A projected balance sheet, also known as pro forma statement of financial position, lists certain financial accounts payable to, and receivable from, a company for a given future period. The accounting principles governing the preparation of this type of balance are the same that apply to the preparation of the balance sheet. The only difference between the two forms is the detail of items that will be reflected on the balance sheets.
In order to prepare a projected balance sheet based on accurate financial information, it is important to first determine the total direct and indirect financing that a company will receive during the year. The difference between these two amounts, plus the amount of cash infusing the company, is the basis for calculating the financing requirements for the year. Included in this total are investment finance charges, which are mentioned in the corporate cash flow projections. It is also important to consider financing requirements for property, plant and equipment, capital assets and net tangible assets.
The value of all other assets is then calculated as a percentage of the total assets. One should note that the values in the projections are based on assumptions, most notably the value of the company’s short-term borrowings. If these assumptions prove to be inaccurate, the revisions to the projections will have an immediate impact on the value of the company’s stock. The amount of revenue the company will earn, as reflected in the projections, is determined by the total revenue mix of customers, lenders and owners. There are two primary factors used to measure the valuation of the company’s short-term debts: interest and dividend payments. Dividends are included in the valuation of the stock as they represent a percentage of the ownership interest.
The balance of the projected balance sheet can also be affected by changes in the financial position of the company. There are two types of changes: negative and positive. A company’s performance can be either up or down depending on the nature of its assets and liabilities. Therefore, there are certain assumptions made in calculating the forecast balance sheet that are based on the financial position of the organization.
For companies that have been in operation for more than two years, the first set of assumptions considers the operating profit and the expenses incurred during the first two years. It is assumed that the operational profit and the expenses will continue at their prior level. Likewise, the first set of assumptions considers the retained earnings of the company as being neutral. It is assumed that the retained earnings will continue to decline at a constant rate unless the market conditions change dramatically. Other assumptions in the first set of the projected balance sheets include the tax rate, the number of years expected to be in operation, the dividend yield and the reinvestment plan.
Other things that are considered for the projection are the level of the fair value of the assets and liabilities, the level of the debt load and the gross margin. Fair value is defined as the amount that would be sold or bought in the open market; net value is determined by subtracting the fair value from the current fair value; and the debt load is the weighted average cost of debt divided by the total current and long-term debts. The assumptions regarding the debt load and the gross margin are the most significant because they have a major impact on the way the company makes its profit and therefore affect the projections of the balance sheets. Other things that affect the balance sheets are the foreign currency exchange rate, interest rates, the foreign exchange trade, prices for essential commodities, and the company’s credit rating.