BIBLIOGRAPHY AND REFERENCES
5. To model interest expense
3.5 MODELLING THE BALANCE SHEET
Only the net interest expense is missing from the income statement and the tax expense if there are going to be profits. The FP&A will come back to these figures later on. He is now ready to model the balance sheet.
include long-term investments of SteelCo and the FP&A decides to leave this account intact for the next 4 years. Exhibit 3.15 shows the proforma balance sheet up to now.
Next the FP&A needs to forecast the current assets accounts. Recalling Exhibit 3.4, the current accounts include the accounts receivable, inventory, cash and the other current assets.
In order to forecast accounts receivable, the FP&A needs the forecast sales for the years 2014 to 2017 and the days sales outstanding or DSO for the same period. He has both of the above (see Exhibits 3.10 and 3.11). So the accounts receivable for 2014 will be:
Accounts Receivable 2014 = Sales 2014 × DSO 2014 / 365 * 1.2, or Accounts Receivable 2014 = €117,564k × 85 / 365 * 1.2 = €32,854k.
Following a similar rationale he calculates the accounts receivable for 2015, 2016, and 2017 which are €27,983k, €24,207k, and €22,764k respectively. Remember here that the VAT charge of 20% is added to accounts receivable to denote that a customer owes the company not only the sale price but also the VAT on the sale.
Moving on, inventory needs to be forecast. Again the FP&A needs an income statement account which is the cost of goods sold and the Days Inventory Outstanding or DIO. The DIO has already been forecast for the years 2014 to 2017 (see Exhibit 3.10) and the cost of goods sold can be derived indirectly from Exhibit 3.12 where both the sales and the gross margin have been calculated. Thus the inventory for 2014 will be:
Inventory 2014 = Cost of Goods Sold 2014 * DIO 2014 / 365, where Cost of Goods Sold 2014 = Sales 2014 − Gross Margin 2014, or Inventory 2014 = (€117,564k − €11,169k) * 85 / 365 = €24,777k.
In a similar way the inventory for 2015, 2016, and 2017 is forecast as €21,104k, €19,473k, and €18,313k respectively. Cash deposits is the next current assets account that needs to be modelled. This is a fairly easy task. Historic financial statements have shown that the com-pany has never operated with cash deposits below €3,500k and the treasury department has verified that. Because cash plays such a vital role in the smooth operation of businesses, some companies maintain a minimum cash balance that ensures that they have sufficient funds to pay their suppliers when needed. The minimum cash balance for SteelCo is set at €3,500k.
Finally, the other current assets, although they have been declining year on year, probably due to the decline in SteelCo’s activity, are set constant at the last actual year amount, that is €1,230k. The FP&A could model them as a percentage of sales or as a percentage of total assets although the latter would result in a circular reference. Since this amount is fairly small compared to the total assets (less than 1% in the balance sheet for 2013) he does not bother with it any more. The balance sheet so far looks like the one shown in Exhibit 3.16.
EXHIBIT 3.15 Proforma balance sheet non-current accounts
Next the FP&A needs to model the owner’s equity and liabilities accounts. If you recall Exhibit 3.4, owner’s equity is broken down into the share capital and retained earn-ings accounts. The share capital account remains fairly stable unless there is a share capital increase. For the time being such information is not available so it will be left intact.
Period profits after tax and after dividends, if any, affect the retained earnings account (see Exhibit 2.13). So, assuming that the share capital will not change in the next 4 years, the FP&A has to forecast only retained earnings. Since the income statement is not yet ready, he leaves this account for later and proceed with the liability accounts. The balance of long-term debt is easy to forecast since he knows the repayment schedule of the loan. The company has to repay the 39% by June of 2017 in 2 instalments per year. The duration of the loan is 9 years and its initial amount was €70 million. So by applying some simple maths each year the company will have to repay:
€70,000k × 39%/9 years = €3,033k
During the last year of the loan the company will have to repay half of this amount in June 2017 since in the first year they paid half of this amount in December 2008. Thus:
Long-term Debt 2014 = Long-term Debt 2013 − Debt Repayment 2013, or Long-term Debt 2014 = €53,317k − €3,033k = €50,283k.
Similarly, long-term debt for years 2015 to 2017 is calculated at €47,250k, €44,217k, and
€42,700k respectively.
The next account is short-term debt. This account is used to balance the balance sheet as we will see in the next paragraph. So for the time being it will remain empty. Then there follows the accounts payable account. As with accounts receivable and inventory, the FP&A needs the income statement account of COGS and DPO. The DPO has already been forecast for the years 2014 to 2017 (see Exhibit 3.10) and the COGS has been derived above. Thus the accounts payable for 2014 will be:
Accounts Payable 2014 = Cost of Goods Sold 2014 * DPO 2014 / 365, or Accounts Payable 2014 = (€117,564k – €11,169k) * 50 / 365 = €14,575k.
In a similar way, accounts payable for the years 2015 to 2018 are forecast at €13,190k,
€13,388k, and €12,590k respectively. Finally, the other liabilities account is the last one EXHIBIT 3.16 Forecast balance sheet assets accounts
missing from a complete balance sheet. Like the other current assets account, other liabilities has a declining trend year over year, probably due to the decline of SteelCo’s activity, and is set constant at the last actual year’s amount which is €2,147k.
Exhibit 3.17 shows the balance sheet with all the forecast accounts up to 2017 except the retained earnings and short-term debt accounts. Note that the FP&A has made use of an in-built error check that raises the alert that the balance sheet does not balance (last line of the balance sheet of Exhibit 3.17). This issue will be resolved in the next section. Moreover, given the way the balance sheet has been modelled, all the line items are either linked to the income statement directly, or determined through the creation of an assumption that is held to a different area of the model (e.g. the “Assumptions” worksheet). Tempting as it was, no hard-coded numbers have been entered! For example, CAPEX, Depreciation, DSO, DIO, and DPO are recorded elsewhere and pulled through to the balance sheet.
The FP&A is now approaching the end of the modelling process. The structure of the balance sheet has been built and in the next section they will attempt to balance it.