Karen Lamont is in the process of starting a new business ans wants to forecast

Question

Karen Lamont is in the process of starting a new business ans wants to forecast the first years income statement and balance sheet. She has made a number of assumptions

1 million in sales the first year

operating and gross profit margins will be 20 percent and 50 percent.

accounts recivable 12%

invetory as sales 15%

accounts payable 7%

accruals 5%

bank loaned her 300,000 and 100,000 is short term debt and 200,000 is long term debt. Both interest rates are 8%

firms tax rate is 30%

Lamont will need to purchase 350,000 in plant/equipment and she will peovide any other financing needed

QUESTIONS ARE:

1. Based on lamonts assumptions, prepare a pro forma income statement and balance sheet?

2. If her estimates are correct, what will be the firms current ratio and debt ratio? Explain the meaning iof these ratios?

Explanation / Answer

1.

Income Statement for Year 1:

Balance Sheet at the end of Year 1:

2.

a) Current ratio = CA / CL = 416400 / 160000 = 2.60

As explained by current ratio, the convenience to fulfil the short term obligations. In our case, the company has $2.60 to fulfil $1 of liability / obligations.

b) Debt ratio = Total Debt / Total Assets = 660000 / 766400 = 0.86

The debt ratio tells us the debt content in the total Assets. In our case, the company has 86% of the total assets financed by the debt. It makes the company more risky.

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Sales $1000000 Less: COGS 500000 Gross Profit 500000 Less: operating costs 300000 Operating Profits 200000 Less: Interest (600000*8%) 48000 Income before tax 152000 Less: Taxes @ 30% 45600 Net Income (tranferred to RE) 106400

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