CHAPTER TWO

FINANCIAL STATEMENT ANALYSIS

AND

FINANCIAL PLANNING
 Financial analysis: An Introduction
Financial analysis

• is the process of identifying the financial

strength and weakness of a firm by:

 properly establishing r/nship b/n the

items of FS for certain period(s).

• The focus of FA is on key figure in the FS

and the significant r/nships that exist
b/n them.
• FA is used by several groups of users like:
 managers,
 credit analysts, and
 investors.
• FA helps users to obtain a better understanding of
the firm’s financial conditions and performance.
• The analysis of FS is designed to reveal the relative
strengths and weakness of a firm.

• It helps users to understand the numbers

presented in the FS and serve as a basis for
financial decisions.
 Financial Statements Analysis

• It is a process of evaluating the r/nships

among component parts of FS
• FA can be undertaken by:
 management of the firm, or
by parties outside the firm like:
• owners,
• creditors,
• investors and so forth.

• The sources of data for FA are accounting records,

Balance sheet and IS
• FMgrs need information provided by analysts both
to evaluate: 
the firm’s past performance and
to map the future plans

• Investors need information of FA to estimate both:

future cash flows from the firm and
the riskiness of those cash flows
 Stages in Financial Analysis
• The major stages are:
i) Preparation.
• The preparatory steps include:
 establishing the objectives of the analysis
and
assembling the FS & other pertinent financial
data.
• FS analysis focuses primarily on the B/sheet & IS.

• It is simply objective setting and data collection.

ii) Computation.
• This involves the application of various tools and
techniques to:
 gain a better understanding of the firm’s financial condition
and performance.
• Computerized FS analysis programs can be applied as part of
this stage of FA.
iii) Evaluation and Interpretation.
• Involves:
 the determination for the meaningfulness of the
analysis and
 to develop:
• conclusions,
• inferences, and
• recommendations about the firm’s performance and
financial condition.
• It is the most important of the three stages of FA.
 
Tools and Techniques of Financial Analysis
• The most frequently used techniques are:
1) Ratio Analysis
2) Common size Analysis
3) Index Analysis
 1) Ratio Analysis
• It is a mathematical r/ionship among money amounts in the FS.
• It is defined as the numerical or quantitative r/nship of two
items or variables.
• It is a widely used tool of FA.
• It standardizes financial data by converting money figures to
ratios in the FS.
• Ratios are usually stated in terms of times or percentages.
• It helps us to draw meaningful conclusions and interpretations
about:
 strength and weakness of a firm
 as well as its historical performance and
 current condition can be determined.
• In FA, a ratio is used as a benchmark for
evaluating the financial position and performance
of a firm.
• The absolute accounting figures reported in the FS
do not provide a meaningful understanding of the
performance and financial position of a firm.
• An accounting figure conveys meaning when it is
related to some other relevant information
• Ratios are an analyst’s microscope to view of a
firm’s financial health’
 Standards for Ratio Comparisons
1. Past Ratios:
• Ratios calculated from the past FS of the same firm
i.e.,
 Longitudinal or
 Trend based standards

2. Competitors’ Ratios:
• Ratios of some selected firms, especially:
 the most progressive and successful competitor, at
the same point in time i.e.,
 Single period or
 Cross-section based standards.
3. Industry Ratios
• Ratios of the industry to which the firm belongs
i.e.,
Industry based standards

4. Projected Ratios
• Ratios developed using the projected, or pro
forma, FS of the same firm i.e.,
Projected (pro forma) statements based
standards
 Types of Ratio Analysis
 

1. Liquidity ratios
2. Activity ratios

3. Debt/leverage ratios
4.Profitability ratios
5.Market value ratios
1. Liquidity Ratio
• Liquidity refers to the firm’s ability to meet its
obligation in the short-run, usually one year.

• LR are based on the r/nship b/n CA and CL.

• It shows the firm’s CAs sufficient to pay its CLs.

• The most important liquidity ratios are:

Current ratio,

 Acid-test ratio and

Cash ratio.
a) Current Ratio

• It measures the firm’s ability to satisfy the

claims of short term creditors by using all CAs.

CA
CR = CL
 
Example: The current ratio of GLOBAL Company for 2008 is:
Br. 347
CR = Br. 99
= 3.5 times or = 3.5:1
• The general minimum norm for CR at international
level is 2.0.
• But the acceptability of a value of CR depends on
the nature of the industry in which the firm is
categorized and standards established for
comparisons.
• Assume, the industry average for GLOBAL
Company is 4.1 times.
• GLOBAL’s CR is below the average of its industry,
• So its liquidity position is relatively weak.
• A very high CR may imply that:
There is excessive cash due to poor cash
management
Receivables are excess due to poor credit
management
The prevalence of excessive inventory due
to lack of proper inventory management.
 Very High CR
• The result of very high CR is to:
have very high liquidity which is safety
of funds for:

 short term creditors to reduce

risk to creditors.
• However, the result shows:
 a scarification of profitability b/c CAs are
less profitable than long term assets.
 Very Low CR
• It may be caused by:
Conservative mgt of CAs w/c may be the
opposite for very high CR.
• Very low CR can be improved with:
Long term borrowing and
sell of stocks to increase current assets

Liquidate current liabilities using long-term

assets.
b) Quick (Acid test) Ratio:
• It is based on CAs w/c are highly liquid- excluding
inventories and prepaid expenses.
 Inventories are deemed to be the least liquid components of
CAs and
 prepaid expenses which are not available to pay off current
liabilities.

• Quick assets include:

 cash,
 marketable securities, and

 receivables (such as notes receivable and account

receivable).
 QR= CA- (I-PE(QA))
CL
• The quick ratio of GLOBAL Company is:
QR = 347,000-210,000-15,000
99,000
= 1.23times
C) Cash Ratio  
Cash Ratio = Cash
CL
 
 2. Activity Ratios
• These ratios are also called:
 efficiency ratio, or
asset management ratio, or
 asset utilization ratios.

• It compares the level of sales or CGS with the level

of investment in various assets.
• These ratios are used to measure the speed with
which various assets are converted into sales
revenue and assets are effectively managed.
• It describes how efficiently a firm uses its assets to
generate sales.
 a) Inventory Turnover Ratio

• It measures how quickly inventory of a firm is

sold.
• It indicates the efficiency of the firm in managing
and selling inventories.
Inventory Turnover Ratio = CGS
Inventory
Example: The inventory turnover ratio of GLOBAL
Company is
Br. 539,000

ITO = Br. 210,000

= 2.55 times
• This implies that GLOBAL Company replaces its
inventories about 2.55 times in a year.
• Generally, higher inventory turnover is considered
to be good b/c:
 it means that storage costs are low,
but if it is too high the firm may be risking
inventory outages and the loss of customers.
• An ITO ratio significantly higher than the
Industry Average indicates:
Superior selling practice
Improved quality and profitability
Fewer cases of damage or obsolete inventory
• An ITO ratio significantly lower than the average
firm in the industry indicates:
Over investment in inventory
Inferior quality goods, stock of unsalable or
obsolete inventory
Funds locked up in inventory
Higher rent of space, insurance cost,
property tax & others.
 b) Average Age of Inventory (AAI):

• It is the reciprocal of the inventory turnover.

• It is also called as days of inventory holdings b/c it is the length of time

inventory is held by the firm.

 
AAI= Inventory X 360days
CGS

Or

AAI = 360 days

ITO
Example: The average age of inventories in GLOBAL Company’s store is
AAI = 210,000 X 360 = 360 = 141 days
539,000 2.55

• GLOBAL Company held its inventory on average for 141 days.

• The general principle, however, is the lower is the better without leaving the

firm out of stock.

C) Account Receivable Turnover (ARTO):
• It provides information about the management of A/R.

• It indicates how many times A/R is converted into cash during the year.

• The higher the value of ARTO, the more efficient is the expected credit

management.

ARTO = Credit Sales

A/R

• Example: ARTO = 830,000 = 10.64 times

78,000
 

• Higher ARTO is generally better.

• Too higher figure of ARTO might indicate that the firm is delaying

credit to creditworthy customers thereby losing sales.

• If the ARTO is too low, it would suggest that the firm is having

difficulty of collecting on its sales.

 d) Average Collection Period (ACP) (Days’ Sales Outstanding)
• It indicates how many days it takes for a firm to collect its credit

sales.

• It is the average number of days for w/c A/R remain outstanding.

• It measures the quality of A/R since it indicates the speed of

collections.

 
ACP = Account Receivable or
Net Sales/360
 
   ACP = 365* A/R
  NS

Example: ACP = 78,0000 = 33.83days

830,000/360
• The ACP is the inverse of ARTO.

• The lower ACP is usually better.

• The shorter the ACP, the better is the quality of

debtors.
• An excessively longer ACP implies a very liberal and
inefficient credit and collection performance.
• This certainly delays the collection of cash and hurts
the firm’s liquidity.

The chances of bad debts are also increased.

• Too low ACP is not necessarily favorable b/c:
 it may indicate a very restrictive credit and
collection policy.
 e) Fixed Assets Turnover (FATO):
• FATO is used to measure the efficiency of a
firm to utilize its investment in fixed assets.
• It is the birr amount of sales that are generated
by each birr invested in fixed assets.
NS
FATO = NFA
 
Example: The FATO for GLOBAL Company, in 2008 is
FATO = 830,000 = 1.58 times
525,000
• So, GLOBAL Company generated Br.1.58 for
each birr invested in FA.
• The larger is the better for FATO.
f) Total Assets Turnover (TATO)
• TATO describes how efficiently a firm is using its assets
to generate sales.
• It is the ability of a firm to generate sales from all
financial resources committed to TA.
• Higher TATO is better.
 
NS
TATO= TA

• Example: TATO = 830,000 = 0.895 times

927,000

• So, GLOBAL Company generated 89.5 cents in sales for

each birr invested in TAs.

 3. Leverage Ratios
• It used to measure the extent to which non-owner
supplied funds have been used to finance a firm’s
assets as compared with the funds provided by
owners.
• It also describes the degree to which the firm uses
debt in its capital structure.
• So, a firm which uses a lot of debt is said to be
highly leveraged.
• Leverage ratios provide important information for
creditors and investors.
• Creditors might be concerned that a firm w/c has too
much debt will have difficulty in repaying loans.
• Investors might be concerned b/c a larger amount of
debt can lead to a larger amount of volatility in the
firm’s earnings.
• The most commonly stated leverage ratio are:
 Debt Ratio,
 Debt-Equity Ratio,

 Time Interest Earned Ratio,

 Fixed Payment Coverage ratio.

• The first two ratios are considered as component
ratio while the last two are coverage ratios.
• They are component b/c these ratios measure the
proportion of the financing sources and they are
all about the major balance sheet elements.
• The others are coverage ratios due to their
emphasis on the ability of the firm to cover its
interest and other fixed charges.
a) Component Ratios
i) Total Debt Ratio (DR):
• It measures the proportion of TA financed by the firm’s
creditors.
DR = TD = 1- TE
TA TA

DR = 1- ER
•  Example: The DR of GLOBAL Company
DR = 299,000 = 32.25 %
927,000
• The DR of GLOBAL Company shows that liabilities covers
about 32.25 % of their capital structure.
• Creditors have supplied for GLOBAL Company about 32 cents
of every birr in assets.
ii) Debt Equity Ratio (DER)
• The DER indicates the r/nship b/n:

 the TD funds provided by creditor and

 those provided by the owners of the firm.

• This ratio reflects the relative claim of creditors and SHs against the assets of

the firm.

DER = TD = TA -1
TE TE
ER = 1- DR

• Example: The proportion of debt and equity in financing the assets of GLOBAL

Company is
DER = 299,000 = 47.61 %
628,000

• Creditors of GLOBAL Company provided about 48 cents in financing total

assets for every birr contributed by the owners.  

 b) Coverage Ratios
• Describe the quantity of funds available to cover
certain expenses.
• Unlike the component ratios, higher ratios are
desirable in coverage ratios.
• Too high ratios indicate that:
 the firm is underutilizing its debt capacity
and
therefore not maximizing shareholder wealth.
i) The Times Interest Earned Ratio (TIER)

• It measures the ability of the firm to pay its

interest obligations by comparing EBIT to interest

expense.

TIER= EBIT
Interest expense

• Example: TIER = 101,000 = 5.05 times

20,000

• The Company can cover its interest 5.05 times

using funds for the payments of interest expenses.

• A High TIER indicates that:
 the firm has sufficient margin of safety to
cover its interest charges
• A very low TIER suggest that:
 creditors are more at risk in receiving
interests due;
failure to meet interest can bring legal action
by creditors possibly resulting in bankruptcy;
and
the firm may face difficulty in raising
additional funds through debt.
ii) Fixed Charge Coverage Ratio (FCCR)

• It reflects the total amount of earning available to meet all

fixed payment obligations like:

 Interest,

 principal payments (PP),

 lease payments, and

 preferred stock dividends (PD) are financing related fixed

charges.

FCCR = EBIT + Lease Payment

Interest +Lease payment + PD+ PP
(1-T)
 4. Profitability Ratios
• It measures the operating efficiency of a company.
• It is used to evaluate the overall management
effectiveness and efficiency in generating profit on:
 sales,
 total assets and
 owners’ equity.
• Without exception, high ratios are preferred.
• Profitability ratio includes:
 Gross profit margin,
 Operating profit margin,
 Net profit margin,
 Return on investment, and
 Return on equity.
a) Gross Profit Margin

• It Measures the gross profit relative to sales.

• It indicates the amount of fund available to pay the

firms expenses other than its cost of sales.

GPM = GP
NS

Example: GPM = 291,000 = 35%

830,000

• The Company maintained 35 cents remained from each

birr sales after deducting each CGS from net sale.

 
b) Operating Profit Margin (OPM)

• This profit is the operating profit.

• It indicates how much is left over after the operating

expenses.

• It serves as an overall measure of operating effectiveness.

OPM = NOP
NS
 

Example: OPM = 101,000 = 12.2 %

830,000

• GLOBAL Company generated about 12 cents in OP per Br.

of net sales.  
 c) Net Profit Margin (NPM)

• It measures the percentage of each sales birr

remaining after deducting all cost and expenses.

• It is the percentage of sales that remains for the

shareholders of the firm.

NPM/PM= NI
NS
 
• Example: PM= 64,000 = 8%
830,000
 d) Return on Investment (ROI)

• It represents pool of funds supplied by shareholders and lenders.

• It reflects the total earning produced with the use of the total

assets of the firm.

• It measures the overall effectiveness of management in

generating profit with its available assets.

ROI = NI
TA

Example: ROA= 64,000 = 6.9%

927,000

• This implies that GLOBAL generates about 7 cents for every birr

invested in assets.
 e) Return on Equity (ROE)

• It is to measure the return earned on the owners’ investment.

ROE= NI
TE
 
• Example: ROE = 64,000 = 10%
628,000

• GLOBAL Company generates about 10 cents for every birr in

shareholders equity.

• A substantially higher ROE indicate that:

 a firm is more risky due to high financial leverage.

• A very low ROE may also indicate:

 a kind of conservative financing policy.

 
5. Valuation Ratios / Market/BV Ratios
• It is also called SH ratios.
• It includes:

1. Earning Per Share (EPS)

2. Dividends per Share (DPS)

3. Dividend Payout Ratio

4. Price-Earning Ratio
5. Market Values to Book Values Ratio
 a) Earning Per Share (EPS)
• EPS is the amount of income earned during a period per share of common

stock.

EPS = Net income available for CSHs

Number of CS outstanding

EPS = NIAFCSHs
No. of shares outstanding
     

Example: Assume that GLOBAL Company has a total number of common

shares outstanding of 10,000.

• The earning per share is therefore computed as:

EPS = 64,000 = 6.4
10,000

• EPS does not show how much is retained and how much is distributed as

dividend. 
 b) Dividends per Share (DPS)

• It is the Birr amount of cash dividends paid

during a period as per share of common stock.
• The net profits after taxes and preference
dividends belong to common shareholders.
• But the income which they really receive is the
amount of earning distributed as cash dividends.
• Therefore, a large number of present and potential
investors may be interested in DPS than EPS.
 DPS = Earnings paid to CSHs(dividends)
Number of ordinary shares outstanding

DPS = D
NSO
Example: DPS = 15,000 = 1.5
10,000
c) Dividend Payout Ratio (DPOR)
• It is simply DPS divided by the EPS.

• Dividend Payout Ratio = Dividends paid CSH

Earning Available CSHs

  or

  DPOR = DPS
   EPS

• DPOR shows the percentage of earnings paid to SHs.

Example: DPOR = 15,000 = 1.5 = 23.44%
64,000 6.4

• Interpretation is that GLOBAL Company paid 23.44% of its

earnings in dividends.
 d) Price-Earning Ratio (PER)
• It is widely used by the security analysts to values the firm’s

performance as expected by investors.

• It indicates investors’ judgment or expectations about the firm’s

performance.

• It indicates the degree of confidence that investors have in the firm’s

future performance.

• The higher the PER, the greater is the investors’ confidence in the

firm’s future.

PER= Market values per share

Earnings per share
 
  PER = MVPS
EPS
 e) Market Values to Book Values Ratio (MV to BV
Ratio)

• It is the ratio of share price to book

values per share.

Market to Book value ratio = Market value per share

Book value per
share
 
   MV to BV = MVPS
BVPS
 
 
 Advantage of Ratio Analysis
are easy to compute
Provide standards of comparison at a point in
time.
are useful to indicate problem areas of the a
firm
When combined with other tools, it
contribute to the tasks of evaluating a
financial performance of the firm.
Limitations and Cautions for Use of Ratio
Analysis
• Limitations of Ratios :
 A single ratio provide little information
 Ratios generally do not identify the cause of the
firm’s difficulties.
 Ratios can easily be misinterpreted.
 For example: a decrease in the value of ratio does not
necessarily mean the something undesirable has
happened.

 Very few standards exist that can be used to

judge the adequacy of a ratio or set of ratios.
 Cautions While Using Ratios
 FS being compared should be dated at the same point in
time

 It is preferable to use audited FS for ratio analysis

 Financial data being compared should have been developed

in the same way.
 The use of different accounting methods:

• different inventory valuation methods and

• depreciation methods should be considered while

calculating ratios for d/t firms of probably the same
nature.

• The use of different methods will distort the result of

ratios for comparison.
 2. Common Size Statement Analysis 
• Common size Analysis – expresses individual FS
accounts as a percentage of a base amount.
• A common size status expresses each item:
 in the B/sheet as a percentage of total assets
and
in income statement as a percentage of total
sales.
• Common size statements can be used to compare
firms of different sizes.
• In common-size statements analysis:

 all b/sheet items are divided by TA and

all IS items are divided by the total sales.

• Illustration
 3. Index Analysis
• It expresses items in the FS as an index relative to the base

year.

• All items in the base year are assumed to be 100%.

• This analysis is most appropriate for income statement items.

• Analysis of percentages for FS where:

 all FS figures for the base year are equated to 100 % and

 subsequent year FS items are expressed as a percentage of the

base year.

• Illustration
 FINANCIAL PLANNING 
• The management of every firm always tries to
maximize efficiency and wealth of the SHs.
• This is through having a well designed financial
planning and budgeting.
• In the process of financial planning:
 the mgt tries to identify the required
financial gap and
 assess the need for external financing .
• Financial planning indicates:
 firm’s growth,
 Its performance,
 Plan for investment and
 fund requirement during a period of time.
• It involves the preparation of projected FS.
Financial Planning:
evaluates the impact of alternative investing
and financing decisions;
attempts to make optimal decisions,
 projects the consequence of these decisions
for the firm in the form of financial plan and
 compare future performance against the
plan.
 Planning Process
• Planning:
 is the design of future state of an entity and

 is an effective way to achieve stated objectives.

• The major steps are: 

1)Set up Objective:

• Objectives explain the desired state or position of an enterprise in the future.

• This represents the purpose for which the firm is organized.

• The firm must have clearly stated:

 strategic,

 operational and

 financial objectives.

 
2) Make Assumptions:

• It explains the expected conditions on which the

plan is based.
• When one make an objective, there exists some
assumptions regarding:
 the economic condition,
 political situations, and
 other circumstances in which the firm is working.

 
3) Determine Goals
• Goals are operational specifications of
the broad objectives with:
time dimension and
quantity dimensions.
• Goals are quantified targets to be
attained within a specific period.
4) Determine Strategies
• It lays down the foundation or the activities to be
followed in attaining the objectives and goals.
• It specifies the way to achieve the objectives and goals.

• Example: objective of a firm may be to maximize return

for a period of time by increasing sales.
• The goal may be increase sales by 10% at the end of the
year.
• The firm’s strategies may include:

 reduction of selling price and/ or

 liberalizing credit policy among others.

5) Formulate Budget
• Budget is the expression of the company’s plan in terms of
financial terms.
• It is a plan explicitly stating the goals in terms of time and
expected financial results for each major segments of the firm.
• An enterprise must also have idea about:
 the d/t cash inflows and outflows,
 the requirement of additional fund, if the plan is to be implemented.

• Example:

 cash budget,
 sales budget,

 capital budget, etc

• Financial budget

• It is the financial expression of operating budget.

• It expresses:
 the cash flows,
 financial positions, and
 operating results.

• The most important types of financial budgets are:

 Cash budget,
 pro-forma or projected financial statements and
 Capital budget.
 Financial Statement Forecasting
• It is an integral part of planning.

• It uses past data to estimate future financial

requirements.
• The decisions made by FMgrs are made on the basis
of forecasts of one kind or another.
• There are d/t methods of forecasting.

Percent of sales method

• It is the simplest method of forecasting IS & B/sheet.

• The method can be used with relatively little data

available. 
• The fundamental assumption of the percent of sales method is

that many (but not all) IS & B/sheet items maintain a constant

r/nship to the sales level.

• The method assumes that the forecast level of sales is already

known.
Sales forecast
• It starts with a review of sales during the past five to ten
years.
• The development of sales forecast may consider:
 Product divisions.
 The level of economic activity
 change in population growth
 The firm’s probable market share
 The exchange rate fluctuations for export oriented firms
 Advertising campaigns, promotional discounts, credit terms, etc
 Forecasting an Income Statement
• The level of detail in IS will affect how many
items will fluctuate with sales.

Illustration
• GLOBAL Co. for the year 2008 prepare the pro-forma
IS for 2009.
• Assume that sales increases by 20 percent.
• Forecasted sales

= 830,000 + (830,000x 0.2)

= 830,000 + 166,000= Br. 966,000

• Cost of goods sold has a direct r/nship to sales.
• The CGS as percentage of sales
= 539,000 = 65%

830,000
• Forecasted CGS :

= 0.65x 996,000 = Br. 647,400

For GLOBAL Company both marketing and
general administrative expenses stay constant.
Elements of IS those have no direct relation
with sales are:
 Depreciation expenses

 Interest expense.

 Tax though indirectly related to sales level.

 Dividend but is dependent on:

 the retention ratio and

 the dividend policy of the firm.

 Forecasting a Balance Sheet
• It is forecasted in the same way as the IS.
• The components of b/sheet are to be determined
based on sales depending on their direct r/nship
to sales. 

 
• Example: take the b/sheet of GLOBAL
Co. for the year 2008 to prepare the pro-forma
b/sheet for the year 2009.
 Cash
• It is proportional to sales.
• If the firm sells more goods, it accumulates more cash.

• Even though cash balance changes:

 it will not change by the same percentage as sales.
Example:
• Cash to sales percentage
= 44,000 = 5%
830,000
• Hence, the forecasted cash balance:
= 996,000X 0.05
= Br. 49,800
 Account Receivable
• It will increase proportionally with sales.
• Example: For GLOBAL Co., the forecasted A/R is:

• A/R to sales percentage

= 78,000 = 9%

830,000
• Forecasted A/R:
= 996,000x0.9

= Br. 89,640
 Inventory
• Inventory to sales percentage:

= 210,000 = 25%

830,000
• Forecasted balance of inventory:
=996,000 x0.25
= Br. 249,000
• B/sheet Accounts have no relation with sales:
Prepaid Expenses
Fixed Assets

Accumulated Depreciation
Patent
 Spontaneous Sources of Financing
• These are the sources of financing that:

 arise during the ordinary courses of doing business.

• Example: Account Payable

• Once the credit account is established with suppliers:

 no additional work is required to obtain credit;

 it just happens spontaneously when the firm makes purchases.

• Not all CLs are, spontaneous sources of financing.

• E.g.

 short-term notes payable and

 long-term debts due in one year are not spontaneously

emerging sources of financing.

Discretionary Sources of Financing
• These are financing sources w/c:
 require a large effort on the part of the firm to
obtain.
• The firm must make a conscious decision to obtain these
funds.
• It needs the decision of top level mgt to use these sources of
financing.
• Examples:

 any types of bank loan,

 bonds,
 common and
 preferred stocks.
• Now comeback to the illustration for GLOBAL Company:

Accounts Payable
• is one of the spontaneous sources of financing for GLOBAL
Company and is directly related to sales.
• Accounts payable to sales percentage :
= 76,000 = 9%
830,000
• Forecasted balance of accounts payable:
= 996,000x0.09 = Br. 89,640
 
Accrued wages and salaries:
• are accrued liabilities representing primarily accrued expenses
which are spontaneous sources of financing.
 
• Accrued wages and salaries to sales percentage
= 4,000 = 0.05%
830,000
= 996,000x0.005 = Br. 4,980
The following elements have no relation with
sales
 Interest Payable
 Long Term Notes Payable and
 Common Stocks

Retained Earnings
• It will increase with sales but not in the same rate
as sales.
• The balance for RE of GLOBAL Co.is:

= 328,000 + 84,310
= Br. 412,310 
 Additional Funds Needed
• It is the d’ce b/n TA and TL & TEs.
• After completing forecasting, the balance
must be A = L +C.
• But the sum of the projected balances will not
balance.
• The additional fund required is financed
through discretionary financing sources.
• The fund is also called discretionary financing
fund.  
 a) Deficit Discretionary Funds
• It is when the firm’s forecasted TA > L+E.
• Therefore, arrangement should be made for
more liabilities and/or equities to finance the
level of assets needed to support the volume of
sales expected.

 b) Surplus of Discretionary Funds

• It is when the firm’s forecasted TA < L+E.

 
Example: For GLOBAL Co., the d’ce b/n TA and TL &
TE is:

ADFN = TA– [TL+ TE]

= 955,440 - 1,038,036
= (Br. 82,596).
• It is indicates, GLOBAL Company expects to have
Br. 82,596 more in discretionary funds that:
 are needed to support its forecasted level of
assets.

• In this case, the company should forecast a

surplus of discretionary funds.
THANK YOU!!!