Mary Lou Black, M.D., president of Narcolarm, Inc., was in the process of preparing a business plan, including some pro forma financial statements, for her new venture [see Narcolarm, Inc. (A) and Narcolarm, Inc. (B)].
Enlisting the help of a niece who had recently completed a course in accounting, Dr. Black first prepared a list of requirements and activities necessary to launch the new enterprise. These requirements and activities led to the development of an initial balance sheet, shown in Exhibit 1.
Next, again with the help of her niece, Dr. Black projected the activities that would take place during the first year of operations. Dr. Black had decided to produce all Narcolarms to order, thereby assuring herself that there would be no WIP or finished goods inventories.
In the course of making their projections, Dr. Black and her niece realized that they needed to include corporate income taxes in their calculations. They estimated that their tax rate would be 48 percent, resulting in a total tax of $29,630. They also estimated that $10,000 of this would be paid in cash during the year, leaving $19,630 still owed as of the end of the year.
With this information, they were able to prepare a pro forma balance sheet and income statement for the first year of operations. These statements are shown in Exhibit 2.
Following this, Dr. Black's niece suggested that they also prepare a statement of cash flows for the period between the two balance sheets. Together, the two set about this new task.
- Be sure you understand how the taxes were included in the financial statements. What would have been the impact on the financial statements of paying, say, $20,000 in cash before the end of the year?
- Prepare a pro forma SCF for the period between the two balance sheets. Use both the direct and indirect methods. Why must you know the components of the cost of goods sold account to prepare the SCF using the indirect method?
- Has your opinion of Dr. Black's proposed venture changed with this new information? Why or why not?