Financial Forecasting and Decision Making

Chapter 7RECONCILING THE INCOME STATEMENT AND BALANCE SHEET

LEARNING OBJECTIVES

The purpose of this chapter is to show how you can reconcile the pro forma income statement and balance sheet. After completing this chapter, you should be able to do the following:

•     Identify why the pro forma income statement and balance sheet must be reconciled.

•     Recall how to reconcile the pro forma income statement and balance sheet.

Why There Must Be a Reconciliation

The income statement and balance sheet values depend on each other. Hence we cannot simply prepare a pro forma balance sheet and a pro forma income statement separately. New assets must be financed and the financing costs decrease income, thereby decreasing internally generated funds and increasing expected funds needed (EFN). More debt may be needed to finance the increased EFN, further reducing income. The following chart illustrates the problem.

One could solve this problem by writing a computer program utilizing a “do-loop.” However, it can be solved directly by developing a reconciliation equation.

KNOWLEDGE CHECK

1.     Select the statement that is most true.

a.     The pro forma income statement and pro forma balance sheet can be prepared independently of each other.

b.     In order for the balance sheet to balance, the pro forma income statement and the pro forma balance sheet must be reconciled.

c.