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Additional Funds Needed Method

Additional Funds Needed Method

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Published by ClassOf1.com
Most companies expect growth in sales, which means its assets also must grow. Asset growth requires additional funds, so the firm may have to raise additional external capital if it has insufficient internal funds. If we assume that none of the firm’s ratios will change, we can use a simple approach, the Additional Funds Needed (AFN) method, to forecast financial requirements.
Most companies expect growth in sales, which means its assets also must grow. Asset growth requires additional funds, so the firm may have to raise additional external capital if it has insufficient internal funds. If we assume that none of the firm’s ratios will change, we can use a simple approach, the Additional Funds Needed (AFN) method, to forecast financial requirements.

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Published by: ClassOf1.com on Jul 26, 2013
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Finance
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Sub: Finance Topic: Financial Forecasting
*
The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not forsubmitting the same in lieu of their academic submissions for grades.
Finance Homework Help from Classof1.com 
 Additional Funds Needed Method
Most companies expect growth in sales, which means its assets also must grow. Asset growth requires additional funds, so the firm may have to raise additionalexternal capital if it has insufficient internal funds. If we assume that none of the
firm’s ratios will change, we can use a sim
ple approach, the Additional FundsNeeded (AFN) method, to forecast financial requirements.
 
Required Increase in Assets
In a steady-state situation in which no excess capacity exists, the firm musthave additional plant and equipment, more delivery trucks, higherinventories, and so forth if sales are to increase. In addition, more sales will lead to more accounts receivable, and those receivables must befinanced from the time of the sale until they are collected. Therefore, bothfixed and current assets must increase if sales are to increase. Of course, if assets are to increase, liabilities and equity must also increase by a likeamount to make the balance sheet balance.
 
Spontaneous Liabilities
The first sources of expansion funding are the “spontaneous” increasesthat will occur in a company’s accounts payable and accrued wages andtaxes. The company’s suppliers give it 10 days to pay for inventory 
 
 
Sub: Finance Topic: Financial Forecasting
*
The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not forsubmitting the same in lieu of their academic submissions for grades.
Finance Homework Help from Classof1.com 
purchases, and since purchases will increase with sales, accounts payable will automatically rise.
For example
, if sales rise by 10% then inventory purchases will also rise by 10%, and this will cause accounts payable to rise spontaneously by thesame 10%. Similarly, because the company pays workers every two weeks,more workers and a larger payroll will mean more accrued wages payable.Finally, higher expected income will mean more accrued income taxes, andits higher wage bill will mean more accrued withholding taxes. No interestnormally is paid on these spontaneous funds, but their amount is limited by credit terms, contracts with workers, and tax laws. Therefore,spontaneous funds will thus be used to the extent possible, but there islittle flexibility in their usage.
 
 Addition to Retained Earnings
The second source of funds for expansion comes from net income. Part of 
company’s profit will be paid out in dividends, but the remainder will be
reinvested in operating assets, as shown in the Assets section of the balance sheet; a corresponding amount will be reported as an addition toretained earnings in the Liabilities and equity section of the balance sheet.There is some flexibility in the amount of funds that will be generated fromnew reinvested earnings because dividends can be increased or decreased,

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