparing a monthly cash budget.
The first step is:
a.
estimate the amount of cash disbursements.
b.
calculate cash flow from operations.
c.
determine the percentage of cash collections by month.
d.
determine beginning-of -the -month cash balance.
31. Mark follows the cash budget like it was carved in stone. He has fallen prey to the one real danger in
over-reliance on a cash budget:
a.
inflexibility.
b.
pliability.
c.
exaggeration.
d.
errors.
32. Entrepreneurs determine financial requirements based on ________.
a.
predictions
b.
suggestions
c.
assumptions
d.
projections
33. Maria is projecting sales for her company for the upcoming new year. To be financially effective, she
a.
can over-project for sales if she has done research.
b.
should develop realistic sales projections.
c.
would be better served by under-projecting sales so she won’t be disappointed.
d.
ignore projections until after 1 year of operations when she can realistic project.
34. Jaime is preparing his forecasts for the coming year. How many scenarios should he prepare when
forecasting and budgeting?
a.
1
b.
2
c.
3
d.
The number depends on the business.
35. Tony operates a computer retail business. Based on the industry, how often should sales projections be
for the company in projecting sales?
a.
monthly for Year 1; annual for Years 2 and 3
b.
annual for Year 1; quarterly for Years 2 and 3
c.
monthly for Year 1; quarterly for Years 2 and 3
d.
annual for Year 1, monthly for Years 2 and 3
MATCHING
Match the term with its definition.
a.
Cash budget
e.
pro forma financial statements
b.
Current ratio
f.
percentage-of-sales technique
c.
Line of credit
g.
spontaneous debt financing
d.
Net working capital
1. Statements that project a firm’s financial performance and condition, including projected profits, assets
and financing requirements, and cash flows
2. A short-term loan
3. Short-term debts, such as accounts payable, that automatically increase in proportion to a firm’s sales
4. A listing of cash receipts and cash disbursements, usually for a relatively short time period
5. A method of forecasting asset requirements
6. Current assets less current liabilities
ESSAY
1. Bowz 4 Kidz is a new business that Ellie has started out of her home utilizing an online business
model. In developing pro forma financials, what general questions do the statements need to answer
and how will they be applied to Ellie’s business?
2. Discuss factors that drive profits in the order that they appear on the income statement.
3. Natasha has been in business for a little over a year with her Sips and Munchies Coffee Shop where she
sells an array of coffees and pastries. She rents a building with a downtown location and manages the
business and employees herself. Discuss factors that drive the company’s profits.
4. What are the categories that constitute working capital versus net working capital?
5. Explain the percentage-of-sales technique. Will this technique differ by industry type?
6. Briefly explain liquidity and its relationship to the current ratio.
7. What are sources of equity ownership in a business? Are these sources cash resources?
8. Faye is developing a statement of cash flows for Yummy Gummies, a candy company that she owns.
She has a net profit of $15,000 and an increase in inventory of $7,500. She took out a line of credit
with her bank to finance her business and has decreased accounts receivable by $4,000. She has also
invested in equipment for shaping her candy. How will the above information be listed on the cash
flow statement?
9. Andrea is working on forecasting her financial statements for her consulting business. Discuss three
suggestions for Andrea to make her forecasting more effective.
