The Income Statement Sales

Table 24.3: A Possible PepsiCo Pro Forma Income Statement Model for 2002

Income Statement December Estimated

1999 2000 2001 2002 2003

= Sales1 $25,093 $25,479 $26,935 $27,906 ■ ■ ■

+ SG&A3 $11,018 $11,104 $11,608 $12,279 ■■■

- = Operating Expenses6 $21,610 $21,661 $22,914 $23,486 ■■■ = Operating Income7 $3,483 $3,818 $4,021 $4,420 ■■■ + Net Interest Income8 $792 -$57 $8 $0 ■■■ = Income Before Tax9 $4,275 $3,761 $4,029 $4,420 ■■■

- Corporate Income Tax10 $1,770 $1,218 $1,367 $1,591 ■■■ = Income After Tax11 $2,505 $2,543 $2,662 $2,828 ■■■

- Extraordinary Items12 $0 $0 $0 $0 ■■■ = Net Income 13 $2,505 $2,543 $2,662 $2,828 ■■■

Explanations (Notes):

1. Grows by historical 3.6%. 6. Sum the above. 10. 36%ofIBT.

2. $3,506+26% of sales. 7. Subtract the above. 11. Subtract the above.

3. 44% of sales. 8. Too ignorant and lazy. 12. Too ignorant and lazy.

4. 3-year historical average. 9. Subtract the above. 13. Subtract the above.

The base for detailed pro formas is sales prediction.

Explain all your assumptions!

The detailed projection method usually starts by forecasting future sales in the income statement. Your sales forecast is the single most critical aspect of any pro forma, because it becomes the baseline number from which many other financial item forecasts will follow. For example, in PepsiCo's case, you could use a mechanistic model that extrapolates sales growth from historical financials. Table 24.3 allows you to compute that PepsiCo sales grew at an annualized rate of ($26,935/525,093)1/2 - 1 « 3.6% from 1999 to 2001. Let us assume that PepsiCo sales will continue in 2002 at the same growth rate. Therefore, you could project PepsiCo sales in 2002 to be $26,935 ■ ($26,935/$25,093)1/2 « $26,935 ■ (1 + 3.6%) « $27,906.

Like every other pro forma line items, the sales forecast should have a footnote (in Table 24.3) to explain the basis behind the estimate. Admittedly, our footnotes in Table 24.3 are mostly perfunctory. For example, note 1 does not even explain where the 3.6% came from. In the real world, you would carefully explain the background assumptions behind each and every critical component of your pro forma—sometimes with many paragraphs and additional tables.

Use more information! Do not believe that sales forecasting is always as simple as this. You could and should use an economic model that uses detailed business intelligence. For example, as a real-world analyst, you might use your knowledge as to

• whether PepsiCo was about to launch many exciting new products or whether it had few new projects in the pipeline;

• whether PepsiCo paid less in dividends in order to reinvest its earnings into operations, which eventually would turn into more sales or profitability;

• whether there is a recession or a boom on the horizon for 2002;

and so on. This would help you adjust your sales estimates for a more accurate projection. In a real pro forma where your money is on the line, it would be outright reckless to forecast sales through a mechanistic model without an economic model!

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