Management Consulting/IGNOU- Answer of Questation
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Q4-Assume that you are in import business. Does a bank need to be satisfied about your credit worthiness before extending non fund facilities to you. Discuss this issue with a Banker and explain fully.
Q5-5. “In simulating financial decision, the strategy that produces the best simulated result is not necessarily the optimal financing strategy”, do you agree with this statement? Why or why not?
Q-1. How can Entrepreneurial Competencies and Skills be developed through suitable training interaction? Explain.
Q-55. “The cash flow statement provides a way of relating an entrepreneur’s earning efforts with their effect on the cash balances”. Discuss this statement with reference to control of Cash Flow statement.
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.4. Assume that you are in important business. Does a bank need to be satisfied about your credit worthiness before extending non fund facilities to you. Discuss the issue with a banker and explain fully.
Banks are prohibited from entering into any commitment for granting any loans or advances to or on behalf of any of its directors, or any firm in which any of its directors is interested as partner, manager, employee or guarantor, or any company (not being a subsidiary of the banking company or a company registered under Section 25 of the Companies Act, 1956, or a Government company) of which, or the subsidiary or the holding company of which any of the directors of the bank is a director, managing agent, manager, employee or guarantor or in which he holds substantial interest, or any individual in respect of whom any of its directors is a partner or guarantor.
Q.5. “In simulating financial decision, the strategy that produces the best simulated results is not necessarily the optimal financing strategy”, do you agree with this statement? Why or why not?
Companies are increasingly turning to simulations to help build strategic alignment and execution capability when faced with one or more of the following business challenges:
• Implementing a new strategy and key performance objectives
• Accelerating innovation and strategy execution
• Improving business acumen and financial decision-making
• Transforming sales organizations into business-results accelerators.
• Focusing leadership development on front-line execution.
• Implementing culture change aligned to
"How Proforma statement can help a company strategically
In the investing world, it describes a method of calculating financial results in order to emphasize either current or projected figures.
Pro forma financial statements could be designed to reflect a proposed change, such as a merger or acquisition, or to emphasize certain figures when a company issues an earnings announcement to the public.
Investors should be careful when reading a company's pro-forma financial statements, as the figures may not comply with generally accepted accounting principles (GAAP). In some cases, the pro-forma figures may differ greatly from the those derived from GAAP.
As a vital part of the planning process, pro forma statements can help minimize the risks associated with starting and running a new business. They can also help convince lenders and investors to provide financing for a start-up firm. But pro forma statements must be based upon objective and reliable information in order to create an accurate projection of a small business's profits and financial needs for its first year and beyond. After preparing initial pro forma statements and getting the business off the ground, the small business owner should update the projections monthly and annually.
USES OF PRO FORMA STATEMENTS
A company uses pro forma statements in the process of business planning and control. Because pro forma statements are presented in a standardized, columnar format, management employs them to compare and contrast alternative business plans. By arranging the data for the operating and financial statements side-by-side, management analyzes the projected results of competing plans in order to decide which best serves the interests of the business.
In constructing pro forma statements, a company recognizes the uniqueness and distinct financial characteristics of each proposed plan or project. Pro forma statements allow management to:
• Identify the assumptions about the financial and operating characteristics that generate the scenarios.
• Develop the various sales and budget (revenue and expense) projections.
• Assemble the results in profit and loss projections.
• Translate these data into cash-flow projections.
• Compare the resulting balance sheets.
• Perform ratio analysis to compare projections against each other and against those of similar companies.
• Review proposed decisions in marketing, production, research and development, etc., and assess their impact on profitability and liquidity.
Simulating competing plans can be quite useful in evaluating the financial effects of the different alternatives under consideration. Based on different sets of assumptions, these plans propose various scenarios of sales, production costs, profitability, and viability. Pro forma statements for each plan provide important information about future expectations, including sales and earnings forecasts, cash flows, balance sheets, proposed capitalization, and income statements.
Management also uses this procedure in choosing among budget alternatives. Planners present sales revenues, production expenses, balance sheet and cash flow statements for competing plans with the underlying assumptions explained. Based on an analysis of these figures, management selects an annual budget. After choosing a course of action, it is common for management to examine variations within the plan.
If management considers a flexible budget most appropriate for its company, it would establish a range of possible outcomes generally categorized as normal (expected results), above normal (best case), and below normal (worst case). Management examines contingency plans for the possible outcomes at input/output levels specified within the operating range. Since these three budgets are projections appearing in a standardized, columnar format and for a specified time period, they are pro forma.
During the course of the fiscal period, management evaluates its performance by comparing actual results to the expectations of the accepted plan using a similar pro forma format. Management's appraisal consists of testing and re-testing the assumptions upon which management based its plans. In this way pro forma statements are indispensable to the control process.
Pro forma statements provide data for calculating financial ratios and for performing other mathematical calculations. Financial models built on pro forma projections contribute to the achievement of corporate goals if they: 1) test the goals of the plans; 2) furnish findings that are readily understandable; and 3) provide time, quality, and cost advantages over other methods.
Financial modeling tests the assumptions and relationships of proposed plans by studying the impact of variables in the prices of labor, materials, and overhead; cost of goods sold; cost of borrowing money; sales volume; and inventory valuation on the company in question. Computer-assisted modeling has made assumption testing more efficient. The use of powerful processors permits online, real-time decision making through immediate calculations of alternative cash flow statements, balance sheets, and income statements.
Assessing the Impact of Changes
A company prepares pro forma financial statements when it expects to experience or has just experienced significant financial changes. The pro forma financial statements present the impact of these changes on the company's financial position as depicted in the income statement, balance sheet, and the cash-flow statement. For example, management might prepare pro forma statements to gauge the effects of a potential merger or joint venture. It also might prepare pro forma statements to evaluate the consequences of refinancing debt through issuance of preferred stock, common stock, or other debt.
Businesses also use pro forma statements in external reports prepared for owners (stockholders), creditors, and potential investors. For companies listed on the stock exchanges, the SEC requires pro forma statements with any filing, registration statements, or proxy statements. The SEC and organizations governing accounting practices require companies to prepare pro forma statements when essential changes in the character of a business's financial statements have occurred or will occur. Financial statements may change because of:
• Changes in accounting principles due to adoption of a generally accepted accounting principle different from one used previously for financial accounting.
• A change in accounting estimates dealing with the estimated economic life and net residual value of assets.
• A change in the business entity resulting from the acquisition or disposition of an asset or investment, and/or the pooling of interests of two or more existing businesses.
• A correction of an error made in a report or filing of a previous period.
Management's decision to change accounting principles may be based on the issuance of a new accounting principle by the Financial Accounting Standards Board (FASB); internal considerations taking advantage of revised valuations or tax codes; or the accounting needs of a new business combination. By changing its accounting practices, a business might significantly affect the presentation of its financial position and the results of its operations. The change also might distort the earnings trend reported in the income statements for earlier years. Some examples of changes in accounting principles might include valuation of inventory via a first-in, first-out (FIFO) method or a last-in, first-out method (LIFO), or recording of depreciation via a straight-line method or an accelerated method.
When a company changes an accounting method, it uses pro forma financial statements to report the cumulative effect of the change for the period during which the change occurred. To enable comparison of the pro forma financial statements with previous financial statements, the company would present the financial statements for prior periods as originally reported, show the cumulative effect of the change on net income and retained earnings, and show net income on a pro forma basis as if the newly adopted accounting principle had been used in prior periods.
A change in accounting estimates may be required as new events occur and as better information becomes available about the probable outcome of future events. For example, an increase in the percentage used to estimate doubtful accounts, a major write-down of inventories, a change in the economic lives of plant assets, and a revision in the estimated liability for outstanding product warranties would require pro forma statements.
THE SEC FORMAT
The SEC prescribes the form and content of pro forma statements for companies subject to its jurisdiction in circumstances such as the above. Some of the form and content requirements are:
1. An introductory paragraph describing the proposed transaction, the entities involved, the periods covered by the pro forma information, and what the pro forma information shows.
2. A pro forma condensed balance sheet and a pro forma condensed income statement, in columnar form, showing the condensed historical amounts, the pro forma adjustments, and the pro forma amounts. Footnotes provide justification for the pro forma adjustments and explain other details pertinent to the changes.
3. The pro forma adjustments, directly attributable to the proposed change or transaction, which are expected to have a continuing impact on the financial statements. Explanatory notes provide the factual basis for adjustments.
With the passage of the Sarbanes-Oxley Act of 2002, modifying accounting and disclosure statements, the SEC has begun issuing new requirements related to pro forma statements. Most specifically, the SEC has found that pro forma statements, which are not required to follow Generally Accepted Accounting Principles (GAAP), may give a false impression of the company's actual financial status. For this reason, SEC requires that all pro forma statements be accompanied with forms that do conform to GAAP, the company required to select those versions of formal statements most closely resembling the pro forma.
Pro Forma Statements for Changes in Entity and for Business Combinations
The FASB, the AICPA, and the SEC have provided significant directives to the form, content, and necessity of pro forma financial statements in situations where there has been a change in the form of a business entity. Such a change in form may occur due to changes in financial structure resulting from the disposition of a long-term liability or asset, or due to a combination of two or more businesses.
The purpose of pro forma financial statements is to facilitate comparisons of historic data and projections of future performance. In these circumstances users of financial statements need to evaluate a new or proposed business entity on a basis comparable to the predecessor business in order to understand the impact of the change on cash flow, income, and financial position. Pro forma adjustments to accounting principles and accounting estimates reformat the statements of the new entity and the acquired business to conform with those of the predecessor.
Occasionally, a partnership or sole proprietorship will sell all or part of the business interest. Sometimes it is necessary, especially if the business is "going public," to reorganize into a corporation. The financial statements of a corporation with a very short history are not helpful in a thoughtful analysis of future potential. Similarly, because of the differences in federal income tax liabilities, a restatement of the predecessor business in historical terms only confuses the picture. Since the financial statements of the predecessor business do not contain some of the expense items applicable to a corporation, the pro forma financial statements make adjustments to restate certain expenses on a corporate basis. In particular these would include:
Pro Forma Statements
• Stating the owners' salaries in terms of officers' salaries.
• Calculating the applicable federal taxes on the predecessor business as though it were a corporation.
• Including corporate state franchise taxes.
• Adding the balance of the partners' capital to contributed capital in the combined company rather than to retained earnings for partnerships acquired through the pooling of interests.
Subchapter S corporations exercise the tax-option of the shareholders to individually assume the tax liability rather than have it assumed by the corporation as a whole. If the shareholders choose to go public or change their qualifications, the corporation loses the tax-option. Therefore, in addition to the pro forma statement showing historical earnings, the new company will make pro forma provision for the taxes that it would have paid had it been a regular corporation in the past. When acquisition of a Subchapter S corporation is accomplished through the pooling of interests, the pro forma financial statement may not include any of the retained earnings of the Subchapter S corporation in the pooled retained earnings.
When presenting the historical operations of a business previously operated as a partnership, the financial information is adjusted to bring the statement in line with the acquiring corporation. Historical data listed in these instances includes net sales; cost of sales; gross profit on sales; selling, general, and administrative expenses; other income; other deductions; and income before taxes on income. Pro forma adjustments would restate partnership operations on a corporate basis, including estimated partnership salaries as officers and estimated federal and state taxes on income, as well as pro forma net income and pro forma net income per share. Accountants make similar adjustments to pro forma statements for businesses previously operated as sole proprietorships and Subchapter S corporations.
Acquisition or Disposal of Part of a Business
For a company that decided to acquire part of a new business or dispose of part of its existing business, a meaningful pro forma statement should adjust the historical figures to demonstrate how the acquired part would have fared had it been a corporation. Pro forma statements should also set forth conventional financial statements of the acquiring company, and pro forma financial statements of the business to be acquired. Notes to the pro forma statements explain the adjustments reflected in the statements.
A pro forma income statement combines the historical income statement of the acquiring company and a pro forma income statement of the business to be acquired for the previous five years, if possible. Pro forma adjustments exclude overhead costs not applicable to the new business entity, such as division and head office expenses.
The purchase of a sole proprietorship, partnership, Sub-Chapter S corporation, or business segment requires pro forma statements for a series of years in order to reflect adjustments for such items as owners' or partners' salaries and income taxes. In this way, each year reflects the results of operations of a business organization comparable with that of the acquiring corporation. However, the pro forma statements giving effect to the business combination should be limited to the current and immediately preceding periods.
Pro forma statements are an integral part of business planning and control. Managers use them in the decision-making process when constructing an annual budget, developing long-range plans, and choosing among capital expenditures. Pro forma statements are also valuable in external reporting. Public accounting firms find pro forma statements indispensable in assisting users of financial statements in understanding the impact on the financial structure of a business due to changes in the business entity, or in accounting principles or accounting estimates.
Although pro forma statements have a wide variety of applications for ongoing, mature businesses, they are also important for small businesses and start-up firms, which often lack the track record required for preparing conventional financial statements. As a planning tool, pro forma statements help small business owners minimize the risks associated with starting and running a new business. The data contained in pro forma statements can also help convince lenders and investors to provide financing for a start-up firm.