Instructions

Case Study: Building a Pro Forma Income Statement

Key Takeaways

Understand the importance of accurate financial projections.

Appreciate the significance of market research and data analysis in making informed projections.

Learn how different factors can influence the financial performance of a business.

Gain insights into the critical components of a pro forma income statement.

Scenario

You are a group of highly talented student entrepreneurs hired by a local family to investigate the financial viability in opening a coffee shop on the University at Buffalo campus. Your contract requires that you create a three$-$year pro forma income statement for the coffee shop. The pro forma income statement will be shared with an investor.

Assignment

Complete a three$-$year Pro Forma Report for your team project.

Show the market size you are addressing with a campus coffee shop. Cite market research from public sources. $(5$ points$)$

Estimate the market penetration rates for a three$-$year period. $(5$ points$)$

Show a detailed breakdown of the COGS for the business for the three$-$year period. $(5$ points$)$

Show a detailed breakdown of the operating cost for the business for the three$-$year period. $(5$ points$)$

Show the three$-$year pro forma summary that will be used in presentations. $(5$ points$)$

Overview of a Pro Forma Income Statement

A pro forma income statement is a financial document that outlines projected revenues, expenses, and profits for a future period. The key elements typically included in a pro forma income statement are:

Revenue: This section includes all the income generated from the sale of goods or services. It might break down revenue by different sources or product lines.

Cost of Goods Sold $($COGS$)$: This represents the direct costs associated with producing the goods or services sold. It includes materials, labor, and manufacturing overhead. These costs vary with the level of product and service sales.

Gross Profit: Calculated by subtracting the COGS from the revenue, it reflects the profit generated before considering operating expenses.

Operating Expenses: These are costs incurred in running the day$-$to$-$day operations of the business. They include items like salaries, rent, utilities, marketing expenses, and depreciation. These costs do not vary with the level of product and service sales, they are fixed costs.

Operating Income $($or Earnings Before Interest and Taxes $-$ EBITDA$)$: This is the profit obtained after subtracting operating expenses from the gross profit.

Pro forma statements are often used for planning, forecasting, or presenting potential scenarios to stakeholders. They can help in making informed business decisions and projecting future financial performance based on assumptions and estimates.

Revenue

Revenue represents the total income generated by a company from its primary business activities, such as selling goods or providing services. Determining revenue involves a clear understanding of the goods sold or services rendered and the pricing strategy.

Here's how revenue is determined:

Sale of Goods: For businesses selling physical products, revenue is calculated by multiplying the number of units sold by the selling price per unit. It's essential to record revenue at the point when goods are delivered or services are rendered, not necessarily when the payment is received.

Rendering Services: For service$-$based businesses, revenue is typically recognized when the services are performed or as milestones are achieved. The revenue is calculated based on the agreed$-$upon rates or contracts for services provided.

Pricing Strategy: The selling price per unit of goods or services greatly impacts revenue. Pricing decisions are influenced by factors like market demand, competition, value creation, and market pricing.

Adjustments and Returns: Companies may need to account for adjustments or returns that affect revenue. For instance, returns, refunds, or discounts provided to customers after the sale may reduce the initially recorded revenue.

Multiple Revenue Streams: Some businesses have multiple revenue streams from various sources. In such cases, revenue determination involves segregating and accurately accounting for each revenue stream separately.

Accurate determination of revenue is crucial for financial reporting, performance analysis, and decision$-$making within a business. It reflects the top line of a company's income statement and is a key metric for assessing business growth, profitability, and overall financial health.

Cost of Good Sold $($COGS$)$

The Cost of Goods Sold $($COGS$)$ is a critical element in a company's financial statements, especially in the context of the income statement. It represents the direct costs associated with the production or acquisition of the goods that a company sells during a specific period.