Question

Cash	1		AP	2
Receivables	15		NP	11
Inv	11		LOC	0
Total CA	27		Acc	5
NFA	24		Total CL	18
Total Assets	51		Long-term Debt	12
			Common stock	15
			RE	6
			Total L + CE	51
Given the above balance sheet and the below info, determine the AFN.
CurrentSales	100
Net income	5
Sales Growth	15%
Dividends	1

Answer 1

Additional Funds Needed (AFN) is calculated using the below formula:

------------------(1)
where,
A₀ - current level of assets. In our case, A₀ = 51. Here, we assume that the plant is operating at full capacity and that each asset item grows proportionally with sales.
L₀ - current level of liabilities which would increase with the increase in sales. In our case, we will include only accounts payable and accruals in L₀ as only these would increase with the increase in sales. Change in sales is not directly related to change in notes payable. The impact on retained earnings will be calculated from the expression S₁ * PM * RR. So L₀ = 7
S₀ - current year sales = 100
S₁ - next year sales which is 100 * 1.15 = 115
S - increase in sales in the next year, i.e., S₁ - S₀ = 15
PM - profit margin = 5%
RR - retention ratio which is (1 - payout ratio). Since dividend of 1 has been paid out of the net income of 5, the payout ratio is 1/5 = 20%. So RR = 80%.

Substituting these values in (1), we get

AFN = 51 * (15/100) - 7 * (15/100) - (115 * 0.05 * 0.80)
= 7.65 - 1.05 - 4.60
= 2.00

Hence, an additional funding of 2.0 would be needed to support a 15% sales growth in the next year.