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34) Which of the following represents a way of coping with uncertainty in a cash budget?
A) careful estimation of cash budgets outputs
B) developing a pro forma income statement to forecast sales and then express the various income
statement items as percentage of projected sales
C) always using the prior year's data for estimates of the future
D) using scenario analysis, or "what if" approach, to analyze cash flows under a variety of circumstances
35) Gerry Jacobs, a financial analyst for Best Value Supermarkets, has prepared the following sales and
cash disbursement estimates for the period August through December of the current year.
Ninety percent of sales are for cash, the remaining 10 percent are collected one month later. All
disbursements are on a cash basis. The firm wishes to maintain a minimum cash balance of $50. The
beginning cash balance in September is $25. Prepare a cash budget for the months of October, November,
and December, noting any needed financing or excess cash available.
36) Terrel Manufacturing expects stable sales through the summer months of June, July, and August of
$500,000 per month. The firm will make purchases of $350,000 per month during these months. Wages
and salaries are estimated at $60,000 per month plus 7 percent of sales. The firm must make a principal
and interest payment on an outstanding loan in June of $100,000. The firm plans a purchase of a fixed
asset costing $75,000 in July. The second quarter tax payment of $20,000 is also due in June. All sales are
for cash.
(a) Construct a cash budget for June, July, and August, assuming the firm has a
beginning cash balance of $100,000 in June.
(b) The sales projections may not be accurate due to the lack of experience by a newly-hired sales
manager. If the sales manager believes the most optimistic and pessimistic estimates of sales are $600,000
and $400,000, respectively, what are the monthly net cash flows and required financing or excess cash
balances?
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37) In the preparation of a quarterly cash budget, the following revenue and cost information have been
compiled. Prepare and evaluate a cash budget for the months of October, November, and December
based on the information shown below.
∙ The firm collects 60 percent of sales for cash and 40 percent of its sales one month later.
∙ Interest income of $50,000 on marketable securities will be received in December.
∙ The firm pays cash for 40 percent of its purchases.
∙ The firm pays for 60 percent of its purchases the following month.
∙ Salaries and wages amount to 15 percent of the preceding month's sales.
∙ Sales commissions amount to 2 percent of the preceding month's sales.
∙ Lease payments of $100,000 must be made each month.
∙ A principal and interest payment on an outstanding loan is due in December of $150,000.
∙ The firm pays dividends of $50,000 at the end of the quarter.
∙ Fixed assets costing $600,000 will be purchased in December.
∙ Depreciation expense each month of $45,000.
∙ The firm has a beginning cash balance in October of $100,000 and maintains a minimum cash balance
of $200,000.
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38) Harry's House of Hamburgers (HHH) wants to prepare a cash budget for months of September
through December. Using the following information, prepare the cash budget schedule and interpret the
results.
∙ Sales were $50,000 in June and $60,000 in July. Sales have been forecasted to be $65,000, $72,000,
$63,000, $59,000, and $56,000 for months of August, September, October, November, and December,
respectively. In the past, 10 percent of sales were on cash basis, and the collection were 50 percent in the
first month, 30 percent in the second month, and 10 percent in the third month following the sales.
∙ Every four months (three times a year) $500 of dividends from investments are expected. The first
dividend payment was received in January.
∙ Purchases are 60 percent of sales, 15 percent of which are paid in cash, 65 percent are paid one month
later, and the rest is paid two months after purchase.
∙ $8,000 dividends are paid twice a year (in March and September).
∙ The monthly rent is $2,000.
∙ Taxes are $6,500 payable in December.
∙ A new hamburger press will be purchased in October for $2,300.
∙ $1,500 interest will be paid in November.
∙ $1,000 loan payments are paid every month.
∙ Wages and salaries are $1,000 plus 5 percent of sales in each month.
∙ August's ending cash balance is $3,000.
∙ HHH would like to maintain a minimum cash balance of $10,000.
4.4 Profit planning: pro forma statements
1) Profit planning's main focus is on the firm's cash receipts and disbursements throughout the year.
2) Compared to the short-term focus of cash planning, profit planning has a broader emphasis that
encapsulates the firm's overall financial position.
3) Firms construct pro forma financial statements by studying past relationships between key accounts on
the income statement and balance sheet and making judgments about whether those relationships will
continue in the near future.
4) The two main inputs required to construct pro forma financial statements are the ________.
A) actual financial statements and cash budget from the prior year
B) actual financial statements for the last two years
C) actual financial statements from last year and the sales forecast for the next year
D) the cash budget from last year and the sales forecast for the next year
5) Development of pro forma financial statements helps a financial manager to project the amount of
external financing required to support a given level of sales as well as overall financial performance of the
firm in the coming year.
6) The primary purpose in preparing pro forma financial statements is ________.
A) for cash planning
B) to ensure the ability to pay dividends
C) for risk analysis
D) for profit planning
7) ________ are projected financial statements.
A) Pro forma statements
B) Statements of retained earnings
C) Cash budgets
D) Cash flow statements
1) Since the percentage-of-sales method assumes that all the form's costs and expenses are variable, it
tends to understate profits when sales are increasing and overstate profits when sales are decreasing.
2) The key inputs for preparing pro forma income statements using the percent-of-sales method are the
________.
A) sales forecast for the preceding year and financial statements for the coming year
B) sales forecast for the coming year and the cash budget for the preceding year
C) sales forecast for the coming year and financial statements for the preceding year
D) cash budget for the coming year and sales forecast for the preceding year
3) In a period of rising sales, utilizing past cost and expense ratios (percent-of-sales method) when
preparing pro forma financial statements will tend to ________.
A) overstate costs and overstate profits
B) overstate costs and understate profits
C) understate costs and overstate profits
D) understate costs and understate profits
4) The percentage-of-sales method of preparing pro forma income statements assumes that ________.
A) sales are fixed
B) all costs inversely vary with sales
C) all costs are independent
D) all costs are variable
5) The percent-of-sales method of developing a pro forma income statement forecasts sales and other line
items as a ________.
A) percentage of projected sales
B) percentage of average sales over a period
C) percentage of projected total assets
D) percentage of average total assets over a period
6) The best way to adjust for the presence of fixed costs when preparing a pro forma income statement is
________.
A) to proportionately vary the fixed costs with the change in sales
B) to adjust for projected fixed-asset outlays
C) to disproportionately vary the costs with the change in sales
D) to break the firm's historical costs into fixed and variable components
7) The percent-of-sales method to prepare a pro forma income statement assumes a firm has no fixed
costs. Therefore, the use of the past cost and expense ratios generally tends to ________ profits when sales
are increasing.
A) accurately predict
B) overstate
C) understate
D) have no effect on
8) For firms with high fixed costs, the percent-of-sales approach for preparing a pro forma income
statement tends to ________.
A) overestimate profits when sales are increasing
B) underestimate profits when sales are increasing
C) underestimate profits when assets are increasing
D) overestimate profits when assets are increasing
Table 4.4
Use the percent-of-sales method to prepare a pro forma income statement for the year ended December
31, 2019, for Hennesaw Lumber, Inc.
Hennesaw Lumber, Inc. estimates that its sales in 2019 will be $4,500,000. Interest expense is to remain
unchanged at $105,000 and the firm plans to pay cash dividends of $150,000 during 2019. Hennesaw
Lumber, Inc.'s income statement for the year ended December 31, 2018 is shown below. From your
preparation of the pro forma income statement, answer the following multiple choice questions.
9) The pro forma net profits after taxes for 2019 are ________. (See Table 4.4)
A) $272,550
B) $207,000
C) $122,550
D) $57,000
10) The pro forma cost of goods sold for 2019 is ________. (See Table 4.4)
A) $3,500,000
B) $3,750,000
C) $3,825,000
D) $4,000,000
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11) The pro forma operating expenses for 2019 are ________. (See Table 4.4)
A) $150,000
B) $200,000
C) $210,000
D) $225,000
12) The amount that will transfer from the 2019 income statement to the 2019 balance sheet as an addition
to retained earnings is ________. (See Table 4.4)
A) $150,000
B) $57,000
C) $122,550
D) $272,550
13) Income Statement
Huddleston Manufacturing Company
For the Year Ended December 31, 2018
Huddleston Manufacturing estimates its sales in 2019 will be $3 million. Interest expense is expected to
remain unchanged at $70,000, and the firm plans to pay cash dividends of $140,000 during 2019. Use the
percent-of-sales method to prepare a pro forma income statement for the year ended December 31, 2019,
based on the 2018 income statement shown above.
55
Table 4.6
Income Statement
Ace Manufacturing, Inc.
For the Year Ended December 31, 2018
14) Ace Manufacturing, Inc., is preparing pro forma financial statements for 2019. The firm utilized the
percent-of-sales method to estimate costs for the next year. Sales in 2018 were $2 million and are expected
to increase to $2.4 million in 2019. The firm has a 40 percent tax rate.
(a) Given the 2018 income statement in Table 4.6, estimate net profit and retained earnings for 2019.
(b) If $200,000 of the cost of goods sold and $40,000 of selling expense are fixed costs; and the interest
expense and dividends are not expected to change, what is he dollar effect on net income and retained
earnings? What is the significance of this effect?
4.6 Preparing the pro forma balance sheet
1) One basic weakness of the simplified pro forma approaches lies in the assumption that certain
variables, such as cash, accounts receivable, and inventories, can be forced to take on certain "desired"
values.
2) In a period of rising sales utilizing past cost and expense ratios (percent-of-sales method), when
preparing pro forma financial statements and planning financing, will tend to ________.
A) understate retained earnings and understate the additional financing needed
B) overstate retained earnings and overstate the additional financing needed
C) understate retained earnings and overstate the financing needed
D) overstate retained earnings and understate the financing needed
3) Under the judgmental approach for developing a pro forma balance sheet, the "plug" figure required to
bring the statement into balance may be called the ________.
A) cash balance
B) retained earnings
C) external financing required
D) accounts receivable
4) The ________ method of developing a pro forma balance sheet estimates values of certain balance sheet
accounts while external financing is used as a balancing, or plug, figure.
A) percent-of-sales
B) accrual
C) judgmental
D) cash
