Question

Top executive officers of Fanning Company, a merchandising firm, are preparing the next year's budget. The controller has provided everyone with the current year's projected income statement. Sales revenue Cost of goods sold Gross profit Selling & administrative expenses Net income Current Year $2,200,000 1,650,000 550,000 298,000 $ 252,000 Cost of goods sold is usually 75 percent of sales revenue, and selling and administrative expenses are usually 10 percent of sales plus a fixed cost of $78,000. The president has announced that the company's goal is to increase net income by 10 percent. Required The following items are independent of each other. a. Prepare a pro forma income statement. What percentage increase in sales would enable the company to reach its goal? b. The market may become stagnant next year, and the company does not expect an increase in sales revenue. The production manager believes that an improved production procedure can cut cost of goods sold by 1 percent. Prepare a pro forma income statement still assuming the President's goal to increase net income by 10 percent. Calculate the required reduction in selling & administrative expenses to achieve the budgeted net income. c. The company decides to escalate its advertising campaign to boost consumer recognition, which will increase selling and administrative expenses to $341,000. With the increased advertising, the company expects sales revenue to increase by 10 percent. Assume that cost of goods sold remains a constant proportion of sales. Prepare a pro forma income statement. Will the company reach its goal?

Answer 1

Answer a. Calculating % increase in sales to achieve 10% increase in net profit.

Calculating Sales Revenue for Next year

Let the sales Revenue be "S".

Sales = (Net Profit + Selling & Admin Expense) / Gross Profit Ratio

S = [(252000 x 1.10) + 0.1 S + 78000) / 0.25

S = (277000 + 0.1 S + 78000) / 0.25

0.25 S = 355000 + 0.1 S

0.15 S = 355000

S = 2366666.67

Sales Revenue = $2366666.67

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Proforma Income Statement.

FANNING Company
Pro forma Income Statement			Calculations
Sales Revenue	$2366666.67
Cost of goods Sold	1775000.00
Gross Profit	591666.67
Selling & Administration Expenses	314666.67		[(2366666.67*0.1) + 78000]
Net Income	$277000.00
Percentage Increase in Sales Revenue	7.58	%	[(2366666.67-2200000) /2200000 * 100]

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Answer b.

Calculating reduction in selling and administration expense to achieve the budgeted net income.

FANNING Company
Pro forma Income Statement			Calculations
Sales Revenue	2200000
Cost of goods Sold	1628000
Gross Profit	572000		(25% +1%= 26%)
Selling & Administration Expenses	295000		(Balancing Figure)
Net Income	277000
Reduction in Selling & Admin Expense	3000		(298000-295000)

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Answer c.

Pro forma Income Statement.

FANNING Company
Pro forma Income Statement			Calculations
Sales Revenue	2420000
Cost of goods Sold	1815000
Gross Profit	605000		(Gross Profit Ratio @25%)
Selling & Administration Expenses	341000		Given
Net Income	264000
Budgeted Net Income Target	277000
Will the Company reach its goals?	No