Prospective Analysis
The prospective analysis is how a company oversees for its developments in the future and how it can meet its obligations given the current state of the company. It helps the managers give hope to the investors by analyzing the possible outcomes resulting from investments shortly. The prospective analysis does not include historical data since it is concerned with the future of the company. Therefore, it focuses on the projections of the financial statements through forecasting on what is likely to happen. The prospective analysis helps the company to realize the risks that may pose a danger to the company’s performance by evaluating them and mitigation (Cortez, and Wesley pg. 99). Through prospective analysis, a company can use its financial plans and examine how the growth of cash flows from different departments and the company’s success per the set goals. Income statements show how the company is expected to earn in the future.
Forecasted Income Statements
The income statement is used in accounting to show the operating status of a company. It displays the company’s profits gained before the imposition of taxes and after the tax fee will be imposed. Income statements also show the amount of cost that be incurred to meet sales and the cost of producing goods. Other incomes that the company gains during the financial years also highlighted in the income statements. The table below shows the forecasted income statements for Treasury Wines Estates Company limited for three years 2020, 2021 & 2022.
Treasury Wines Estate (TWE)
Income Statement Forecasts
For The Years 2020, 2021 &2022
| ITEM | 2020 ($M) | 2021 ($M) | 2022 ($M) |
| Sales | 2,883 | 3,330
| 4,500 |
| COGS | 2,000
| 2,200
| 2,500 |
| Gross profit | 883
| 1,130
| 2,000 |
| (Less operating Expenses) | (183) | (130)
| (200) |
| Add Operating income. | 300 | 500
| 700 |
| Earnings Before Income Tax (EBIT) | 1,000 | 1,500
| 2,500 |
| Deduct Tax (Corporate tax @30) | 300 | 450
| 750 |
| NET PROFIT | 700 | 1,050 | 1,750 |
Fig 1: income statement forecasts
Treasury Wines Estates (TWE)
The critical ratios for years 2020, 2021 & 2022
| Ratio | 2020 (%) | 2021 (%) | 2022 (%) |
| Gross profit margin | 30.63
| 33.93 | 44.44 |
| Net profit margin | 24.28
| 31.53 | 38.89 |
| Interest coverage (EBIT/Interest expenses) | 546.45 | 1,153.85 | 1,250 |
Fig 2: key ratio forecasts.
The essential elements that should be included in the income statement forecasts for three years in the future have been included above in fig. 1. They include sales that can be predicted in 3 years. The other elements are the cost of goods sold and the gross profit obtained from the difference between sales and damage of products sold (Lessambo pg. 255). The other element is identifying expenses expected to be incurred over the period. The tax rate for the corporate bodies is at 30% from the total earnings; thus, it is deducted to obtain net profit earnings for the year.
The calculated expected ratios that have led to the projections are shown in fig. 2.
To obtain a gross profit margin = gross profit*100
Sales
Net profit margin = net profit after tax*100.
Sales
As the trends can be seen in Figures 1 & 2, the information shows that the company’s state of operations is expected to be positive in the coming three years. The total sales expected to increase from $2,883 million in the year 2020 to $3,330 million in the year 2021 and finally $4,500 million in the year 2022. Treasury Wines Estates is expected to have a marginal increase in total, and this is a good sign of the future since it means that the number of customers is increasing, leading to high sales.
The cost of goods sold is increasing because as the sales increase, the operating expenses are expected to grow though at a slow rate as compared to the sales increase. The company’s environmental analysis is favorable, leading to high sales over the period (Monahan pg.198). The company is expected to be in a stable state of financial position since it is making more profits, and as compared to the trends shown in the table above, the expected to improve over every year (Wu et al. pg. 110). The cash flows over the company are likely to increase since it is in favorable conditions to prosper. The company had identified risks that may have affected the transactions through the development of SWAT analysis. To the other companies that were struggling to join the industry, they analyzed competitive strategies to survive.
Forecasting balance sheet
The balance sheet also called the statement of financial position is a summary of the company’s business standards. It includes assets, liabilities, and capital. The debit side in a balance sheet is composed of assets, while the credit side is composed of liability items and money invested. Below is the projected balance sheet information for the next three years.
Treasury Wines Estate (TWE)
Forecasted Balance Sheet
For the years 2020, 2021 & 2022
| ITEMS | 2020 ($M) | 2021 ($M) | 2022 ($M) |
| Non-current assets | 61,500 | 61,500 | 61,500 |
| Less depreciation | (1,025) | (2,050) | (3,075) |
| Total | 60,475 | 59,450 | (58,425) |
| Current Assets | |||
| Cash | 34,325 | 37,917 | 36,319 |
| Account receivable | 2,630 | 2,941 | 3,095 |
| Inventory | 15,140 | 17,365 | 18,640 |
| Others | 8,000 | 8,000 | 8,000 |
| Total | 60,095 | 66,223 | 66,054 |
| TOTAL ASSETS | 120,570 | 125,673 | 124,479 |
| Capital and shares | 20,900 | 20,272 | 18,859 |
| Current liabilities | 30,099 | 36,273 | 36,947 |
| Non-current liabilities | 69,571 | 69,129 | 68,673 |
| Total liability | 99,670 | 105,401 | 105,620 |
| TOTAL CAPITAL AND LIABILITY | 120,570 | 125,673 | 124,479 |
Fig. 3
As shown in Figure 3 above, the amount of non-current assets is unchanged while the depreciation increases every year. The non-current liabilities have decreased while the current liabilities are expected to increase over the years. It is a clear indication that the company will be able to meet its short term goals without being affected by the amount of non-current liability they have borrowed.
Treasury Wines Estate
Forecasted ratios for the years 2020, 2021 & 2022
| RATIO | 2020 | 2021 | 2022 |
| Current ratio
| 1.99 | 1.83 | 1.79 |
| Debt ratio
| 0.83 | 0.83 | 0.85 |
| Equity ratio
| 0.17 | 0.16 | 0.15 |
Fig. 4
The equity ratio is decreasing; therefore, it is an indication that the company is doing well. It is given by
Equity ratio = shareholders’ equity / total assets
Debt ratio = total liabilities / total assets
Current ratio = current assets / current liabilities.
The balance sheet shows the financial standing of the company. It also gives investors an easy time to make decisions based on the company’s performance. The balance sheet shows how a company is expected to meet its short term obligations and pay off its current liabilities to sustain the smooth running0 of the business.
Valuation
Business valuation is a process used to identify the company’s value or worthiness in the case it is needed for sale or change in business form. Therefore, several types of business valuations are used to determine the company’s economic value. It enables investors to weigh on whether to withdraw their investment based on the expected return or to continue investing. Some of the methods usually used in the valuation of business fair value include a discounted cash flow model and the asset-based approach.
Discounted Cash Flow method
The discounted cash flow model involves the analysts forecasting future business cash flows and cutting back on the current market value of the business (Bian et al. pg. 326). The discounted cash flow method is slightly different from other forms of valuation in that it considers the inflation rate while calculating the business value. The example below will help to calculate the value of the business.
| YEAR | 0 | 1 | 2 | 3 |
| TWE | -1,000 | 500 | 400 | 300 |
Fig. 5
The table below shows different cash flows of the Treasury Wines Estate for three years. The discounted rate of return is 10% for the project. To determine the company’s net present value, we have to add all current costs for each year, as illustrated above.
The formula is PV=FV/ (1+i)n1
PV0= -1,000 PV2= 400/ (1+0.1)2= 330.58
PV1=500/ (1+0.1)1 = 454.55 PV3 = 300/ (1+0.01)3= 225.39
To find the net present value of the Treasury wines Estate, we add all the future values of the company. PV= PV0+ PV1 +PV2+PV3
PV= -1,000+454.55+330.58+225.39 = 10.52
Asset-Based Approach
It is a kind of business valuation method whereby the company’s worthiness is determined by obtaining the company’s net assets by deducting total liabilities from the total amount of assets. In the valuation of business using an asset-based method, the company is required to evaluate the type of obligations to be included in the approach. It is because some of the liabilities such as long-term liabilities that take a period of more than 10 years to be paid back are not included in this approach and thus they are termed as capital liabilities. Asset-based valuation does not include considering the time value of money and therefore the value of a company is valued at the current period without considering what would be its value in the future.
Since the total liabilities are excluded from the total assets, the reminder which is the owners’ equity is termed as the value of the company. Therefore,
Asset-based valuation method= total assets- total liabilities
= 120,570- 99,669
= 20,900
Therefore, the estimated value of shares = net assets/ equity capital
= 120,570/ 20900
= $ 5.77 per share
The parameters used in determination of valuation models include
- Time – the company should consider whether the company is being valued at in relevance to the future time or it is using the current performance to determine.
- Comparison – a company is valued with regard in competition with other companies that are in the same industry. It helps to estimate the value of the company.
- Dividend policy – it is the policy that is adopted by the company to pay off its shareholders. If the company has a dividend policy that is expensive to maintain then the company would be valued at low price.
- Residual earnings – a company is valued taking into considerations the amount of income the company gets after paying off the shareholders. It shows the ability of a company to make more profits since the main aim of operating business enterprise profit maximization.
The economic scenarios refers to the relationship between the balance of prospering and falling in the exchange rates for the upside or downside growth rate and may include
- Cost of goods sold – it shows how a company is cost effective. If the cost of goods sold is low then the company has advantage of production and supply.
- Revenue growth – if the company’s revenue is showing increase then we might say that the company is in a favorable conditions
- Profit maximization – profit refers to the net residual income that is available in the company’s account after deducting tax and paying the shareholders.
Recommendations
As we have seen in the calculation for the net present value, in three years, the amount is $10.52 million. It is a clear indication that the project should be accepted and pursued. If a net present value of any business under the discounted cash flow method is positive, then the business venture should be considered and taken since it can account for its initial investment after three years and make profits. Treasury Wines Estate is recommended to continue with the same investment policy since it is leading the company into making profits.
Treasury Wines Estate has taken precautions to evaluate the environmental factors that may affect the business from success. It is one of the critical performance measures that any business should determine to be in a competitive shape with the rival companies. The company’s financial statements have been well evaluated, and the risks for various kinds have been mitigated to allow smooth control and management of the business. Investors of the company should not withdraw their shares since the company is in good shape to compete and can as well make profits after three years. The company is yielding a lot of earnings shortly in the next ten years. The company would be making a lot of money with its current strategic options and the competitive advantage over the other companies.
References
Bian, Yuan, et al. “A dynamic lot-sizing-based profit maximization discounted cash flow model considering working capital requirement financing cost with infinite production capacity.” International Journal of Production Economics 196 (2018): 319-332.
Cortez, Roberto Mora, and Wesley J. Johnston. “The future of B2B marketing theory: A historical and prospective analysis.” Industrial Marketing Management 66 (2017): 90-102.
Haghshenas, E., M. Gholamalifard, and N. Mahmoudi. “Applied introduction of ecosystem service modeling of marine aquaculture: Approach for estimation of production and net present value (NPV).” ISFJ 26.1 (2017): 141-152.
Lessambo, Felix I. “Forecasting Financial Statements’ Analysis.” Financial Statements. Palgrave Macmillan, Cham, 2018. 251-258.
Monahan, Steven J. “Financial Statement Analysis and Earnings Forecasting.” Foundations and Trends® in Accounting 12.2 (2018): 105-215.
Wu, Jiang, et al. “Inventory models for deteriorating items with maximum lifetime under downstream partial trade credits to credit-risk customers by discounted cash-flow analysis.” International Journal of Production Economics 171 (2016): 105-115.