CP

430 CHAPTER 11 Financial Planning and Forecasting Financial Statements

d.Additional funds needed (AFN); AFN formula; capital intensity ratio

e.Lumpy assets

Certain liability and net worth items generally increase spontaneously with increases in sales.

Put a check (
) by those items that typically increase spontaneously:

Accounts payable Mortgage bonds

Notes payable to banks Common stock

Accrued wages Retained earnings

Accrued taxes

The following equation can, under certain assumptions, be used to forecast financial require-

ments:

Under what conditions does the equation give satisfactory predictions, and when should it not

be used?

Suppose a firm makes the following policy changes. If the change means that external, non-

spontaneous financial requirements (AFN) will increase, indicate this by a (
); indicate a de-

crease by a (); and indicate indeterminate or no effect by a (0). Think in terms of the immedi-

ate, short-run effect on funds requirements.

a.The dividend payout ratio is increased.

b.The firm decides to pay all suppliers on delivery, rather than after a 30-day delay,

to take advantage of discounts for rapid payment.

c.The firm begins to sell on credit (previously all sales had been on a cash basis).

d.The firm’s profit margin is eroded by increased competition; sales are steady.

Self-Test Problems (Solutions Appear in Appendix A)

Weatherford Industries Inc. has the following ratios: A*/S 0 1.6; L*/S 0  0.4; profit

margin 0.10; and dividend payout ratio 0.45, or 45 percent. Sales last year were $100 mil-

lion. Assuming that these ratios will remain constant, use the AFN formula to determine the

maximum growth rate Weatherford can achieve without having to employ nonspontaneous ex-

ternal funds.

Suppose Weatherford’s financial consultants report (1) that the inventory turnover ratio is

sales/inventory 3 times versus an industry average of 4 times and (2) that Weatherford could

reduce inventories and thus raise its turnover to 4 without affecting sales, the profit margin, or

the other asset turnover ratios. Under these conditions, use the AFN formula to determine the

amount of additional funds Weatherford would require during each of the next 2 years if sales

grew at a rate of 20 percent per year.

Van Auken Lumber’s 2002 financial statements are shown below.

Van Auken Lumber:

Balance Sheet as of December 31, 2002

(Thousands of Dollars)

Cash $ 1,800 Accounts payable $ 7,200

Receivables 10,800 Notes payable 3,472

Inventories 12,600 Accruals 2,520

Total current assets $25,200 Total current liabilities $13,192

Net fixed assets 21,600 Mortgage bonds 5,000

Common stock 2,000

Retained earnings 26,608

Total assets $46,800 Total liabilities and equity $46,800

ST–3

EXCESS CAPACITY

ST–2

ADDITIONAL FUNDS NEEDED

ST–1

GROWTH RATE

11–4

AFN(A*/S 0 )(S)(L*/S 0 )(S)MS 1 (RR).

11–3

11–2

Financial Planning and Forecasting Financial Statements 427