16: Financial Planning
The bottom line for Walk-A-Bout Shoes is that its pro forma outlook is quite good. If the company
achieves its sales growth target and keeps expenses and current asset and current liability accounts in line
with historical norms, then it can invest $20 million in new fixed assets while reducing its outstanding
interest-bearing debt.
In one sense, this conclusion is hardly surprising. If we take the 2016 data for Walk-A-Bout Shoes
and plug it into Equation 16.1, we find that the company’s sustainable growth rate is 31.8%. Therefore,
the company’s target growth rate of 30% should leave it with some financial ‘slack’. Going through the
added steps to build pro forma statements provides the company with much more information than
does the sustainable growth rate alone. With the figures in Tables 16.1 and 16.2 programmed into a
spreadsheet, analysts could easily study the effects of changes in any of the assumptions – such as Walk-
A-Bout Shoes’ ability to pay down debt – or identify a need to increase the credit line balance.
A Shorthand Approach for Estimating External Funds Required
We can use the notation defined earlier to present another shorthand approach for estimating the amount
of external funds required (EFR) – the external financing that a company will require. Equation 16.2
states that the EFR is a function of three factors. The first term in the equation, (A/S)ΔS, indicates the
additional investment in assets required for a company if it plans to maintain its total asset turnover ratio
and increase the dollar volume of sales by ΔS. The second term measures the inflow of funds available to
finance this growth. The inflow represented by the second term assumes that the relationship between
a company’s sales and its spontaneous liabilities (in this case, accounts payable (AP)) remains constant.
The third term captures the additional financing inflows that the company creates internally through
retained earnings. Thus, we have:
Eq. 16.2 EFR=∆−∆
A
S
S
AP
S
Sm−+Sg() 11 ()––d
If we apply this shorthand calculation to Walk-A-Bout Shoes, we can determine its external funds
requirement (in thousands of dollars):
=×−×
−
××+×−=
EFR
,
() ()
()( ),
$116, 250
$250 000
$75, 000
$19,500
$250, 000
$75, 000
$32, 175
$250, 000
$250, 000 10 .3010.50 $8 111
Under the assumptions of this model, Walk-A-Bout Shoes will require additional external funding of
$8.1 million. In the pro forma projections in Table 16.2, Walk-A-Bout Shoes’ total external financing
actually declines by $6.7 million.^4 Why the discrepancy? Closer examination of the pro forma statements
reveals that several of the assumptions in Equation 16.2 do not hold in a more complete analysis. For
instance, from 2016 to 2017, Walk-A-Bout Shoes’ ratio of assets to sales is not constant, as the equation
assumes; instead, the ratio declines from 0.465 to 0.419. Walk-A-Bout Shoes is increasing sales more
rapidly than assets, so its funding needs are actually less than Equation 16.2 assumes. When we
4 Comparing Table 16.1 and Table 16.2 produces a $5 million reduction in long-term debt and a $1.7 million ($5.0 million – $3.3 million)
reduction in the line of credit. The figures are imprecise because the interest expense and outstanding debt figures in Table 16.2 are not
fully reconciled.
external funds required
(EFR)
The expected shortage or
surplus of financial resources,
given the company’s growth
objectives
With what frequency do
companies construct pro
forma financial statements for
planning purposes?
thinking cap
question
Daniel Carter, Vice
President of Finance,
BevMo!
‘We use information
on our expectations to
manage expectations of
investors.’
See the entire interview on
the CourseMate website.
COURSEMATE
SMART VIDEO
Source: Cengage Learning