Introduction to Corporate Finance

PART 5: SPECIAL TOPICS

IMPORTANT EQUATIONS

16.1 g =

md

A

E

A

S

md

A

E

*

(1 –)

–(1–)

16.2 EFR=∆ ∆+

A

S

S

AP

S

––SmSg(1 )(1–d)

proportion to sales. Yet certain balance sheet

accounts do not typically increase in a linear

fashion. As a result, analysts typically use

one line item on the balance sheet as a ‘plug

figure’ that can be used to make sure the pro

forma balance sheet balances. Analysts can

also estimate directly the amount of external

financing required to fund a company’s

anticipated growth by using the equation for

external funds required (EFR). This approach,

like the preparation of pro forma statements,

helps managers determine if they can expect

a scarcity or surplus of financial resources,

given the company’s growth objectives.

■ During the year, a company’s investment in

current assets tends to rise and fall with

sales. This seasonal pattern creates

temporary cash surpluses and deficits that

the company must manage. Three basic

financing strategies – conservative,

aggressive and matching – can be used to

fund both the long-term trend and seasonal

fluctuations in a business. The conservative

strategy is generally the least risky and least

profitable, the aggressive strategy is the

usually most risky and most profitable, and

the matching strategy falls between the

other two in terms of risk and profits.

■ A cash budget forecasts the short-term cash

inflows and outflows of a company. For a

company with significant seasonal variations,

the financial manager typically prepares the

cash budget month by month. This allows

the company to determine peak short-

term financing needs and peak short-term

investment opportunities, typically over an

annual or quarterly period.

■ The financial manager must also consider

intra-month cash flows to ensure that

sufficient credit is available. Changes

in collection and payment periods can

significantly affect the cash budget’s

projections.

LO16.5

LO16.6

KEY TERMS

aggressive strategy, 585

bottom-up sales forecast, 578

cash budget, 586

cash disbursements, 587

cash receipts, 586

conservative strategy, 583

creditor days, 590

debtor days, 590

economic value added (EVA), 573

external funds required (EFR), 581

matching strategy, 585

percentage-of-sales method, 578

plug figure, 578

pro forma financial statements, 577

return on investment (ROI), 573

strategic plan, 571

sustainable growth model, 574

top-down sales forecast, 578

SELF-TEST PROBLEMS

Answers to Self-test problems and the Concept review questions throughout the chapter appear on

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