518 Part 6 Working Capital Management, Forecasting, and Multinational Financial Management
Earlier estimate of AFN! 1.1($1,000)! $1,100 million
Di" erence! #$44 millionThus, the existence of excess capacity would lower Allied’s required AFN from
$114 million to $114 million $ $44 million " $70 million.
A similar situation could occur with respect to inventories, cash, or any other
asset. Moreover, the L 0 */S 0 ratio could be increased if the! rm negotiated longer credit
terms for its purchases. Similarly, it might be possible for Allied to improve its pro! t
margin or to lower its dividend payout ratio. Because so many conditions can change,
it is useful to go beyond the AFN equation analysis and construct Allied’s forecasted
! nancial statements, the topic of the next section. Also, we want to know how good
or bad the! rm’s! nancial ratios will be and what the impact will be on its EPS. The
AFN tells us nothing about those things, but the forecasted! nancial statements do.Forecasted Financial
Statements
Financial statements that
project the company’s
financial position and
performance over a period
of years.Forecasted Financial
Statements
Financial statements that
project the company’s
financial position and
performance over a period
of years.(^8) This section is relatively straightforward, but it does involve a number of steps. The table can be developed
with a calculator, but it’s far easier to do using Excel. We recommend that everyone read the section and look at
Table 16-2 while doing so. Finance majors should read the section especially carefully. It also would help if they
accessed the chapter model and worked through it.
SEL
F^ TEST If the key ratios are expected to remain constant, the AFN equation can be
used to forecast the need for external funds. Write out the equation and
explain its logic.
How would an increase in each of the following factors a$ ect the AFN?
(1) Payout ratio
(2) Capital intensity ratio, A 0 */S 0
(3) Pro! t margin
(4) Days sales outstanding, DSO
(5) Sales growth rate
Is it possible for the AFN to be negative? If so, what would that indicate?
If excess capacity exists, how would that a$ ect the calculated AFN?
16-4 FORECASTED FINANCIAL STATEMENTS
8
The AFN equation provides useful insights into the forecasting process—if you
understand the AFN, you will! nd it easier to understand forecasted! nancial
statements. Therefore, Allied’s CFO used the AFN calculations in Table 16-1 as a
warm-up for his presentation of the forecasted 2009! nancial statements. We
describe how he developed the forecast presented in Table 16-2 in this section.
Following is a brief discussion of the table.16-4a Part I. Inputs
Rows 2 through 9 show the basic inputs, or assumptions, used in the forecast. The
CFO had met previously with the CEO and other top executives. They had
reviewed the ratio analysis developed in Chapter 4 and concluded that improve-
ments must be made in 2009. Otherwise, a private equity buyer or hedge fund
might decide to take over the! rm; and if that occurred, the executives would
probably lose their jobs.