Exam 9: Financial Planning and Forecasting Financial Statements

On the basis of historical relationships between its balance sheet items and its sales, profit margin, and dividend policy, Thode Corporation's analysts have graphed the relationship of additional funds needed (on the Y-axis) to possible growth rates in sales (on the X-axis). If Thode decides to increase the percentage of earnings paid out as dividends, which of the following changes would occur in the graph?

Pro forma financial statements, as discussed in the text, are used primarily to assess a firm's historical performance.

Brown & Sons recently reported sales of $100 million, and net income equal to $5 million. The company has $70 million in total assets. Over the next year, the company is forecasting a 20 percent increase in sales. Since the company is at full capacity, its assets must increase in proportion to sales. The company also estimates that if sales increase 20 percent, spontaneous liabilities will increase by $2 million. If the company's sales increase, its profit margin will remain at its current level. The company's dividend payout ratio is 40 percent. Based on the AFN formula, how much additional capital must the company raise in order to support the 20 percent increase in sales?

A firm's profit margin is 5 percent, its debt/assets ratio is 56 percent, and its dividend payout ratio is 40 percent. If the firm is operating at less than full capacity, then sales could increase to some extent without the need for external funds, but if it is operating at full capacity with respect to all assets, including fixed assets, then any positive growth in sales will require external financing.

The percentage of sales method would be appropriate if, in a regression of sales on each asset and spontaneous liability, the regression line was linear and passed through the origin.

The term "spontaneously generated funds" generally refers to increases in the cash account that result from growth in sales, assuming the firm is operating with a positive profit margin.

To determine the amount of additional funds needed, you may subtract the expected increase in liabilities (a source of funds) from the sum of the expected increases in retained earnings and assets (both uses of funds).

The percentage of sales method produces accurate results unless which of the following conditions is (are) present?

Two firms with the same capital intensity ratios were generating the same sales. However, one firm was operating below capacity. If the two firms expect the same growth in sales in the next period, it is more likely that the firm operating at full capacity will need additional funds, other things held constant.

If the capital intensity ratio (A*/S0) of a firm actually decreases as sales increase, use of the percentage of sales method will typically understate the amount of additional funds required, other things held constant.