l Forecast Financial Statements with the

Percentage of Sales Approach to determine

Discretionary Financing Needed.
l Discuss Limitations of Percentage of Sales
Approach.
l Determine Sustainable Growth Rate.
l What’s a cash budget?
l 1)Project sales revenues and
expenses.
l 1) Project sales revenues and
expenses.
l 2) Estimate current assets and fixed
assets necessary to support projected
sales.
l 1) Project sales revenues and
expenses.
l 2) Estimate current assets and fixed
assets necessary to support projected
sales.
– Percent of sales forecast
l Suppose this year’s sales will total $20
million.
l Next year, we forecast sales of $25
million.
l Net income should be 10% of sales.
l Dividends should be 40% of earnings.
l Our task: forecast balance sheet and
determine discretionary (outside)
financing needed.
 This year % of $20m
Assets
Current Assets $6m 30%
Fixed Assets $10m 50%
Total Assets $16m
Liab. and Equity
Accounts Payable $3m 15%
Accrued Expenses $2m 10%
Notes Payable $1m n/a
Long Term Debt $3m n/a
Total Liabilities $9m
Common Stock $4m n/a
Retained Earnings $3m
Equity $7m
Total Liab. & Equity $16m
 Next year % of $25m
Assets
Current Assets 30%
Fixed Assets 50%
Total Assets
Liab. and Equity
Accounts Payable 15%
Accrued Expenses 10%
Notes Payable n/a
Long Term Debt n/a
Total Liabilities
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $25m
Assets
Current Assets $7.5m 30%
Fixed Assets 50%
Total Assets
Liab. and Equity
Accounts Payable 15%
Accrued Expenses 10%
Notes Payable n/a
Long Term Debt n/a
Total Liabilities
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $25m
Assets
Current Assets $7.5m 30%
Fixed Assets $12.5m 50%
Total Assets
Liab. and Equity
Accounts Payable 15%
Accrued Expenses 10%
Notes Payable n/a
Long Term Debt n/a
Total Liabilities
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $25m
Assets
Current Assets $7.5m 30%
Fixed Assets $12.5m 50%
Total Assets $20.0m
Liab. and Equity
Accounts Payable 15%
Accrued Expenses 10%
Notes Payable n/a
Long Term Debt n/a
Total Liabilities
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $25m
Assets
Current Assets $7.5m 30%
Fixed Assets $12.5m 50%
Total Assets $20.0m
Liab. and Equity
Accounts Payable $3.75m 15%
Accrued Expenses 10%
Notes Payable n/a
Long Term Debt n/a
Total Liabilities
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $25m
Assets
Current Assets $7.5m 30%
Fixed Assets $12.5m 50%
Total Assets $20.0m
Liab. and Equity
Accounts Payable $3.75m 15%
Accrued Expenses $2.50m 10%
Notes Payable n/a
Long Term Debt n/a
Total Liabilities
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $25m
Assets
Current Assets $7.5m 30%
Fixed Assets $12.5m 50%
Total Assets $20.0m
Liab. and Equity
Accounts Payable $3.75m 15%
Accrued Expenses $2.50m 10%
Notes Payable $1.00m n/a
Long Term Debt $3.00m n/a
Total Liabilities
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $25m
Assets
Current Assets $7.5m 30%
Fixed Assets $12.5m 50%
Total Assets $20.0m
Liab. and Equity
Accounts Payable $3.75m 15%
Accrued Expenses $2.50m 10%
Notes Payable $1.00m n/a
Long Term Debt $3.00m n/a
Total Liabilities $10.25m
Common Stock n/a
Retained Earnings
Equity
Total Liab. & Equity
 Next year % of $25m
Assets
Current Assets $7.5m 30%
Fixed Assets $12.5m 50%
Total Assets $20.0m
Liab. and Equity
Accounts Payable $3.75m 15%
Accrued Expenses $2.50m 10%
Notes Payable $1.00m n/a
Long Term Debt $3.00m n/a
Total Liabilities $10.25m
Common Stock $4.00m n/a
Retained Earnings
Equity
Total Liab. & Equity
l Next year’s projected retained earnings = last
year’s $3 million, plus:
l Next year’s projected retained earnings = last
year’s $2 million, plus:

projected net income cash dividends

sales sales net income
l Next year’s projected retained earnings = last
year’s $3 million, plus:

projected net income cash dividends

sales sales net income

$25 million x .10 x (1 - .40)

l Next year’s projected retained earnings = last
year’s $3 million, plus:

projected net income cash dividends

sales sales net income

$25 million x .10 x (1 - .40)

Proj. RE = $3m + $1.5m = $4.5 million

 Next year % of $25m
Assets
Current Assets $7.5m 30%
Fixed Assets $12.5m 50%
Total Assets $20.0m
Liab. and Equity
Accounts Payable $3.75m 15%
Accrued Expenses $2.50m 10%
Notes Payable $1.00m n/a
Long Term Debt $3.00m n/a
Total Liabilities $10.25m
Common Stock $4.00m n/a
Retained Earnings $4.50m
Equity $8.50m
Total Liab. & Equity
 Next year % of $25m
Assets
Current Assets $7.5m 30%
Fixed Assets $12.5m 50%
Total Assets $20.0m
Liab. and Equity
Accounts Payable $3.75m 15%
Accrued Expenses $2.50m 10%
Notes Payable $1.00m n/a
Long Term Debt $3.00m n/a
Total Liabilities $10.25m
Common Stock $4.00m n/a
Retained Earnings $4.50m
Equity $8.50m
Total Liab. & Equity $18.75m
l Projected Assets $20.00m
l Projected Liabilities & Equity $18.75m
l Discretionary Financing Needed $1.25m
l Zippy must decide how to raise this financing.
l Options: short and/or long term borrowing, sell new
common stock, cut dividends.
l Let’s assume Zippy will borrow an additional
$0.25m through Notes Payable and an additional
$1m through Long Term Debt.
l Here’s Zippy’s complete projected balance sheet.
 Next year % of $25m
Assets
Current Assets $7.5m 30%
Fixed Assets $12.5m 50%
Total Assets $20.0m
Liab. and Equity
Accounts Payable $3.75m 15%
Accrued Expenses $2.50m 10%
Notes Payable $1.25m 1m+0.25m
Long Term Debt $4.00m 3m+1m
Total Liabilities $11.5m
Common Stock $4.00m Whew!
n/a Now,
Retained Earnings $4.50m the Accy Police
will be happy!
Equity $8.5m
Total Liab. & Equity $20.0m
l The formula approach gives the same result as our
first approach, but focuses on the projected changes
in the balance sheet.
l DFN = Proj. Inc. in Assets – Proj. Inc. in Liab – Proj
Retained Earnings
– Proj. Inc in Assets = Assetst/Salest x Chg in sales
– Proj Inc in Liab = Liabt/Salest x Chg in Sales
– Proj. RE = NPM x Proj Sales x (1 – b), where b is
dividend payout ratio = Divs/Net Income
l Change in sales = 25m – 20m = 5m
l Original sales = 20m
l Change in Assets = (16m/20m) x 5m = 4m
l Change in Liab = (3m+2m)/20m x 5m = 1.25m
l Projected RE = 10% x 25m x (1-.4) = 1.5m
l DFN = 4m – 1.25m – 1.5m = 1.25m
l Recall, Zippy’s original DFN is 1.25m.
l What if Zippy’s profit margin was expected to be
only 5%?
l What if Zippy’s profit margin was the original
10%, but it’s dividend payout ratio is only
expected to be 30%?
l What if Zippy’s sales are expected to increase to
$28 million with original assumptions of 10%
profit margin and 40% dividend payout ratio?
l Change in sales = 25m – 20m = 5m
l Original sales = 20m
l Change in Assets = (16m/20m) x 5m = 4m
l Change in Liab = (3m+2m)/20m x 5m = 1.25m
l Projected RE = 5% x 25m x (1-.4) = 0.75m
l DFN = 4m – 1.25m – 0.75m = $2m
l Lower profit margin = more DFN
l Change in sales = 25m – 20m = 5m
l Original sales = 20m
l Change in Assets = (16m/20m) x 5m = 4m
l Change in Liab = (3m+2m)/20m x 5m = 1.25m
l Projected RE = 10% x 25m x (1- .3) = 1.75m
l DFN = 4m – 1.25m – 1.75m = $1m
l Lower dividend payout ratio = less DFN
l Change in sales = 28m – 20m = 8m
l Original sales = 20m
l Change in Assets = (16m/20m) x 8m = 6.4m
l Change in Liab = (3m+2m)/20m x 8m = 2m
l Projected RE = 10% x 28m x (1- .4) = 1.68m
l DFN = 6.4m – 2m – 1.68m = $2.72m
l Higher Projected Sales = more DFN
l The maximum sales growth rate a firm can
have while maintaining its capital structure
(financing mix).
g* = ROE (1 - b) where

b = dividend payout ratio

(dividends / net income)
ROE = return on equity
(net income / common equity) or
g* = ROE (1 - b) where

b = dividend payout ratio

(dividends / net income)
ROE = return on equity
(net income / common equity) or

net income sales assets

sales assets common equity
 This year % of $20m
Assets
Current Assets $6m 30%
Fixed Assets $10m 50%
Total Assets $16m
Liab. and Equity
Accounts Payable $3m 15%
Accrued Expenses $2m 10%
Notes Payable $1m n/a
Long Term Debt $3m n/a
Total Liabilities $9m
Common Stock $4m n/a
Retained Earnings $3m
Equity $7m
Total Liab. & Equity $16m
l Original Total Assets: $16m, Original Total Debt: $9m
l Original Debt Ratio: 9/16 = 56.25%
l Current Net income is 10% of $20m or $2m.
l Current Equity = $7m
l Dividend payout ratio = 40% or .4
l G = 2m/7m x (1-.4) = 28.6% x .6 = 17.1%
l Our forecast for Zippy: 25% growth in sales (20m to
25m) with the following balance sheet.
 Next year % of $25m
Assets
Current Assets $7.5m 30%
Fixed Assets $12.5m 50%
Total Assets $20.0m
Liab. and Equity
Accounts Payable $3.75m 15%
Accrued Expenses $2.50m 10%
Notes Payable $1.25m 1m+0.25m
Long Term Debt $4.00m 3m+1m
Total Liabilities $11.5m
Common Stock $4.00m Whew!
n/a Now,
Retained Earnings $4.50m the Accy Police
will be happy!
Equity $8.5m
Total Liab. & Equity $20.0m
l Projected Total Assets: $20m
l Projected Total Debt/Liabilities: $11.5m
l Projected Debt Ratio = 11.5/20 = 57.5%

l Since the projected growth rate of 25% is

greater than the sustainable growth rate of
17.1%, the debt ratio increases from 56.25%
to 57.5%.
l Budget: a forecast of future events.
l Budgets indicate the amount and
timing of future financing needs.
l Budgets provide a basis for taking
corrective action if budgeted and
actual figures do not match.
l Budgets provide the basis for
performance evaluation.
l Don’t worry about constructing cash
budgets!
l Omit problems 4-6a and 4-11a