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Out of these cookies, the cookies that are categorized as necessary are stored on your browser as they are essential for the working of basic functionalities of the website. Estimate the depreciation expenses that are assumed to be included in the cost of goods sold so that this amount can be removed when you are compiling the cash flow statement.
To calculate taxable profit or loss, you must include the depreciation expense in the income statement; you can show it as a separate item. Instead, you must forecast a detailed schedule for all the items. The list of items in Exhibit 3 is representative of what might be included. Even if the entrepreneur is providing all the necessary start-up funds, the wisdom of taking a salary comparable to what might be expected in a more mature company is questionable, to say the least.
Perhaps the best advice is to start off rather low and increase the salary as profits permit. Some items were mere guesses nonsales travel and telephone , and some catchall attempts start-up costs.
A company needs to develop a detailed schedule see Exhibit 4 for an example to include the items relevant to the business at hand. For McDonald Company, we included salaries for two salespeople for the first month, three for the second, and four for the fourth month on through the rest of the first year. Travel expenses for the salespersons were estimated to be equal to salaries after the first few months. The only other forecast item on the income statement is taxes.
At first, there are no taxes, but even with the tax-loss carryforward forward for 15 years, back for 3 , taxes have to be included for the second year. Include state income taxes, if any, and use the percentage to be applied to net profit before tax.
Estimating state income taxes is quite simple; the complication comes in forecasting the accrued taxes for the balance sheet. Once the income forecast is complete, you can turn to the balance sheet. Keep the balance sheet as simple as you did the income statement.
The first item on the balance sheet—cash—is the balancing item and is thus not forecast separately. Instead, it results from the computation of the cash flow statement. Accounts receivable may be forecast in two ways, each yielding different results. A separate schedule is necessary for example, see Exhibit 5. The standard way of forecasting accounts receivable is to use a turnover ratio equal to monthly sales times 12 divided by the turnover figure—for example, 9. Because of the seasonality of sales, you would get dramatically different accounts receivable balances if you applied a constant turnover to each month.
These turnovers make clear that the first procedure is advisable for monthly cash flow forecasting for a new venture, especially if sales are seasonal. Inventory presents a more difficult problem than accounts receivable.
Because of the pronounced seasonality in production and sales, using a constant turnover for cost of goods sold is not possible.
While the balance sheet shows inventory as one line, three types of inventory are actually on hand at any time: raw material, work in process, and finished goods. If you are using a cost accounting model, each month will produce these three totals. But because of the complexity of this model, you may wish to estimate perhaps guess is the better term what each of these inventory components will be, total them for each month, and use that number as the amount for inventory for the balance sheet.
In the case of McDonald, we estimated unit production for the first year to be as shown in Exhibit 7. By estimating the average cost of each finished unit, you can approximate the finished-goods component of inventory. With an eye to the production schedule, you can estimate how much raw material you will require.
By spreading this raw material over the other months, you can get a crude estimate of the raw material component. You estimate work in process by examining the production schedule and assuming an average cost for the units, say, when they are half completed. Totaling these admittedly crude estimates as in Exhibit 8 reveals a surprisingly close approximation of the needed inventory level required.
Other assets, which for a new venture include principally prepaid expenses, should be itemized and priced on a separate schedule and the total shown on the balance sheet. Do not show these items as a turnover or a percentage of sales. Plant, property, and equipment must also be individually budgeted and not shown as a percentage of sales. If the vendor of the equipment or a third party offers financing, show it in the liabilities section of the balance sheet.
For the McDonald Company, the accounts payable amount included all raw material purchases except for the initial one and assumed payment in the following month. These purchases further assumed, of course, that once under way the business could get credit. For other companies, accounts payable might include items in addition to raw material purchases. For the McDonald Company, we put those items in a separate account—accrued expenses not shown on the sample cash flow statement.
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