Question

Question

Briefly define the Additional Funds Needed (AFN) Equation Method.

The AFN equation shows that external financing requirements depend on five key factors. Briefly define each.

Answer 1

Additional Funds Needed is fund required to finance increased assets of the organisation. Additional funds needed (AFN) is calculated as the excess of required increase in assets over the increase in liabilities and increase in retained earnings

AFN equation: Refer image attached

As per AFN Equation, External Financing depends on following five factors

1. Sales Growth: Highly growing companies required large increase in assets to supports the growth and for the same such companies need external financing which depends on rate of sales growth.

2.Capital intensity: Defined as Assests required per unit sales. So higher the ration more capital is required for each sales unit.

3.Profit Margin: Higher the profit margin more the money available to finance its assets so lesser the external funds required.

4. Retention ratio: Lesser the dividend payout, higher the funds available for company to finance its assets need. So need for external financing is less.

5.Spontaneous Asset to Liability ration: Comapnies that spontaneously generates more liabilities through account payable and accrual ,will have reletively lower need of external financing.