Question

Given a company, identify which “plug” variables the company could

consider in addressing the EFN, and the pros and cons of using each variable.

Answer 1

Answer to finance question

Q: which “plug” variables the company could consider in addressing the EFN, and the pros and cons of using each variable.

Ans: A plug variable is used to match the balance sheet i.e. Proforma Balance sheet. A plug variable varies to ensure that balance is matched with the given income statement and consistent with the same.

A external financing need is requirement of a corporate to generate cash from outside investors apart from internal shareholders. This it is true in case of such industries which are capital intensive. Thus the higher predictable growth start-ups and more predictable future earning companies use debts financing hence they use external financing.

There are various plug variables to a financial statement. In given scenario, EFN , plug variation is Long term debts such equity and Dividend. Let us take an example as shown below

A recent years financial statement is shown below

Sales = $1000

Cost= $800

Net Income = $200 ( 1000-800)

Balance sheet figures as shown below

Asset=$500

Debt= $250

Equity= $250

We assume that all the variables are directly related to sales so all item will grow with growth in sale. Say, sale will increase by 20% hence all the items will increase by 20%.

The result is

Sales = $1200

Cost= $960

Net Income=$240

Balance sheet items with 20% increase

Asset=$600

Debts=$300

Equity=$300

On comparison, we find that income is $240 but the equity increased by $50 only. The answer is that the difference between 240-5-=190 is paid as cash dividend hence in this case, dividend is the plug variable.