Chapter 6

MINI CASE: PHARMA BIOTECH CORPORATION

Percent-of-Sales Projected Financial Statements
(Leach & Melicher, 2012, pp. 216-222)

The Pharma Biotech Corporation spent several years working on developing a DHA product
that can be used to provide a fatty acid supplement to a whole variety of food products.
DHA stands for docsahexaenoic acid, an omega-3 fatty acid found naturally in cold water
fish. The benefits of fatty fish oil have been cited in studies of the brain, eyes, and the
immune system.
Unfortunately, it is both difficult to consume enough fish to get the benefits of DHA and
most individuals might be concerned about the taste consequences associated with adding
fatty fish oil to eggs, ice cream, or chocolate candy. To counter these constraints, Pharma
Biotech and several competitors have been able to grow algae and other plants that are
rich in DHA. The resulting chemical compounds then are used to enhance a variety of food
products.
Pharma Biotechs initial DHA product was designed as additives to dairy products and
yogurt. For example, the ventures DHA product was added to cottage cheese and fruitflavored yogurts to enhance the health benefits of those products. After the long product
development period, Pharma Biotech began operations in 2009. Income statement and
balance sheet results for 2010, the first full year of operations, have been prepared.
Pharma Biotech, however, is concerned with forecasting its financial statements for next
five years because it is uncertain as to the amount of additional financing of assets that will
be needed as the venture ramps up sales. Pharma Biotech expects to introduce a DHA
product that can be added to chocolate candies. Not only will consumers get the
satisfaction of the taste of the chocolate candies, but they will also benefit from the DHA
enhancement.
Since this is expected to be a block buster new product, sales are expected to increase 50
percent next year (2011) even though the new product will come on line in mid-year. An
additional 80 percent increase in sales is expected the following year (2012).
The Income Statement for the fiscal year ended December 31, 2010 and the Balance Sheet
at December 31, 2010 is show on the following worksheet.
The venture uses the formula method based on percent-of-sales relationships to
estimate the additional funds needed (AFN) for the two year forecast period from 2011
through 2012.
As noted in the textbook (pages 216-222), the venture's goal is to project the financial
statements to quantify the future operations. The percent-of-sales forecasting method
projects account balances by assuming that most expenses and balance sheet items can be
expressed as a percent of sales.

Chapter 6 MINI CASE: PHARMA BIOTECH CORPORATION

Please complete the Excel working papers on the following worksheet to prepare a forecast
for Pharma Biotech's income statement, balance sheet, and cash flow statement. You will
use the venture's percent-of-sales forecasting method to project account balances by
assuming that most expenses and balance sheet items can be expressed as a percent of
sales.
Problems:
1. Using the worksheet (CH6 Case AFN Before Financing), prepare the proforma income
statement, balance sheet, and statement of cash flows for 2012 before obtaining any
additional financing.
Note: The pro forma statements for 2011 isshown as an example. This is a complex
worksheet. Please review the formulas in relevant Excel cells to ensure you understand the
appropriate calculations for the forecast year 2011 Once you understand the
calculations, you may replicate these cells for the forecast year to complete the
working papers for forecast year 2012.
Also note the basic accounting equation applies:
Total Assets = Total Liabilities + Shareholders Equity (Common Stock + Retained
Earnings)
Addendum to Case (not part of the assignment):
This information is further explanation of how the firm will finance the additional funds
needed. Pharma Biotech Corporation will use the required AFN you calculated and obtain
the additional funds needed in 2011 and 2012 by selling or issuing more common stock and
by borrowing from lenders at an interest rate of 10%. This initial financing needed will be
obtained equally each year by issuing new stock (50%) and by borrowing from lenders
(50%).
The venture will then adjust these proforma balance sheet to reflect the increase in
common stock and/or the increase in long term debt. In addition, the interest expense
(income statement) will be increased to cover the cost of additional long-term debt.

Pharma Biotech Corporation

Percent of Sales Forecasted Financial Statements
(Amounts in Thousands)

Income Statement
50% Growth 80% Growth

Income Statements
Net Sales
Operating Expenses
Interest
Earnings Before Tax (EBT)
Taxes (40%)
Net Income (NI)

Actual
Percent
2010
of Sales
Forecast Basis
$
15,000 100.00% 1+growth rate x current sales
13,000
86.67% .8667 x forecasted sales
400
2.67% Fixed (initially)
$
1,600
10.67%
640
4.27% .40 x EBT
$
960
6.40%

Cash Dividends (40% of NI)

Added Retained Earnings

Balance Sheets
Cash & Marketable Securities
Accounts Receivable
Inventories
Total Current Assets
Fixed Assets, Net
Total Assets

Actual
Percent
2010
of Sales
Forecast Basis
$
1,000
6.67% .0667 x forecasted sales
2,000
13.33% .1333 x forecasted sales
2,200
14.67% .1467 x forecasted sales
$
5,200
34.67%
6,800
45.33% .4533 x forecasted sales
$
12,000
80.00%

Accounts Payable
Bank Loan (Short-term)
Accrued Liabilities
Total Current Liabilities

384
576

1,600
1,800
1,200
4,600.0

2.56% .40 x NI
3.84%

10.67% .1067 x forecasted sales

12.00% Fixed
8.00% .0800 x forecasted sales
30.67%

Base
Forecast
2011
22,500
19,500
400
$
2,600
1,040
$
1,560

2,200
2,400
2,800
12,000

14.67% Fixed
16.00% Fixed
18.67% Cumulative
80.00%

1,200
1,800

Base
Forecast
2011
$
1,500
3,000
3,300
$
7,800
10,200
$
18,000

Base
Forecast
2012
$
2,701
5,399
5,941
$
14,041
18,358
$
32,399

2,400
1,800
1,800
6,000

4,321
1,800
3,240
9,361

Additional Funds Needed (AFN)-a)

Long-Term Debt (Old)
Common Stock (Old)
Retained Earnings
Total Liabilities & Equity

624
936

Base
Forecast
2012
40,500
35,101
400
$
4,999
1,999
$
3,000

3,664

12,902

2,200
2,400
3,736
18,000

2,200
2,400
5,536
32,399

The AFN, which is cumulative on the balance sheet, is calculated from the Statement of Cash Flows (below) and
(a- inserted into the balance sheet above.

Notes
From Income Statement
Change in Balance Sheet
Change in Balance Sheet
Change in Balance Sheet
Change in Balance Sheet

Statement of Cash Flows

Net Income
(Increase)/Decrease in Accounts Receivable
(Increase)/Decrease in Inventory
Increase/(Decrease) in Accounts Payable
Increase/(Decrease) in Accrued Liabilities
Cash Flow from Operations

Base
Forecast
2011
1,560
(1,000)
(1,100)
800
600
860

Change in Balance Sheet

(Increase)/Decrease in Fixed Assets

Cash Flow from Investments

(3,400)
(3,400)

(8,158)
(8,158)

Change in Balance Sheet

Change in Balance Sheet
Change in Balance Sheet
From Income Statement

Increase/(Decrease) Bank Loan

Increase/(Decrease) Long-Term Debt
Increase/(Decrease) Common Stock
Payment of Cash Dividends
Cash Flow from Financing

0
0
0
(624)
(624)

0
0
0
(1,200)
(1,200)

Net Cash Flow

(3,164)

(8,037)

Additional Funds Needed (AFN):

Beginning Balance (BB) Cash
Ending Cash Before Borrowing
Target Ending Cash
Additional Funds Needed (AFN)
Cumulative AFN

1,000
(2,164)
1,500
3,664
3,664

1,500
(6,537)
2,701
9,238
12,902

=Ending Balance Prior Year

Net Cash Flow less BB Cash
= 66.7 % Sales Forecast
Move to Balance Sheet

Base
Forecast
2012
3,000
(2,399)
(2,641)
1,921
1,440
1,321