FINANCIAL PLANNING

And
Forecasting Financial Statements

PREPARED BY: AHMAD A. EL KARRIRI St. No. 120130071

PREPARED BY: ASHRAF S. HIJAZI St. No. 120130160

PREPARED BY: AHMAD KUHAIL St. No. 120130240

SUPERVISOR: DR. FARES ABU MOAMMAR

 Introduction

A recent survey shows that high-performance

companies also focus on the links between
forecasting, planning, and business strategy rather
than on just cost management and cost accounting.
Introduction
 Introduction
FINANCIAL PLANNING &
forecasting financial statements

12.1 Overview of financial planning

12.2 Sales Forecast
12.3 (AFN) Method
12.4 Forecasted financial statement method (FFS)
12.5 Forecasted when the ratios change
 12.1 Overview of financial planning
Most companies have strategic plans, operating plans, and financial plans.

1
Strategic plans usually have statements for mission,
Strategic plans
corporate scope, corporate objectives, and strategies.

Mission Corporate Statement of Corporate

Statement Scope Corporate Objectives Strategies
which is a A firm’s This statement sets Once a firm has
statement of the corporate scope forth specific goals or defined its purpose,
firm’s overall defines its line or scope, and objectives,
lines of business
targets to help it must develop a
purpose.
and operating managers strategy for achieving
its geographic focus on the firm’s its goals. Corporate
“Our mission is to primary objectives. strategies are broad
maximize area of
operations. approaches rather than
shareowner value detailed plans.
over time.”
 Overview of financial planning
Most companies have strategic plans, operating plans, and financial plans.

2
Operating plans provide detailed implementation
Operating plans
guidance to help the firm realize its strategic vision. These
plans can be developed for any time horizon, but most
The plan
companies use a 5-year horizon, with the plan being quite
explains who is
detailed for the first year but less and less specific for each
responsible for
succeeding year.
each particular
function, when
specific tasks are
to be
accomplished,
targets for sales
and profits, and
the like.
 Overview of financial planning
Most companies have strategic plans, operating plans, and financial plans.

The Financial Plan The Financial Planning process generally involves 5 steps;

The firm forecasts financial statements under alternative versions of the

operating plan in order to analyze the effects of different operating procedures
on projected profits and financial ratios.

Next, it determines the amount of capital that will be needed to support the
plan; that is, it finds out how much the new assets needed to achieve the target
sales will cost,
 Overview of financial planning
Most companies have strategic plans, operating plans, and financial plans.

The Financial Plan The Financial Planning process generally involves 5 steps;

Forecasts the funds that will be generated internally. If internal funds are
insufficient to cover the required new investment, then it must identify
sources from which the required external capital can be raised, taking account
of any constraints
due to bond covenants that limit its debt ratio and other financial ratios.
The firm establishes a performance-based management compensation system that
rewards employees for creating shareholder wealth. The emphasis here should be
on the long run, not on profits over the next few quarters or even years. A failure
in this area was perhaps the most important factor leading to the worldwide
financial and economic crisis that hit in 2008 and 2009.
 Overview of financial planning
Most companies have strategic plans, operating plans, and financial plans.

The Financial Plan The Financial Planning process generally involves 5 steps;

Finally, management must monitor operations after implementing the plan to

spot any deviations and then take corrective actions.
 ‫ القوائم المالية‬/‫التنبؤ بالمبيعات‬

12.2 Sales Forecast

The sales forecast generally starts with a review of sales during the past 5 to
10 years
 ‫ القوائم المالية‬/‫التنبؤ بالمبيعات‬

12.2 Sales Forecast

The sales forecast generally starts with a review of sales during the past 5 to
10 years
look at past growth. MicroDrive’s recent annual growth rates have averaged
10.3%, and the compound growth rate from 2006 to 2010 is the value for g in
this equation:

The value of g can be found by solving the equation with a financial calculator.
Enter N=4,PV=−2058, PMT = 0, and FV = 3000; then press I/YR to get g = 9.9%.

No sensible manager would ever just forecast a continuation of past sales

growth without taking account of current conditions in both the
national and global economies, the firm’s and its competitors’ new
products, planned advertising programs, and so on. But in the end, a sales
forecast will emerge.
 ‫طريقة النسبة المئوية للمبيعات‬
‫‪Percent of Sales Method‬‬
‫‪ ‬للتنبؤ بالمبيعات يقوم المدير المالي بالتنبؤ بالميزانية العمومية التقديرية وقائمة‬
‫الدخل التقديرية‪.‬‬

‫‪ ‬أكثر األساليب استخداما ً لهذا الغرض هي طريقة ‪ :‬النسبة المئوية للمبيعات‪.‬‬

‫‪ ‬يعتمد هذا األسلوب على التنبؤ بالمبيعات أولً‪.‬‬
‫‪ ‬تفترض هذه الطريقة أن عناصر القوائم المذكورة تتأثر طرديا ً مع التغير في‬
‫نسبة المبيعات المقدرة‪.‬‬
 ‫‪ ‬يعتبر أسلوب النسبة المئوية للمبيعات من بين أساليب التنبؤ‬
‫باالحتياجات المالية المستقبلية‪ .‬ويقوم هذا األسلوب على افتراض‬
‫وجود عالقة مباشرة وثابتة بين المبيعات وبين بعض بنود الميزانية‪،‬‬
‫ومن ثم يمكن التنبؤ بما ستكون علية تلك البنود إذا ما توافرت بيانات‬
‫عن المبيعات المتوقعة‪.‬‬

‫‪ ‬مالحظة‪ -:‬كلما كانت نسبة الزيادة فى المبيعات للسنة القادمة كبيرة‬

‫كلما احتاجت المنشأة إلى أموال من مصادر خارجية لتغطية‬
‫الموجودات التلقائية المضافة‪ ،‬وكلما كانت نسبة الزيادة فى المبيعات‬
‫قليلة كلما أمكن تغطيتها من األرباح المحتجزة‪.‬‬
 ‫طريقة النسبة المئوية للمبيعات‬
‫• العالقة بين المبيعات وبنود قائمة الدخل‪:‬‬
‫• تؤثر المبيعات بشكل كبير فى التكاليف المتنوعة للمنشأة حيث أن هناك نوعين‬

‫التكاليف الثابتة‬ ‫من التكاليف هما‪ :‬التكاليف المتغيرة و‬

‫• فالتكاليف المتغيرة‪:‬‬
‫ترتبط بشكل مباشر باإلنتاج أو المبيعات‪ ،‬وتتأثر بالزيادة أو النقصان فى‬
‫حالة تغير حجم النتاج أو المبيعات سواء بالزيادة أو النقصان‪.‬‬

‫• التكاليف الثابتة‪ :‬فهى التكاليف التى تبقى ثابتة بحدود الطاقة اإلنتاجية‬
‫العتيادية للمنشأة و تزداد هذه التكاليف على شكل فقرات متدرجة أو‬
‫منتظمة فى حالة لجوء المنشأة إلى زيادة طاقتها اإلنتاجية‬
 ‫طريقة النسبة المئوية للمبيعات‬
‫• العالقة بين المبيعات وبنود الميزانية العمومية‪:‬‬
‫‪ ‬هناك عالقة مباشرة وثابتة بين المبيعات وبعض بنود الميزانية‪ ،‬ومن ثم يمكن‬
‫التنبؤ بما ستكون علية تلك البنود إذا ما توافرت بيانات عن المبيعات‬
‫المتوقعة‪،‬وهذه البنود مثل النقدية والذمم والمخزون‪.‬‬

‫‪ ‬وكلما توقعت المنشأة زيادة فى مبيعاتها فمن المؤكد أن تنعكس هذه الزيادة على‬
‫الفقرات المذكورة سابقاً‪ (،‬زيادة المبيعات تؤدى الى زيادة النقدية وكذلك زيادة‬
‫المبيعات اآلجلة يؤدى الى زيادة المدينون)‪.‬‬

‫‪ ‬هناك بنود بالميزانية ل توجد عالقة مباشرة بينها وبين المبيعات‪ ،‬مثل القروض‬
‫طويلة األجل‪ ،‬األسهم العادية‪.‬‬
 ‫خطوات تقدير القوائم المالية باستخدام أسلوب النسبة المئوية للمبيعات‬
‫‪ ‬الخطوة األولى‪ :‬تصنيف بنود ميزانية الفترة الماضية الى مجموعتين ‪:‬‬
‫مجموعة لها عالقة مباشرة مع المبيعات‪ ،‬و مجموعة ليس لها عالقة مباشرة بالمبيعات‪.‬‬

‫‪ ‬الخطوة الثانية‪ :‬بالنسبة للبنود التي لها عالقة مباشرة بالمبيعات ‪ ،‬يتم ايجاد النسبة المئوية لقيمة كل‬
‫بند منها طبقا ً لميزانية الفترة الماضية إلى رقم المبيعات من نفس الفترة‪.‬‬

‫‪ ‬الخطوة الثالثة‪ :‬التنبؤ بما سيكون عليه كل بند من بنود الميزانية العمومية عن الفترة المقبلة و ذلك‬
‫على النحو التالي‪:‬‬
‫‪ -1‬بالنسبة لبنود الميزانية النى يفترض وجود عالقة مباشرة بينها وبين المبيعات يتم تقديرها بضرب‬
‫النسبة المئوية لكل بند منها في قيمة المبيعات المتوقعة في الفترة المقبلة‪.‬‬
‫‪ -2‬أما باقي البنود التي ليس لها عالقة مباشرة مع المبيعات فتظهر في ميزانية الفترة المقبلة بنفس‬
‫القيمة‪.‬‬

‫‪ ‬الخطوة الرابعة‪ :‬ايجاد مجموع االصول و مجموع الخصوم في الميزانية العمومية المتوقعة‪ ،‬فإذا‬
‫أتضح أن جانب االصول يفوق جانب الخصوم فسوف يمثل الفرق االحتياجات المالية المطلوبة‪،‬‬
‫أما اذا زاد جانب الخصوم على جانب االصول فان الفرق يمثل أموال زائدة عن الحاجة و قد‬
‫يقتضي االمر ضرورة التصرف فيها ‪ ،‬و اذا تساوى االصول مع الخصوم فلن يكون هناك‬
‫احتياجات مالية‪.‬‬
 After much discussion and analysis, MicroDrive’s managers decided that
a 10% increase in sales was the most appropriate forecast.

The firm’s next questions include these:

How much new capital will be needed to fund the increased sales?

Can this capital be raised internally, or will new external funds be

needed?

And in view of current economic conditions, will it be feasible to

raise the needed capital?

We answer these questions in the following sections using two approaches:

(1) The additional funds needed (AFN) method,
(2) The forecasted financial statements method.
12.3 Additional Fund Needed - AFN
Expects 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.

We can use a simple approach, the Additional Funds Needed (AFN)

method, to forecast financial requirements.

Required Increase in Assets

Spontaneous Liabilities
The logic of the AFN approach
Addition to Retained Earnings

Calculating Additional Funds

Needed (AFN)
 The logic of the AFN approach
Required Increase in Assets

The firm must have additional plant and equipment,

more delivery trucks, higher inventories, and so forth if
sales are to increase.

More sales will lead to more accounts receivable, and those receivables must be
financed from the time of the sale until they are collected.

Both fixed 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 like amount to make the balance sheet BALANCE.
 The logic of the AFN approach
Spontaneous Liabilities

The first sources of expansion funding are the

“spontaneous” increases that will occur in MicroDrive’s
accounts payable and accrued wages and taxes.

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 the same 10%.
Similarly, because the company pays workers every two weeks, more workers and
a larger payroll will mean more accrued wages payable.

higher expected income will mean more accrued income taxes, and its higher
wage bill will mean more accrued withholding taxes
 The logic of the AFN approach
Addition to Retained Earnings

The second source of funds for expansion comes from net income.
Part of MicroDrive’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 to retained earnings in the Liabilities and
equity section of the balance sheet. There is some flexibility in the
amount of funds that will be generated from new reinvested
earnings because dividends can be increased or decreased, but if the
firm plans to hold its dividend steady or to increase it at a target
rate, as most do, then flexibility is limited.
 The logic of the AFN approach
Calculating Additional Funds Needed (AFN)

If we start with the required new assets and then subtract both
spontaneous funds and additions to retained earnings, we are
left with the Additional Funds Needed, or AFN.

The AFN must come from external The typical sources of

external funds are bank
sources; hence it is sometimes called loans, new long-term
EFN bonds, new preferred
stock, and newly issued
common stock.
AFN
The mix of the external funds used should be
consistent with the firm’s financial policies,
especially its target debt ratio.
 AFN Formula

If ratios are expected to remain constant:

AFN = (A*/S0)∆S - (L*/S0)∆S - M(S1)(RR)

Required  Assets  Retained

Earnings
Spontaneously 
Liabilities
 Variables in the AFN Formula
• A* = Assets tied directly to sales
• S0 = Last year’s sales
• S1 = Next year’s projected sales
• ∆S = Increase in sales; (S1-S0)
• L* = Liabilities that spontaneously
increase with sales

26
 Variables in the AFN Formula
• A*/S0: assets required to support sales;
“Capital Intensity Ratio”
• L*/S0: spontaneous liabilities ratio
• M: profit margin (Net income/sales)
• RR: retention ratio; percent of net
income not paid as dividend

27
 L*/S0 = ($60+140)/$3,000 = 0.0667 RR =
$56/$113.5 = 0.493
BALANCE SHEET
(in millions of dollars)
INCOME STATEMENT 2009
(in millions of dollars) 2009 Assets
Cash $10.0
Sales $3,000.0 ST Investments $0.0
Costs except depreciation $2,616.2 Accounts receivable $375.0
Depreciation $100.0 Inventories $615.0
Total operating costs $2,716.2 Total current assets $1,000.0
EBIT $283.8 Net plant and equipment $1,000.0
Less Interest $88.0 Total assets $2,000.0
Earnings before taxes (EBT) $195.8
Taxes (40%) $78.3 2009
NI before preferred dividends $117.5 Liabilities and equity
Preferred dividends $4.0 Accounts payable $60.0
NI available to common $113.5 Accruals $140.0
Notes payable $110.0
Dividends to common $57.5 Total current liabilities $310.0
Add. to retained earnings (DRE) $56.0 Long-term bonds $754.0
Total liabilities $1,064.0
Preferred stock $40.0
Common stock $130.0
RR=Retention Ratio Retained earnings
Total common equity
$766.0
$896.0
Total liabilities and equity $2,000.0

L* = Spontaneous Liabilities
28
 The AFN Formula

AFN = (A*/S0)∆S - (L*/S0)∆S - M(S1)(RR)

AFN = 0.667($300)
- 0.067($300)
- 0.0378($3,300)(0.493)

AFN = $118.42 million*

29
 Key Factors in the AFN Equation
The AFN equation shows that external financing requirements depend
on five key factors.

1 Sales growth (g)

Rapidly growing companies require large increases in assets

and a corresponding large amount of external financing, other
things held constant. When capital is in short supply, as was the
case during the financial crisis of 2009, companies may be forced
to limit their growth.
 Key Factors in the AFN Equation
The AFN equation shows that external financing requirements depend
on five key factors.

2 Capital intensity (A0*/S0)

The amount of assets required per dollar of sales, (A0*/S0)

is the capital intensity ratio, which has a major effect on capital
requirements. Companies with relatively high assets-to-sales
ratios require a relatively large amount of new assets for any
given increase in sales; hence they have a greater need for
external financing. If a firm can find a way to lower this ratio—
for instance, by adopting a just-in-time inventory system, by
going to two shifts in its manufacturing plants, or by outsourcing
rather than manufacturing parts—then it can achieve a given level
of growth with fewer assets and thus less new external capital.
 Key Factors in the AFN Equation
The AFN equation shows that external financing requirements depend
on five key factors.

3 Spontaneous liabilities-to-sales ratio(L0*/S0)

If a company can increase its spontaneously generated liabilities,

this will reduce its need for external financing. One way of
raising this ratio is by paying suppliers in, say, 20 days rather than
10 days. Such a change may be possible but, as we shall see in
Chapter 16, it would probably have serious adverse
consequences.
 Key Factors in the AFN Equation
The AFN equation shows that external financing requirements depend
on five key factors.

4 Profit margin (M = Net Income/Sales).

The higher the profit margin, the more net income is available to
support increases in assets—and hence the less the need for
external financing. A firms’ profit margin is normally as high as
management can get it, but sometimes a change in operations can
boost the sales price or reduce costs, thus raising the margin
further. If so, this will permit a faster growth rate with less
external capital.
 Key Factors in the AFN Equation
The AFN equation shows that external financing requirements depend
on five key factors.

5 Profit margin (M = Net Income/Sales).

The higher the profit margin, the more net

income is available to support increases in
assets—and hence the less the need for
external financing. A firms’ profit margin is
normally as high as
management can get it, but sometimes a
change in operations can boost the sales
price or reduce costs, thus raising the margin
further. If so, this will permit a faster growth
rate with less external capital.
 Key Factors in the AFN Equation
The AFN equation shows that external financing requirements depend
on five key factors.

5 Payout Ratio (POR = DPS/EPS)

The less of its income a company distributes as dividends, the

larger its addition to retained earnings—and hence the less its
need for external capital. Companies typically like to keep their
dividends stable or to increase them at a steady rate—
stockholders like stable, dependable dividends, so such a
dividend policy will generally lower the cost of equity and thus
maximize the stock price. So even though reducing the dividend
is one way a company can reduce its need for external capital,
companies generally resort to this method only if they are under
financial duress.
 Key Factors in AFN
• ∆S = Sales Growth
• A*/S0 = Capital Intensity Ratio
• L*/S0 = Spontaneous Liability Ratio
• M = Profit Margin
• RR = Retention Ratio

36
 Affect on AFN

• Higher sales:
– Increases asset requirements  AFN
• Higher dividend payout ratio:
– Reduces funds available internally  AFN
• Higher profit margin:
– Increases funds available internally  AFN
• Higher capital intensity ratio, A*/S0:
– Increases asset requirements  AFN
• Pay suppliers sooner:
– Decreases spontaneous liabilities  AFN
37
 Implications of AFN
• If AFN is positive, additional financing required
• If AFN is negative, surplus funds available
– Pay off debt
– Buy back stock
– Buy short-term investments

38
 A Potential Problem with the AFN Equation:
Excess Capacity

When we use the AFN equation we are implicitly assuming

that the key ratios remain constant at their base-year levels.
However, this assumption may not always be true. For example, in
2010 many firms were operating
at significantly less than their full capacity because of the recession.
Let’s suppose MicroDrive had been operating its fixed assets at only
50% of capacity.
It could then double its sales, which is a 100% increase, without
adding any fixed assets at all. Similarly, if it had 25% more
inventories at the start of the year than
it required, it could increase sales by 25% without increasing its
inventories.
39
 The Self-Supporting Growth Rate
“What is the maximum growth rate the firm could achieve if it had
no access to external capital?”

This rate is called the

“self supporting growth rate”

g
It can be found as the value of g that, when used in the AFN equation
when used in the AFN equation, results
in an AFN of zero.
AFN = zero
 12.4 Forecasted financial statements (FFS)
method
Because financial statements contain numerous accounts, forecasting is
almost always done using computer software such as Excel.

Forecasting financial statements is conceptually similar to the AFN

equation, but it is easy to get lost in the details. Excel’s calculations don’t
necessarily follow this sequence, but keep these conceptual steps in mind
 ‫)‪Forecasted financial statements (FFS‬‬
‫‪method‬‬
‫خطوات التنبؤ بالقوائم المالية « الدخل‪ -‬الميزانية – التدفقات النقدية»‬

‫تىبأ بانعىاصر انتشغيهيت في قائمت انذخم وانميساويت مثم || انمبيعاث‪ ،‬انتكانيف‪ ،‬األصىل‬
‫انتشغيهيت‪ ،‬واالنتساماث انتشغيهيت انتهقائيت‪.‬‬

‫تىبأ بانعىاصر انمعتمذة عهى انسياساث انمانيت نهشركت مثم سياست انتىزيعاث وانتمىيم انمخطط‬
‫مه انذيىن وحقىق انمهكيت‪.‬‬

‫تىبأ بمصروفاث انفائذة‪ ،‬تىزيعاث األسهم انممتازة‬

‫أكمم قائمت انذخم‬

‫حذد انتىزيعاث انىقذيت نألسهم انعاديت‬

‫إصذار أو إعادة شراء أسهم حتى تتىازن انمىازوت‬

 Percent of Sales: Inputs

Pro Forma Ratios Actual Historical Industry

2008 2009 Average Composite

Costs / Sales 87.6% 87.2% 87.4% 87.1%

Depreciation / Net plant & equip. 10.3% 10.0% 10.2% 10.2%
Cash / Sales 0.5% 0.3% 0.4% 1.0%
Accounts Rec. / Sales 11.1% 12.5% 11.8% 10.0%
Inventory / Sales 14.6% 20.5% 17.5% 11.1%
Net plant & equip. / sales 30.5% 33.3% 31.9% 33.3%
Accounts Pay. / Sales 1.1% 2.0% 1.5% 1.0%
Accruals / Sales 4.6% 4.7% 4.6% 2.0%

Table 9.1

43
 Other Inputs

Other Inputs

Sales Growth Rate 10%

Tax rate 40%
Dividend growth rate 8%
Interest rate on notes payable and short-term investments 9%
Interest rate on long-term bonds 11%
Coupon rate on preferred stock 10%

44
 2010 First-Pass Forecasted Income
Statement (Table 9.2)
Table 9-2 MicroDrive, Inc.: Actual and Projected Income Statements (Millions of Dollars)
Actual Forecast
2009 Forecast basis 2010
(1) (2) (3)
1. Sales $ 3,000.0 110% x 2009 Sales = $ 3,300.0
2. Costs except depreciation 2,616.2 87.2% x 2010 Sales = $ 2,877.6
3. Depreciation 100.0 10% x 2010 Net plant = $ 110.0
4. Total operating costs $ 2,716.2 $ 2,987.6
5. EBIT $ 283.8 $ 312.4
6. Less Interest 88.0 Interest rate x 2009 debt = $ 92.8
7. Earnings before taxes (EBT) $ 195.8 $ 219.6
8. Taxes (40%) 78.3 $ 87.8
9. NI before preferred dividends $ 117.5 $ 131.8
10. Preferred dividends 4.0 Dividend rate x 2009 preferred = $ 4.0
11. NI available to common $ 113.5 $ 127.8

12. Shares of common equity 50.0 $ 50.0

13. Dividends per share $ 1.15 108% x 2009 DPS = $ 1.25
14. Dividends to common $ 57.5 2010 DPS x # shares = $ 62.5
15. Additions to retained earnings $ 56.0 $ 65.3

45
Table 9-3 MicroDrive, Inc.: Actual and Projected Balance Sheets (Millions of Dollars)
Actual Forecast
2009 Forecast basis 2010
(1) (2) (3)
Assets
1. Cash $ 10.0 0.33% x 2010 Sales = $ 11.0
2. ST investments 0.0 Previous plus "plug" if needed 0.0
3. Accounts receivable 375.0 12.50% x 2010 Sales = 412.5
4. Inventories 615.0 20.50% x 2010 Sales = 676.5
5. Total current assets $ 1,000.0 $ 1,100.0
6. Net plant and equipment 1,000.0 33.33% x 2010 Sales = 1,100.0
7. Total assets $ 2,000.0 $ 2,200.0

Liabilities and equity

8. Accounts payable $ 60.0 2.00% x 2010 Sales = $ 66.0
9. Accruals 140.0 4.67% x 2010 Sales = 154.0
10. Notes payable 110.0 Previous plus "plug" if needed 224.7
11. Total current liabilities $ 310.0 $ 444.7
12. Long-term bonds 754.0 Same: no new issue 754.0
13. Total liabilities $ 1,064.0 $ 1,198.7
14. Preferred stock 40.0 Same: no new issue 40.0
15. Common stock 130.0 Same: no new issue 130.0
16. Retained earnings 766.0 2009 RE + 2010 Add. to RE = 831.3
17. Total common equity $ 896.0 $ 961.3
18. Total liabilities and equity $ 2,000.0 $ 2,200.0

a
19. Required assets $ 2,200.0
b
20. Specified sources of financing $ 2,085.3
21. Additional funds needed (AFN) $ 114.7

22. Required additional notes payable $ 114.7

23. Additional short-term investments 0.0

46
 Sources of Financing

Specified Sources of Financing

Accounts payable $ 66.0

Accruals $ 154.0
Notes payable (carryover) $ 110.0
Long-term bonds $ 754.0
Preferred stock $ 40.0
Common stock $ 130.0
Retained earnngs $ 831.3
$ 2,085.3

47
What are the additional funds needed
(AFN)?
• Required assets = $2,200.0
• Specified sources of fin. = $2,085.3
• Forecast AFN: $114.7
• MicroDrive must have the assets to make
forecasted sales, and so it needs an equal
amount of financing. So, we must secure
another $114.7 of financing.

48
 Financial Policy Decisions

1. Mature firms rarely issue common stock.

2. Dividends tend to increase at a fairly steady rate
3. Preferred stock rarely used
4. Issuing long-term debt (bonds) is a major event
5. Most firms use short-term bank loans as
financial “shock absorbers.”

49
 Equation AFN = $118.42 vs.
Pro Forma AFN = $114.7

• Equation method assumes a constant

profit margin.
• Pro forma method is more flexible. More
important, it allows different items to
grow at different rates.

50
12.5 Forecasting when the ratios change

Economies of Scale
1,100
1,000

 Declining A/S Ratio

Assets

Base
Stock

Sales
0
2,000 2,500
$1,000/$2,000 = 0.5; $1,100/$2,500 = 0.44. Declining ratio shows economies of
scale. Going from S = $0 to S = $2,000 requires $1,000 of assets. Next $500 of sales
requires only $100 of assets. 51
 Lumpy Assets

1,500
Assets

1,000

500

Sales
500 1,000 2,000
A/S changes if assets are lumpy. Generally will have excess capacity,
but eventually a small S leads to a large A. 52
If 2009 fixed assets had been operated
at 96% of capacity:

Actual sales
Capacity sales =
% of capacity
$3,000
= = $3,125
0.96

With the existing fixed assets, sales

could be $3,125. Since sales are
forecasted at $3,300 less new fixed
assets are needed.
53
 Excess Capacity Adjustment
• Full capacity sales = $3,125 million
• Target FA/Sales:
– Actual FA/Full Capacity Sales
– $1,000/$3,125 = 32%
• Required FA:
– Target FA% x Projected Sales
– 32% * $3,300 = $1,056 million

54
 How would the excess capacity situation
affect the 2010 AFN?
• The previously projected increase in fixed assets was
$100 million.
– From $1,000 to $1,100 million
• With excess capacity, only $56 million is required,
$44 million less.
• Since less fixed assets will be needed, AFN will fall by
$44 million, to:

$118 - $44 = $74 million

55
Summary: How different factors affect the
AFN forecast.
• Economies of scale: leads to less-than-
proportional asset increases.
• Lumpy assets: leads to large periodic AFN
requirements, recurring excess capacity.
• Excess capacity: lowers AFN

56