Finance Reviewer

FINANCIAL FORECASTING

CONSTRUCTING PRO FORMA STATEMENT

Comprehensive means of financial forecasting – to develop a series of pro forma, or projected, financial statements

Based on projected statements – the firm is able to estimate its future level of receivables, inventory, payables, and other corporate accounts as well as its anticipated profits and borrowing requirements.

PRO FORMA INCOME STATEMENT

Pro forma income statement – will provide a projection of how much profit the firm anticipates making over the ensuing time period

* 4 important steps:

1. Establish a sales projection

2. Determine a production schedule and the associated use of new material, direct labor, and overhead to arrive at gross profit

3. Compute other expenses

4. Determine profit by completing the actual pro forma statement

The main consideration in constructing a pro forma income statement – is the cost specifically associated with units sold during the time period

CASH BUDGET

Primary consideration for cash payments - are monthly costs, inventory, and disbursements for general and administrative expenses, interest payments, taxes and dividends

Primary purpose of cash budget – to allow the firm to anticipate the need for outside funding at the end of each month

RISK AND RETURN

DEFINITION OF RISK IN CAPITAL BUDGETING

Risk – variability of possible outcomes from a given investment. Is measured not only in terms of losses but also in terms of uncertainty

THE CONCEPT OF RISK – AVERSE

Risk-averse – for a given situation they would prefer relative certainty to uncertainty. They will require a higher expected value or return for risky investments

*2 important statistical measures:

1. The expected value

2. Standard Deviation

Expected Value – weighted average of the outcomes (D) times their probabilities (P).

Standard deviation – the measure of dispersion or variability around the expected value

The larger the standard deviation, the greater is the risk

Coefficient of...