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CHAPTER OUTLINE
I. Financial forecasting and planning A. The need for forecasting in financial management arises whenever the future financing needs of the firm are being estimated. There are three basic steps involved in predicting financing requirements. . $. &. (. !ro"ect the firm's sales revenues and e#penses over the planning period. %stimate the levels of investment in current and fi#ed assets, which are necessary to support the pro"ected sales level. 'etermine the financing needs of the firm throughout the planning period.
The key ingredient in the firm's planning process is the sales forecast. This forecast should reflect )l* any past trend in sales that is e#pected to continue and )$* the effects of any events, which are e#pected to have a material effect on the firm's sales during the forecast period.
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+.
The traditional problem faced in financial forecasting begins with the sales forecast and involves making forecasts of the impact of predicted sales on the firm's various e#penses, assets, and liabilities. ,ne technique that can be used to make these forecasts is the percent of sales method. . $. The percent of sales method involves pro"ecting the financial variable as a percent of pro"ected sales. As sales volume changes, the level of assets required to support the firm changes. Assets are financed by liabilities and equity, so changes in assets lead to changes in liabilities and equity. +urrent liabilities, such as accounts payable and accrued e#penses, vary spontaneously as sales change. -etained earnings are impacted by changes in net income and dividends. The difference between the pro"ected level of assets and the pro"ected change in liabilities and equity is the discretionary financing needed. !ercent of sales forecasting can give erroneous results for assets that have scale economies or assets that must be purchased in discrete quantities.
&. .
II.
/ustainable rate of growth A. (. /ustainable rate of growth indicates how fast a firm can grow without having to increase the firm0s debt ratio and without having to sell more stock. /ustainable rate of growth, g 1 return on equity # ) 2 dividend payout ratio*
III.
Financial planning and budgeting A. Three functions of a budget are indicating the amount and timing of future financing needs, providing the basis for taking corrective action if actual figures do not match budget estimates, and evaluating performance of the firm. The cash budget represents a detailed plan of future cash flows and can be broken down into four components3 cash receipts, cash disbursements, net change in cash for the period, and new financing needed. Although no strict rules e#ist, as a general rule, the budget period shall be long enough to show the effect of management policies, yet short enough so that estimates can be made with reasonable accuracy. For instance, the capital e#penditure budget may be properly developed for a 45year period while a cash budget may only cover $ months.
(.
+.
62
'.
+ash budgets can be used to develop a pro forma income statement and a pro forma balance sheet. . A pro forma income statement represents a statement of planned profit or loss for the future period and is based primarily on information generated in the cash budget. The pro forma balance sheet for a future date is developed by ad"usting present balance sheet figures for pro"ected information found primarily within the cash budget and pro forma income statement.
$.
.5$.
..&
.5..
.57.
63
7 years. A long5term plan would involve less detailed general statements about the firm's strategic plans covering the ne#t & to 4 years. .58. A cash budget can also be used to determine the amount of e#cess cash on hand that will not be needed to finance future operations. This e#cess cash can then be invested in securities or other profitable alternatives. The careful budgeting of cash is of particular importance to a seasonal operation because cash flows are not continuous. The availability of cash resources must be carefully planned in order that the normal operation of the firm can be continued during slow periods. In addition, it is important to plan for future cash needs so that e#cess funds may be invested.
.5:.
$7< 74<
64
.5$A. a. < +redit /ales /ales February @arch April )estimated* 4.7 $4,444 &4,444 .4,444
Accounts receivable )&9& 94&* $4,444 plus credit sales for April )74< # .4,444* $4,444 less collections from Feb sales )74< # $4,444 # .7* )7,444* less collections from @arch sales)74< # &4,444 # .7* ):,744* Accounts receivable ).9&494&* $:,744 b. +ollections From3 April cash sales February credit sales @arch credit sales A $4,444 7,444 :,744 A &$,744
.5&A. (ased upon the pro"ections made, /ambonoBa can e#pect to have total assets ne#t year equal to A .? million made up of the A million in fi#ed assets plus A?44,444 ).$ # A. million* in current assets. These assets will be financed by known sources of funding comprised of A=44,444 in common equity CA?44,444 D ).7*).47*)A. million* 1 A=44,444E, plus payables and trade credit equal to 4< of pro"ected sales )A.44,444* which totals A .& million. This leaves A744,444 )A .? million 5 A .& million*, which will need to be raised to meet the financing needs of the firm. .5.A. Instructor0s ;ote3 This is an introductory percent of sales financial forecasting problem. /tudents should be able to solve it after a first reading of the chapter. )a* !ro"ected Financing ;eeds 1 !ro"ected Total Assets 1 !ro"ected +urrent Assets D !ro"ected Fi#ed Assets 1 )b*
F # A$4 mG DF A7m D A. mG 1 A
.::m
'F; 1 !ro"ected +urrent Assets D !ro"ected Fi#ed Assets 5 !resent >T' 5 !resent ,wner's %quity 5 C!ro"ected ;et Income 5 'ividendsE 5 /pontaneous Financing
65
)c*
He first solve for the ma#imum level of sales for which 'F; 1 43 'F; 1 )
7 5 .47 5 7 .7 * /ales 2 )7. @5$@58.7@ D.7@* 7
'F; 1 . ?&& /A>%/ 5 A$.=@ 1 4 Thus, /A>%/ 1 A 7.?$@ The largest increase in sales that can occur without a need to raise 6discretionary funds6 is A 7.?$@ 5 A 7@ 1 A?$4,444. .57A. +ash Accounts -eceivable Inventories ;et Fi#ed Assets A. m . m .4m .?m A$.4m +urrent >iabilities >ong5Term 'ebt +ommon /tock plus -etained earnings A.8m ..m .4m A$.4m
66
.58A. )a*
The /harpe +orporation +ash (udget Horksheet 'ec A :7,444 Ian A =4,444 =,444 47,444 88,444 ?4,444 ? ,444 :$,444 ?4,444 :$,444 4,444 $4,444 JJJJJJJ A 4$,444 A:?,444 $$,444 JJJJJJJJ A 44,444 4 Feb A $4,444 $,444 7.,444 7$,744 ?,744 ..,444 ? ,444 ?,744 ? ,444 4,444 $4,444 JJJJJJJ A ,444 A:,744 44,444 JJJJJJJ A 4:,744 4 @ar A &7,444 &,744 :$,444 $:,444 $,744 ?4,444 ..,444 $,744 ..,444 4,444 $4,444 $$,744 JJJJJJJ A =8,744 )A?.,444* 4:,744 JJJJJJJJ A $&,744 4 Apr A$.4,444 $.,444 ? ,444 &8,444 . ,444 8$,444 ?4,444 . ,444 ?4,444 4,444 $4,444 JJJJJJJ A$ 4,444 )A8=,444* $&,744 84,744 A 7,444 A 84,744 @ay A&44,444 &4,444 ..,444 .4,744 $ .,744 &7,444 8$,444 $ .,744 8$,444 4,444 $4,444 847 A =$,847 A$ ,?=7 7,444 )$ ,?=7* A 7,444 A &?,847 Iune A$:4,444 $:,444 ?4,444 :$,444 $:=,444 =4,444 &7,444 $:=,444 &7,444 4,444 $4,444 $$,744 &?8 A ?:,??8 A= , . 7,444 )&?,847* A 8:,74= 4 Iuly A$$7,444 $$,744 8$,444 =4,444 $:.,744 :7,444 =4,444 $:.,744 =4,444 4,444 $4,444 JJJJJJJ A $4,444 A 7.,744 8:,74= JJJJJJJ A$$$,44= 4
;ov /ales A$$4,444 +ollections3 @onth of sale ) 4<* First month )84<* /econd month )&4<* Total +ollections !urchases !ayments )one month lag* +ash -eceipts )collections* +ash 'isbursements !urchases -ent ,ther %#penditures Ta# 'eposits Interest on /hort5Term (orrowing Total 'isbursements ;et @onthly +hange (eginning +ash (alance Additional Financing ;eeded )-epayment* %nding +ash (alance +umulative (orrowing )b*
:$,444
8:
The firm will have sufficient funds to cover the A$44,444 note payable due in Iuly. In fact, if the firm's estimates are realiBed they will have A$$$,44= in cash by the end of Iuly.
.5:A. +ash K%/ @arketable /ecurities ;, Accounts !ayable K%/ ;otes !ayable ;,$ !lant and %quipment ;,& Inventories K%/ +ash receipts follow sales with a lag related to the payment habits of the firm's customers and the firm's policy regarding payments on its accounts payables. $ ;otes payable may well follow sales if the firm uses a line of credit to finance its working capital needs )discussed later in +hapter ?*. & The answer depends on whether or not the firm has e#cess capacity. If there is e#cess capacity, plant and equipment will not vary directly with the level of firms sales. If there is no e#cess capacity, plant and equipment will vary directly. .5?A. )a* +urrent assets ;et fi#ed assets A 8m 7m A& m Accounts payable$ ;otes payable& (onds payable +ommon equity A ?m &m 4m 4m A& m
JJJJJJJJJJJJ # A?4m 1 A 8m $ # A?4m 1 A ?m & A& m 5 A$?m 1 A &m financing needs in $44.* JJJJJJJJJJJJ )b* )c*
Instructor0s ;ote3 This problem follows the te#t e#ample very closely and provides an e#cellent assigned e#ercise to accompany a first reading of the chapter.
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.5=A. )a* %stimating Future Financing ;eeds Armadillo 'og (iscuit +o., Inc. !ro"ected ;eed for 'iscretionary Financing !resent >evel A$.4m A&.4m A7.4m A.7m A.7m 555555 A .4m A$.4m .7m .7m A$.4m A7.4m < of /ales )A7m* 1 ..4 or .4< 1 .84 or 84< 1 . 4 or 4< 1 . 4 or 4< 55555 !ro"ected >evel )(ased on A:m /ales* ..4 # A:m 1 A $.?m .84 # A:m 1 A ..$m A :.4m . 4 # :m 1 .:m
+urrent Assets ;et Fi#ed Assets Total Accounts !ayable Accrued %#penses ;otes !ayable +urrent >iabilities >ong5Term 'ebt +ommon /tock -etained %arnings $ +ommon %quity Total
. 4 # :m 1 .:m !lug Figure 1 . m A $.7 m ;o +hange A$.44m ;o +hange .74m A .7m D .4: # A:m 1 A .==m A$..=m A :.44m
;otes payable is a balancing figure which equals discretionary financing needed, 'F;, which equals3 Total Assets 5 Accounts !ayable 5 Accrued %#penses 5 >ong5Term 'ebt 5 +ommon /tock 5 -etained %arnings 1 A:.4m 5 A4.:m 5 A4.:m 5 A$.4m 5 A4.7m 5 A .==m 1 A . m. The pro"ected retained earnings is the sum of the beginning balance of A .7m plus net income for the period ).4: # A:m*.
The growth in the firm's assets )due to the pro"ected increase in sales* was financed predominantly with notes payable )a current liability*. This led to a substantial deterioration in both the firm's liquidity )as reflected in the current ratio* and an increase in its use of financial leverage.
69
)c*
The slower rate of growth in sales would have allowed Armadillo to finance a larger portion of the funds needed using retained earnings. For e#ample, using the : percent net profit margin Armadillo would have .4: # A8m 1 A.$4,444 it could reinvest after one5year's operations plus .4: # A: million 1 A.=4,444 from the second year's sales. The total amount of retained earnings over the two years then would be A= 4,444 rather than only A.=4,444 as before. This would mean that notes payable would be A&?4,444 after one year, and only A . m 5 . .$m 1 A8=4,444 at the end of the second year. The resulting level of current liabilities would be A$.4=m. Thus, the post sales growth current ratio after two years would be .&. )A$.?m9$.4=m 1 .&.* compared to . $ with a one5year growth period. The debt ratio under the two5year growth period will be only 7?< compared to appro#imately 8.< with the single year growth period. The slower growth pace would allow the firm to e#pand its assets more gradually, thus requiring less e#ternal financing since more earnings can be retained.
.5 4A. Instructor0s ;ote3 This problem differs from the te#t discussion of 6discretionary financing needed6 in that it relies on the pro"ected change in assets rather than the pro"ected level of total assets. Lnder these circumstances 'F; 1 TA 5 /> 5 -% where TA 1 the pro"ected change in total assets, which is the amount of new financing needed )in total*M /> 1 the pro"ected change in spontaneous liabilitiesM and -% 1 the pro"ected change in retained earnings that will be available to finance a portion of the firm's needs for new funds. First, we estimate that the pro"ected change in assets during the coming year will be3 TA 1 .&4 /ales 1 .&4 )A744,444* 1 A 74,444 Thus, total new financing of A 74,444 must be obtained during the ne#t year to support the growth in firm sales. ;e#t, we pro"ect the change in spontaneous liabilities )/>* /> 1 1 . 7 /ales . 7 )A744,444* 1 A:7,444
Finally, we pro"ect new retained earnings )-%* that will be available to help finance the firm's operations during the ne#t year, -% 1 1 1 1 ;ew Income 5 'ividends .47 # !ro"ected /ales 5 .4. # !ro"ected /ales .4 )A7,744,444* A77,444
-%
70
'iscretionary Financing ;eeded )'F;* can now be calculated as follows3 'F; 1 1 1 TA 5 /> 5 -% A 74,444 5 :7,444 5 77,444 A$4,444
;ote that this problem solution works with the change in financing needs rather than totals. The same solution would result if we pro"ected total assets, total spontaneous financing, etc. Nowever, in this problem we do not know the e#isting levels of the assets, liabilities and owners' equity accounts. Thus, we cannot use this latter approach to solve the problem.
71
4-11A
a.
Projections based on expected sales levels June July August 200"000 200"000 180"000 40"000 40"000
Nov Dec Jan Feb Mar Apr May !ales 220"000 175"000 100"000 120"000 150"000 300"000 275"000 #ollections $ont% o& sales 20"000 24"000 30"000 60"000 55"000 '20() *irst +ont% '50() 87"500 50"000 60"000 75"000 150"000 !econd +ont% 66"000 52"500 30"000 36"000 45"000 '30() ,otal collections 173"500 126"500 120"000 171"000 250"000 P-rc%ases 65"000 78"000 97"500 195"000 178"750 130"000 130"000 Pa.+ents 65"000 78"000 97"500 195"000 178"750 130"000 #as% /eceipts 173"500 126"500 120"000 171"000 250"000 #as% 0isb-rse+ents -P-rc%ases 78"000 97"500 195"000 178"750 130"000 /ent 10"000 10"000 10"000 10"000 10"000 1t%er expendit-res 20"000 20"000 20"000 20"000 20"000 ,ax 0eposits 22"500 2nterest on !-, 610 994 borro3in4 ,otal 0isb-rse+ents 5et $ont%l. #%an4e 6e4innin4 #as% 6alance
137"500 100"000 90"000 82"500 267"500 222"500 117"000 0 130"000 117"000 267"500 222"500 130"000 117"000 10"000 10"000 20"000 20"000 22"500 104 0
72
108"000 127"500 247"500 209"360 160"994 182"604 147"000 65"500 22"000 -1"000 -127"500 87"500 86"500 -38"360 20"000 89"006 20"000 84"896 20"000 75"500 94"542
Additional *inancin4 5eeded '/epa.+ent) 7ndin4 #as% 87"500 6alance #-+-lative 6orro3in4
94"542 170"042 0 0
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Projections based on sale 20( %i4%er t%an expected #as% 6-d4et !ales #ollections Nov Dec Jan Feb Mar Apr May June July August 220"000 175"000 120"000 144"000 180"000 360"000 330"000 240"000 240"000 216"000 24"000 87"500 66"000 177"500 93"600 117"000 78"000 93"600 177"500 28"800 60"000 52"500 141"300 234"000 117"000 141"300 36"000 72"000 36"000 144"000 214"500 234"000 144"000 72"000 66"000 48"000 48"000
$ont% o& sales '10() *irst +ont% '60() !econd +ont% '30() ,otal collections P-rc%ases 78"000 Pa.+ents #as% /eceipts 'collection s) #as% 0isb-rse+ents P-rc%ases /ent 1t%er expendit-res ,ax 0eposits 2nterest on !-, borro3in4 ,otal 0isb-rse+ents 5et $ont%l.
90"000 180"000 165"000 120"000 43"200 54"000 108"000 99"000 205"200 156"000 214"500 205"200 300"000 156"000 156"000 300"000 321"000 267"000 140"400 0 156"000 140"400 321"000 267"000
93"600 117"000 234"000 214"500 156"000 156"000 140"400 10"000 20"000 10"000 20"000 10"000 20"000 22"500 10"000 20"000 923 10"000 20"000 1"325 10"000 20"000 22"500 198 10"000 20"000 0
73
123"600 147"000 286"500 245"423 187"325 208"698 170"400 53"900 -5"700 -142"500 -40"223 112"675 112"302 96"600
22"000
75"900
70"200 92"300
20"000
20"000
20"000 112"454 0
70"200
20"000
92"300 132"523
75
Projections based on sales 20( lo3er t%an expected !ales #ollections Nov Dec 220"000 175"000 Jan 80"000 16"000 87"500 66"000 62"400 52"000 Feb Mar Apr May June July August 96"000 120"000 240"000 220"000 160"000 160"000 144"000 19"200 40"000 52"500 24"000 48"000 24"000 48"000 44"000 32"000 32"000 80"000 66"000
$ont% o& sales '20() *irst +ont% '50() !econd +ont% '30() ,otal collections P-rc%ases 52"000 Pa.+ents #as% /eceipts 'collection s) #as% 0isb-rse+ents P-rc%ases /ent 1t%er expendit-res ,ax 0eposits 2nterest on !-, borro3in4 ,otal 0isb-rse+ents 5et $ont%l. #%an4e
169"500 111"700 96"000 136"800 200"000 214"000 178"000 78"000 156"000 143"000 104"000 104"000 93"600 0 62"400 78"000 156"000 143"000 104"000 104"000 93"600 169"500 111"700 96"000 136"800 200"000 214"000 178"000
78"000 156"000 143"000 104"000 104"000 10"000 20"000 10"000 20"000 22"500 10"000 20"000 297 10"000 20"000 662 10"000 20"000 22"500 9
74
92"400 108"000 208"500 173"297 134"662 156"509 123"600 77"100 3"700 -112"500 -36"497 65"338 57"491 54"400
6e4innin4 #as% 22"000 99"100 102"800 6alance Additional 29"700 *inancin4 5eeded '/epa.+ent) 7ndin4 #as% 99"100 102"800 20"000 6alance #-+-lative 29"700 6orro3in4
20"000
20"000
20"000 '859)
76"632 0
76"632 131"032 0 0
77
b.
Narrison will not be able to retire the A$44,444 note at the end of Iune. /ales >evels %#pected D$4< 5$4< Iune %nding +ash (alance A=.,7.$ $,.7. :8,8&$
.5 $A. a. +alculations of the sustainable rate of growth for A'!, Inc. for each of the years === through $44& 3 %&&' 74 ? $ */041( 84 4&( **0*( b. %&&% 4 :$$ *20%4( .. 4&( +0*( %&&* =4 878 *'01%( &8 4&( /0%( %&&& :4 84$ **03'( $? 4&( 10&( *+++ 84 784 *&01*( $. 4&( 304(
+ompare actual sales growth rates to the sustainable rate if growth for each year. %&&' %&&% $,$44 $$.$< =. < *'0*( %&&* ,?44 $?.8< ?.$< %&04( %&&& ,.44 8.:< :.4< +01( *+++ ,$44 ;9A 8..< N9A
A quick review of A'!'s balance sheets over the test years reveals a growing reliance on debt financing. The firm's debt ratio in === was roughly .?< while it had grown to :4< in $44&. Thus, A'! has financed its growth with increased debt financing.
78
.5 &A. a. %&&' >iabilities Assets !e5t to Assets ;et Income +ommon %quity ROE 'ividends 5 /ales Sales gro7t8 rate b. g6 !i))erence .5 .A. a. &&,444 7.,444 3*0*( &,444 $ ,444 *40'( ,$44 4&0&( 84,444 10*( Carrera :a,e Co0 %&&% & ,$44 74,.44 3*0+( $,?44 =,$44 *403( , $4 4&0&( 78,444 *301( %&&* $7,8?4 .&,$44 2+04( $,.44 :,7$4 *'01( =84 4&0&( .?,444 ''0'( %&&& 8,&$4 &$,.44 2&04( ,?44 8,4?4 **0%( :$4 4&0&( &8,444 %&0&( *+++ $,444 $:,444 4404( ,744 7,444 *&0&( 844 4&0&( &4,444 N9A
The sustainable rates of growth for each of the last five years are calculated as follows3 /03( "*02( /0/( 10+( /0%( %20*( 301( *'0'( 30&( N9A
b.
Findlay's sales and inventory balances are plotted in the figure below. ;ote that the relationship between the two variables is very nearly linear. Nowever, the intercept for the relationship is not Bero, consequently the percent of sales pro"ections are going to provide erroneous estimates of future inventories. The average of the inventories as a percent of sales ratio for the last five years was 8.&=<. Thus, we pro"ect inventories for a sales level of A&4 million to be A ,= :,444. That is, !ro"ected Inventories 1 # 1 .48&= # A&4 million 1 A ,= :,444
/imilarly, using the most recent year's percent of sales )7<* we calculate inventories to be A ,744,444. That is,
$44&
!ro"ected Inventories
1 1
percent ofsales
# 1 A ,744,444
He can make a forecast of inventories using the relationship observed between sales and inventories in part a by sketching a line through the observed relationship and e#trapolating the line to sales of A&4,444,444. 79
*2,&&&
%&,&&&
%2,&&&
'&,&&&
'2,&&&
80
/ales ;et Income %arnings per share 'ividends per share ;umber of +ommon /hares +urrent Assets Total Assets +urrent >iabilities >ong5term >iabilities Total >iabilities !referred /tock +ommon %quity Total >iabilities and %quity
78
*0 /ales
Pro@ected Net Inco,e using t8e >ercent o) sales ,et8od0 *+/3 10"0 18 2 28 2.28( 2.406( 1993 13"0 00 3 13 *+/1 10"9 17 35 0.32( 1994 13"5 00 3 25 *+// 11"4 90 6 50 5.66( 1995 14"0 00 3 37 *+/+ 12"4 92 2 19 1.75( 1996 14"5 00 3 49 *++& 13"9 75 5 41 3.87( 1997 15"5 00 3 73 *++* 13"2 59 98 0.74( *++% 12"1 40 2 70 2.22(
;et Income ;et Income9/ales Average ;et Income9/ales !ro"ected /ales !ro"ected ;et Income %0 /ales Total Assets +urrent >iabilities TA9/ales +>9/ales Average TA9/ales
Pro@ected total assets and current lia5ilities *+/3 10"0 18 12"4 03 2"2 34 123.81( 22.30( 99.54( *+/1 10"9 17 12"1 11 2"4 02 110.94( 22.00( *+// 11"4 90 11"9 68 2"4 68 104.16( 21.48( *+/+ 12"4 92 11"2 56 2"7 06 90.11( 21.66( *++& 13"9 75 12"1 30 2"9 10 86.80( 20.82( *++* 13"259 11"473 2"603 86.53( 19.63( *++% 12"140 11"468 2"517 94.46( 20.73(
79
21.23( 1993 13"0 00 12"9 40 2"7 60 1994 13"5 00 13"4 38 2"8 66 1995 14"0 00 13"9 36 2"9 72 1996 14"5 00 14"4 33 3"0 78 1997 15"5 00 15"4 29 3"2 91
83
'0
Pro@ected discretionar. )inancing re-uire,ents )or *++'"+10 *++' 12"9 40 2"7 60 5"8 94 3 59 2"7 20 1"2 07 *++4 13"4 38 2"8 66 5"8 94 3 59 2"7 54 1"5 65 *++2 13"9 36 2"9 72 5"8 94 3 59 2"8 00 1"9 11 *++3 14"4 33 3"0 78 5"8 94 3 59 2"8 58 2"2 44 *++1 15"42 9 3"29 1 5"89 4 35 9 2"94 0 2"94 5
,otal Assets #-rrent 8iabilities 8on4-ter+ 0ebt Pre&erred !toc9 #o++on 7:-it.; 0iscretionar. *inancin4 5eeded;;
O +ommon dividends 1 A . $ # the number of common shares outstanding in ==$ ) $7=,8 7,&?7* Thus, +ommon %quity ) ==&* 1 +ommon %quity ) ==$* D ;I ) ==&* 5 'ividends ) ==&* OO 'iscretionary Financing ;eeded 1 !ro"ected Total Assets 5 +urrent >iabilities 5 >ong5term 'ebt 5 !referred /tock 5 +ommon %quity
?4
$4< .4<
>iabilities and ,wner's %quity Accounts payable &,444,444 >ong5term debt $,444,444 Total >iabilities 7,444,444 +ommon stock ,444,444 !aid5in capital ,?44,444 -etained earnings .,$44,444 +ommon equity :,444,444 Total >iabilities and %quity $,444,444 'F; 1 .5$(. a. < +redit /ales /ales February @arch April )estimated* Accounts receivable )&9& 94.* plus credit sales )April* less coll. from February less coll. from @arch Accounts receivable ).9&494.* b. +ash /ales +ollections from February +ollections from @arch -ealiBed +ash during April
7< ;A ;A ;A
.5&(. (ased upon the pro"ections made, /impson can e#pect to have total assets ne#t year equal to A .:7 million made up of the A million in fi#ed assets plus A.:7 million in current assets ). 7 # 7m*. These assets will be financed by known sources of funding comprised of the firm's common equity, .?7million )A.: million D A.& million. 5 A. 7 million* plus payables and trade credit equal to < of pro"ected sales )A.77 million* which totals A .. million. This leaves A.&7 million, which will need to be raised to meet the financing needs of the firm.
81
.5.(. Instructor0s ;ote3 This is an introductory percent of sales financial forecasting problem. /tudents should be able to solve it after a first reading of the chapter. )a* !ro"ected Financing ;eeds 1 !ro"ected Total Assets 1 !ro"ected +urrent Assets D !ro"ected Fi#ed Assets 1)
: # $7m* D 8m D . m ?
1 A 7,?$$,$$$ )b* 'F; 1 !ro"ected +urrent Assets D !ro"ected Fi#ed Assets 5 !resent >T' 5 !resent ,wner's %quity 5 C!ro"ected ;et Income 5 'ividendsE 5 /pontaneous Financing 1) $7m* 'F; 1 A ,7??,??= )c* He first solve for the ma#imum level of sales where 'F; 1 43 'F; 1 )
: 5.47 5 ? .7 * /ales D 8. m 2$m 2=.7m D.8m ? : .7 # $7m* D 8m D . m 2 $m 2=.7m 2 ).47 # $7m 5 .8m* 2 ) # ? ?
1 .$7778 /ales 5..? million 1 4 Thus, /A>%/ 1 A ?,:?$,$?$ The largest increase in sales that can occur without a need to raise 6discretionary funds6 is A ?,:?$,$?$ 5 A ?m 1 A:?$,$?$. .57(. +ash Accounts -eceivable Inventories ;et Fi#ed Assets .58(. )a* +A/N (L'P%T 'ATA Ianuary February @arch April 44,444 4,444 &4,444 $74,444 @ay Iune Iuly August $:7,444 $74,444 $&7,444 84,444 A .4&m . .m .4m .?&m A$.4m +urrent >iabilities >ong5Term 'ebt +ommon %quity A.&=m .? m .?4m A$.4m
82
The +armel +orporation +ash (udget Horksheet ;ov 'ec A$$4,444 A :7,444 +ollections3 @onth of sale )$4<* First month )84<* /econd month )$4<* Total +ollections !urchases :4,444 !ayments ) mo lag* +ash -eceipts )collections* +ash 'isbursements !urchases -ent ,ther %#penditures Ta# 'eposits Interest on /hort5Term (orrowing Total 'isbursements ;et @onthly +hange (eginning +ash (alance Additional Financing ;eeded )-epayment* %nding +ash (alance +umulative (orrowing )b* Ian A 44,444 $4,444 47,444 ..,444 8=,444 = ,444 ::,444 8=,444 ::,444 4,444 $4,444 A Feb 4,444 $$,444 84,444 &7,444 :,444 :7,444 = ,444 :,444 = ,444 4,444 $4,444 @ar A &4,444 $8,444 88,444 $4,444 $,444 =$,744 :7,444 $,444 :7,444 4,444 $4,444 $&,444 Apr A$74,444 74,444 :?,444 $$,444 74,444 :7,444 =$,744 74,444 =$,744 4,444 $4,444 784 A 4:,444 A8$,444 $$,444 A?.,444 4 A $ ,444 A$$?,444 )A.,444* )A 8,444* ?.,444 ?4,444 78,444 A?4,444 4 A$4,444 78,444 A$$&,484 )A:&,484* $4,444 :&,484 A$4,444 A $=,484 @ay A$:7,444 77,444 74,444 $8,444 $& ,444 8.,744 :7,444 $& ,444 :7,444 4,444 $4,444 ,$= A$48,$= A$.,:4= $4,444 )$.,:4=* A$4,444 A 4.,&7 Iune A$74,444 74,444 87,444 74,444 $87,444 $,444 8.,744 $87,444 8.,744 4,444 $4,444 $&,444 ,4.. A$ ?,7.. A.8,.78 $4,444 ).8,.78* A $4,444 A7:,?=7 Iuly A$&7,444 .:,444 74,444 77,444 $7$,444 4 $,444 $7$,444 $,444 4,444 $4,444 7:= A .$,7:= A 4=,.$ $4,444 )7:,?=7* A: ,7$8 4 Aug 84k
::,444 :4,444
83
The firm will not have sufficient funds to cover the A$74,444 note payable due in Iuly.
.5:(.
+ash @arketable /ecurities Accounts !ayable ;otes !ayable !lant and %quipment Inventories
The answer depends on whether or not the firm has e#cess capacity. If there is e#cess capacity, plant and equipment will not vary directly with the level of firms sales. If there is no e#cess capacity, plant and equipment will vary directly. .5?(. )a* A &.&&m .8:m 4.44m 4.44m A&7.44m )b* Total financing requirements 1 A&7m55however, spontaneous financing accounts for all but the A .8:m increase in notes payable )discretionary financing needed*. )c* /ee answer to question .5 . .5=(. Instructor0s ;ote3 This problem follows the te#t e#ample very closely and provides an e#cellent assigned e#ercise to accompany a first reading of the chapter. )a* %stimating Future Financing ;eeds /ymbolic >ogic +orporation )/>+*, Inc. !ro"ected ;eed for 'iscretionary Financing !resent >evel A$.7m A&.4m A7.7m A. .4m A.7m 555555 < of /ales )A7m* 1 74< 1 84< 1 $4< 1 4< 5555555 A ..$.m ;o +hange A$.44m ;o +hange .74m A .7m D )4: # A?m* 1 A $.48m A$.78m A7.74m A?.?4m !ro"ected >evel )(ased on A?m /ales* .74 # A?m 1 A ..4m .84 # ?m 1 A ..?4m A ?.?4m .$4 # ?m 1 .84m . 4 # ?m 1 .?4m !lug Figure .?.m +urrent assets ;et fi#ed assets A$4.44m 7.44m A&7.44m Accounts payable ;otes payable (onds payable +ommon equity
+urrent Assets ;et Fi#ed Assets Total Assets Accounts !ayable Accrued %#penses ;otes !ayableO
+urrent >iabilities A .74m >ong5Term 'ebt A$.44m +ommon /tock .74m -etained %arningsOO .74m +ommon %quity A$.44m Total >iabilities and %quity
O;otes payable is a balancing figure which equals discretionary financing needed, 'F; or3 Total Assets 5 Accounts !ayable 5 Accrued %#penses 5 >ong5Term 'ebt 5 +ommon /tock 5 -etained %arnings 1 A?.?4m 5 .84m 5 .?m 2 $m 5 .7m 2 $.48m 1 A .?.m. OOThe pro"ected level of retained earnings equals the beginning balance of A .74m plus net income for the period ).4: # A?m*.
84
)b*
'ebt -atio 1 8.< 1 : < The growth in the firm's assets )due to the pro"ected increase in sales* was financed predominantly with notes payable )a current liability*. This led to a substantial deterioration in the firm's liquidity )as reflected in the current ratio* and an increase in its use of financial leverage. )c* The slower rate of growth in sales would have allowed />+ to finance a larger portion of the funds needed using retained earnings. .5 4(.Instructor0s ;ote3 This problem differs from the te#t discussion of 6discretionary financing needed6 in that it relies on the pro"ected change in assets rather than the pro"ected level of total assets. Lnder these circumstances 'F; 1 TA 5 /> 5 -% where TA 1 the pro"ected change in total assets, which is the amount of new financing needed )in total*M /> 1 the pro"ected change in spontaneous liabilitiesM and -% 1 the pro"ected change in retained earnings that will be available to finance a portion of the firm's needs for new funds. First, we estimate that the pro"ected change in assets during the coming year will be3 TA 1 1 ..4 /ales ..4 )A744,444* 1 A$44,444
Thus, total new financing of A$44,444 must be obtained from somewhere during the ne#t year to support the growth in firm sales. ;e#t, we pro"ect the change in spontaneous liabilities )/>* /> 1 1 . 7 # /ales . 7 )A744,444* 1 A:7,444
Finally, we pro"ect new retained earnings )-%* that will be available to help finance the firm's operations during the ne#t year, -% -% 'F; 1 1 1 1 1 1 1 ;ew Income 5 'ividends .47 # !ro"ected /ales 5 .4. # !ro"ected /ales .4 )A7,744,444* A77,444 TA 5 /> 5 -% A$44,444 5 :7,444 5 77,444 A:4,444
;ote that this problem solution works with the change in financing needs rather than totals. The same solution would result if we pro"ected total assets, total spontaneous financing, etc. Nowever, in this problem we do not know the e#isting levels of the assets, liabilities and owners' equity accounts. Thus, we cannot use this latter approach to solve this problem. .5 (. @inimum +ash (alance 1 $7,444
85
Nistorical /ales and (ase +ase /ales !redictions for Future /ales Ianuary $4,444 @ay February 84,444 Iune @arch .4,444 Iuly April =4,444 August /ales %#pansion < 1 4.44< !urchases as a < /ales 1 :7< +ollections3 +urrent @o. &4<
Annual Interest -ate 1 $.44< @o. >ater $ @o. >ater &4< .4<
86
Cas8 Budget )or Aanuar. t8ru Aul. 5ased on eB>ected sales ;ov 'ec Ian Feb /ales $&4,444 $$7,444 $4,444 84,444 +ollections3 @onth of sales &8,444 .?,444 First month 8:,744 &8,444 /econd month =$,444 =4,444 Total +ollections =7,744 :.,444 !urchases =4,444 $4,444 47,444 .$,744 !ayments =4,444 $4,444 47,444 +ash -eceipts =7,744 :.,444 )collections* +ash 'isbursements !ayments for !urchases -ent ,ther %#penditures Ta# 'eposits Interest on /hort5Term (orrowing Total 'isbursements ;et @onthly +hange Analysis of (orrowing ;eeds (eginning +ash (alance %nding +ash );o (orrow* ;eeded )(orrowing* >oan -epayment %nding +ash (alance +umulative (orrowing $4,444 $,444 $4,444 47,444 $,444 $4,444
August $$4,444
87
A &:,444
A$4 ,444 A$44,:74 A$ =,8:& A$ 8,78. A =:,7.7 A ,=&8 A&4,.77 $7,444 77,.77 4 &4,.77 A$7,444 $.,4&$
A&:,444 )A8&,444* )A&:,:74* )A&=, :&* : ,744 4?,744 4 4 A 4?,744 4 4?,744 .7,744 4 4 A.7,744 4 .7,744 :,:74 :,$74 4 A$7,444 A :,$74
$7,444 $7,444 ) ., :&* $8,=&8 &=, :& 4 4 ,=&8 A$7,444 A $7,444 A78,.$& A7.,.?:
88
Cas8 Budget )or Aanuar. t8ru Aul. 5ased on a %&( increase in sales ;ov 'ec Ian Feb @ar Apr /ales $&4,444 $$7,444 ..,444 =$,444 8?,444 $$?,444 +ollections3 @onth of sales .&,$44 7:,844 74,.44 8?,.44 First month 8:,744 .&,$44 7:,844 74,.44 /econd month =$,444 =4,444 7:,844 :8,?44 Total +ollections $4$,:44 =4,?44 87,844 =7,844 !urchases 4?,444 !ayments +ash -eceipts )collections* +ash 'isbursements !ayments for !urchases -ent ,ther %#penditures Ta# 'eposits Interest on /hort5Term (orrowing Total 'isbursements ;et @onthly +hange Analysis of (orrowing ;eeds (eginning +ash (alance %nding +ash );o (orrow* ;eeded )(orrowing* >oan -epayment %nding +ash (alance ..,444 4?,444
August $8.,444
$8,444 : ,444 $4$,744 $$7,444 ?=,444 =?,444 ..,444 $8,444 : ,444 $4$,744 $$7,444 ?=,444 =?,444 202"700 190"800 165"600 195"600 216"600 262"200 273"600
: ,444 $,444 $4,444 $8,744 A$$=,744 5A8&,=44 ?:,744 $&,844 ,.44 4 A$7,444
=?,444 $,444 $4,444 8:$ A$&4,8:$ A.$,=$? $7,444 8:,=$? ).$,=$?* A$7,444
88
A :8,444 A 7?,444 A$8,:44 $?,444 7.,:44 4 4 A7.,:44 A&$,?44 7.,:44 ?:,744 4 4 A?:,744
A$&.,7 . A$7:,.4& A$.?,& 5A&?,= . 5A.4,?4& $7,444 5 &,= . &?,= . 4 A$7,444 A &,??=
+umulative (orrowing
,.44
A.4,& .
A? ,
A8:,$$?
$.,&44
Cas8 Budget )or Aanuar. t8ru Aul. 5ased on a %&( decrease in sales ;ov 'ec Ian Feb @ar Apr /ales $&4,444 $$7,444 =8,444 $?,444 $,444 7$,444 +ollections3 @onth of sales $?,?44 &?,.44 &&,844 .7,844 First month 8:,744 $?,?44 &?,.44 &&,844 /econd month =$,444 =4,444 &?,.44 7 ,$44 Total +ollections ??,&44 7:,$44 4,.44 &4,.44 !urchases :$,444 !ayments +ash -eceipts )collections* +ash 'isbursements !ayments for !urchases -ent ,ther %#penditures Ta# 'eposits Interest on /hort5Term (orrowing Total 'isbursements ;et @onthly +hange Analysis of (orrowing ;eeds (eginning +ash (alance %nding +ash );o (orrow* ;eeded )(orrowing* >oan -epayment %nding +ash (alance =8,444 :$,444
August :8,444
?.,444 .,444 &7,444 74,444 $8,444 &$,444 =8,444 ?.,444 .,444 &7,444 74,444 $8,444 &$4,444 ??"300 157"200 110"400 130"400 144"400 174"800 182"400
89
A $?,444 A A84,&44
8,444 A. ,$44
A 8:,444 A ?$,444 A ?.,? ? A 8.,. ? 5A&8,844 5A&:,844 5A 4,4 ? 8:,.44 &4,?44 4 4 A&4,?44 &4,?44 $7,444 58,?44 .,=?$ & ,?44 4,4 ? 4 4 A$7,444 A $7,444 A :,=?$ $7,444 .$,=?$ ) :,=?$* A$7,444
+umulative (orrowing
A& ,?44
A. ,? ?
$&,?&8
92
b.
Nalsey will not be able to retire the A$44,444 note at the end of Iuly. /ales >evels %#pected D$4< 5$4< Iuly %nding +ash (alance A$7,444 $7,444 $7,444
90