Financial Forecasting and Budgeting

 
Which of the following assumptions is embodied in the AFN equation?
a) Accounts payable and accruals are tied directly to sales, meaning follow the increases or
decreases in sales.
b) None of the firm's ratios will change.
c) Fixed assets, but not current assets, are tied directly to sales.
d) Common stock and long-term debt are tied directly to sales.

The financing decision will consider the following factors, except:

a) Conditions in the debt and equity markets
b) Target capital structure
c) Restrictions imposed by existing purchase agreements
d) Effect of short-term borrowing on its current ratio

When an organization involves its many employees in the budgeting process in a meaningful
way, the organization is said to be using:
a) zero-based budgeting.
b) employee-based budgeting.
c) activity-based budgeting.
d) participative budgeting.

Which of the following statements is incorrect?

a) A typical sales forecast, though concerned with future events, will usually be based on
recent historical trends and events as well as on forecasts of economic prospects.
b) As a firm's sales grow, its current assets also tend to increase. For instance, as sales
increase, the firm's inventories generally increase, and purchases of inventories result in
more accounts payable. Thus, spontaneous liabilities that reduce AFN arise from
transactions brought on by sales increases.
c) Once a firm has defined its purpose, scope, and objectives, it must develop a strategy
for achieving its goals. Corporate strategies are detailed plans rather than broad
approaches.
d) The mission statement is a statement of the firm's overall purpose.

Which of the following choices correctly denotes managerial functions that are commonly
associated with budgeting? (1) Planning, (2) Performance Evaluation, (3) Coordination of
Activities.
a) Yes, No, Yes
b) Yes, Yes, Yes
c) Yes, No, No
d) Yes, Yes, No

In preparation of budget, which committee of the board of directors compiles, reviews and
approves component budgets of the master budget?
a) Audit Committee
b) Corporate Governance Committee
c) Budget Committee
d) Finance Review Committee
The master budget contains the following components, among others: (1) production
budget, (2) budgeted balance sheet, (3) sales budget, and (4) cash budget. Which of these
components would be prepared first and which would be prepared last?
a) First, 1 and Last, 2
b) First, 1 and Last, 4
c) First, 3 and Last, 2
d) First, 3 and Last, 4

Which of the following organizations is not likely to use budgets?

a) Manufacturing firms.
b) Firms in service industries.
c) None, all are likely to use budgets.
d) Merchandising firms.

A budget serves as a benchmark against which:

a) allocated results can be compared.
b) actual results can be compared.
c) allocated results become inconsequential.
d) actual results become inconsequential.
 
The budgeted income statement, budgeted balance sheet, and budgeted statement of cash
flows comprise:
a) the first step of the master budget.
b) the final portion of the master budget.
c) the depiction of an organization's overall actual financial results.
d) the portion of the master budget prepared after the sales forecast and before the
remainder of the operational budgets.
 
Which of the following statements best describes the relationship between the sales-
forecasting process and the master-budgeting process?
a) The sales forecast is typically completed before the master budget and has no impact
on the master budget.
b) The sales forecast is typically completed before the master budget and has little impact
on the master budget.
c) The sales forecast is typically completed after completion of the master budget.
d) The sales forecast is typically completed before the master budget and has significant
impact on the master budget.

The comprehensive set of budgets that serves as a company's overall financial plan is
commonly known as:
a) a proforma budget.
b) an integrated budget.
c) a financial budget.
d) a master budget.
 
Generally speaking, budgets are not used to:
a) evaluate performance.
b) assist in the control of profit and operations.
c) identify a company's most profitable products.
d) create a plan of action.
 
A manufacturing firm would begin preparation of its master budget by constructing a:
a) sales budget.
b) production budget.
c) direct materials budget.
d) direct labor budget
 
A formal budget program will almost always result in:
a) a detailed plan against which actual results can be compared.
b) higher sales.
c) decreased expenses.
d) improved profits.

Which of the following budgets is based on many other master-budget components?

a) Direct labor budget.
b) Cash budget.
c) Overhead budget.
d) Sales budget.
 
Which of the following statements is correct?
a) A firm's AFN must come from external sources. Typical sources include short-term bank
loans, long-term bonds, preferred stock, and common stock.
b) To determine the amount of additional funds needed (AFN), you may subtract the
expected increase in liabilities from the sum of the expected increases in retained
earnings and assets.
c) Strategic plans usually begin with statement of corporate objectives which sets forth
specific goals of the firm.
d) A firm’s corporate scope provide detailed implementation guidance to help the firm
realize its strategic vision.
 
The term “additional funds needed (AFN)” is generally defined as follows:
a) The amount of internally generated cash in a given year minus the amount of cash
needed to acquire the new assets needed to support growth.
b) The amount of assets required per dollar of sales.
c) Funds that are obtained automatically from routine business transactions.
d) Funds that a firm must raise externally from non-spontaneous sources, i.e., by
borrowing or by selling new stock to support operations.
 
 
Which of the following statements is CORRECT?
a) Once a firm has defined its purpose, scope, and objectives, it must develop a strategy or
strategies for achieving its goals. The statement of corporate strategies sets forth
detailed plans rather than broad approaches for achieving a firm's goals.
b) A firm’s corporate purpose states the general philosophy of the business and provides
managers with specific operational objectives.
c) Operating plans provide management with detailed implementation guidance,
consistent with the corporate strategy, to help meet the corporate objectives.
d) A firm’s mission statement defines its lines of business and geographic area of
operations.
 
Which of the following is NOT a key element in strategic planning?
a) The statement of the corporation’s scope.
b) The statement of corporate objectives.
c) The mission statement.
d) The statement of cash flows.

A company's sales forecast would likely consider all of the following factors except:
a) general economic and industry trends.
b) political and legal events.
c) top management's attitude.
d) advertising and pricing policies.
 
All else equal, which of the following is likely to increase a company’s additional funds
needed (AFN)?
a) Accounts payable increase faster than sales.
b) An increase in its dividend payout ratio.
c) The company has a lot of excess capacity.
d) All of the statements are correct.
 
Which of the following is not determinant of growth rate?
a) Total Assets Turnover
b) Profit Margin
c) Credit Policy
d) Dividend Policy
 
Which of the following is not an element of financial planning model
a) Financial requirements
b) Assets requirements
c) Economic Environment assumption
d) Historical financial statements
 
 
A company that has rapidly growing sales will probably
a) have a unbalance increase in assets and, increase in liabilities and retained earnings.
b) find that all of the above are true.
c) need additional long-term financing.
d) have increasing asset requirements.

PROBLEM 1: Clayton Industries is planning its operations for next year, and Ronnie Clayton,
the CEO, wants you to forecast the firm's additional funds needed (AFN). The firm is
operating at full capacity. Data for use in your forecast are as follow: (Pesos are in millions)
Last year’s sales, P350; Sales growth rate, 30%; Last year’s total assets, P500; Last year’s
profit margin, 5%; Last year’s accounts payable, P40; Last year’s notes payable, P50; Last
year’s accruals, P30; Target payout ratio, 60%.

Increase in Assets
Last year’s total assets ₱ 500.00 million
Sales growth rate 30.00%
Increase in Assets ₱ 150.00 million

Increase in Liabilities
Spontaneous liabilities
Last year’s accounts payable ₱ 40.00 million
Last year’s accruals ₱ 30.00 million
Total Spontaneous Liab ₱ 70.00 million
Sales growth rate 30.00%
Increase in Liabilities ₱ 21.00 million

Increase in Retained Earnings

Last year’s sales ₱ 350.00 million
Last year’s profit margin 5.00%
Last year's profit ₱ 17.50 million
Sales growth rate + 100% 130.00%
Current year profit ₱ 22.75 million
Retention ratio 40.00%
Increase in Retained Earnings ₱ 9.10 million

Additional Financing Needed ₱ 119.90 million

PROBLEM 2: Consider the income statement for Heir Jordan Corporation: Sales, 26,000;
Costs, 10,400; Taxable income, 15,600; Taxes (35%), 5,460; Net Income, 10,140; Dividends,
3,448; Additions to retained earnings, 6,692. A 22 percent growth rate in sales is projected.
What is the pro forma addition to retained earnings assuming all costs vary proportionately
with sales?

Increase in Retained Earnings 

Last year's profit ₱ 10,140.00 
Sales growth rate + 100% 122.00% 
Current year profit ₱ 12,370.80 
Retention ratio 66.00%
Additions to Retained Earnings ₱ 8,164.73

Retention ratio 
Net income ₱ 10,140.00 
Dividends ₱ 3,448.00 34.00% 
Addition to retained earnings ₱ 6,692.00 66.00%

PROBLEM 3: The most recent financial statements for Last in Line, Inc. are shown here:
Sales, 18,500; Costs, 14,800; Taxable income, 3,700; Taxes (33%), 1,221; Net Income, 2,479;
Assets, 89,510; Debt, 19,580; Equity, 89,510.Assets and costs are proportional to sales. Debt
and equity are not. A dividend of P992 was paid, and the company wishes to maintain a
constant payout ratio. Next year's sales are projected to be P21,830. What is the amount of
the external financing need?

Increase in Assets 
Last year’s total assets ₱ 89,510.00 
Sales growth rate 18.00% (21,830 / 18,500 = 1.18 - 1 = 18%)
Increase in Assets ₱ 16,111.80 

Increase in Liabilities ₱ - Debt is not proportional to sales 

Increase in Retained Earnings 

Last year's profit ₱ 2,479.00 
Sales growth rate + 100% 118.00% 
 Current year profit ₱ 2,925.22 
Dividends 66.09% (992/2,479 = 33.91% payout ratio)
Increase in Retained Earnings ₱ 1,933.22 

Additional Financing Needed ₱ 14,178.58

PROBLEM 4: The most recent financial statements for Watchtower, Inc. are shown here
(assuming no income taxes): Sales, P4,100; Costs, P2,624; Net income, P1,476; Assets,
P9,110; Debt, P5,833; Equity, P3,277 Assets and costs are proportional to sales. Debt and
equity are not. No dividends are paid. Next year's sales are projected to be P5,002. What is
the amount of the external financing need?

Increase in Assets 
Last year’s total assets ₱ 9,110.00 
Sales growth rate 22.00% (5,002/4,100 = 1.22 - 1 = 22%)
Increase in Assets ₱ 2,004.20 

Increase in Liabilities ₱ - Debt is not proportional to sales 

Increase in Retained Earnings 

Last year's profit ₱ 1,476.00 
Sales growth rate + 100% 122.00% 
Next year profit ₱ 1,800.72 
Retention ratio 100.00% 
Increase in Retained Earnings ₱ 1,800.72 

Additional Financing Needed ₱ 203.48

PROBLEM 5: Based on the AFN equation, what is the AFN for the coming year?
Chua Chang & Wu Inc. is planning its operations for next year, and the CEO wants you to
forecast the firm's additional funds needed (AFN). The firm is operating at full capacity. Data
for use in your forecast are as follow: Last year’s sales, P200,000; Sales growth rate, 40%;
Last year’s total assets, P135,000; Last year’s profit margin, 20.0%; Last year's accounts
payable, P50,000; Last year's notes payable, P15,000; Last year's accruals, P20,000; Target
payout ratio, 25.0%.

Increase in Assets 
Last year’s total assets ₱ 135,000.00 
Sales growth rate 40.00% 
Increase in Assets ₱ 54,000.00

Increase in Liabilities 
Spontaneous liabilities 
Last year’s accounts payable ₱ 50,000.00 
Last year’s accruals ₱ 20,000.00 
Total Spontaneous Liab ₱ 70,000.00 
Sales growth rate 40.00% 
Increase in Liabilities ₱ 28,000.00 
Increase in Retained Earnings 
Last year’s sales ₱ 200,000.00 
Last year’s profit margin 20.00% 
Last year's profit ₱ 40,000.00 
Sales growth rate + 100% 140.00% 
Current year profit ₱ 56,000.00 
Retention ratio 75.00% 
Increase in Retained Earnings ₱ 42,000.00

Additional Financing Needed - ₱ 16,000.00

 
PROBLEM 5: Agustin has projected sales of P500,000, a gross profit margin of 20%, a return
on sales of 8%. Accounts receivable has been 42% of sales while inventory has been 20% of
cost of sales. Agustin has minimum cash balance of P25,000 and fixed assets are projected to
be P90,000. What would be the total assets requirements?

Total Assets Requirement 

Cash (minimum balance) ₱ 25,000 
Accounts receivable ₱ 210,000 
Inventory ₱ 80,000 
Fixed assets ₱ 90,000
Total Assets ₱ 405,000

Accounts Receivable 
Sales ₱ 500,000.00 
AR Rate 42.00%  
Accounts Receivable ₱ 210,000.00 

Inventory 
Sales ₱ 500,000.00 
COS rate 80.00% (100% - GP rate 20% = 80%)
Cost of sales ₱ 400,000.00 
Inventory rate 20.00%
Inventory ₱ 80,000.00

 
PROBLEM 6: Vanilla has projected sales of P800,000, a cost of goods sold to sales ratio
amounted to 32%, a return on sales of 15%. Accounts receivable has been 20% of sales while
inventory has been 10% of cost of sales and prepaid expenses is 20% of the operating
expenses. Vanilla has minimum cash balance of P35,000 and fixed assets are projected to be
P80,000. What would be the total assets requirements?

Total Assets Requirement 

Cash (minimum balance) ₱ 35,000 
Accounts receivable ₱ 160,000 
Inventory ₱ 25,600 
Prepaid expense ₱ 84,800 
Fixed assets ₱ 80,000
Total Assets ₱ 385,400
Accounts Receivable 
Sales ₱ 800,000.00 
AR Rate 20.00% 
Accounts Receivable ₱ 160,000.00 

Inventory 
Sales ₱ 800,000.00 
COS rate 32.00% 
Cost of sales ₱ 256,000.00 
Invetory rate 10.00% 
Inventory ₱ 25,600.00

Prepaid expense
Sales ₱ 800,000.00 Sales 100%
Opex rate 53.00% COS 32%
Opex ₱ 424,000.00 GP 68%
Prepaid expense rate 20.00% OPEX 53%
Prepaid expense ₱ 84,800.00 Profit 15%

PROBLEM 6: The beginning balance of total assets amounted to P1,000, while ending
balance amounted to P1,175. Spontaneous current liabilities and non-spontaneous current
liabilities at the beginning of the year amounted to P200 and P250, respectively. Fixed assets
amounted to P300. Net income amounted to P180 and external financing needed is P25.
What is the plowback ratio? (answer must have no decimal with percentage sign, rounded
off, e.g. 70%)

1. What is the amount of dividends declared by the company?

2. What is the percentage increase in sales?
3. What is the plowback ratio?