Question

1. Answer the following questions regarding financial forecasting:

a. Which items comprise operating current assets? Why is it reasonable to assume that they grow

proportionally to sales or COGS? Which ones are proportional to sales and which ones are

proportional to COGS? Explain

b. What are some reasons that net PP&E might grow proportionally to sales, and what are some

reasons that it might not?

c. What are spontaneous liabilities and why is it reasonable to assume they grow at proportion of

sales or COGS? What are spontaneous liabilities also known as (in fact, we used this alternate

name in previous modules)? What are the most common examples of spontaneous liabilities?

Answer 1

1. a. operating current assets comprises of

· Cash

· Accounts Receivable

· Inventory

· Prepaid expenses

Accounts receivable are due from customers for sales and Inventory is due to purchase of material for manufacture of finished goods or merchandise purchase. Prepaid expenses are relating to Operating expenses for running the business.

Theses current assets generate out of sales hence it is reasonable to assume that they grow proportionately to sales or COGS.

Accounts receivable grow proportionate to sales and Merchandise inventory and prepaid expenses grow proportionate to Cost of goods sold (since inventory is at purchase cost)

b. PP &E which are directly linked to generation of sales will growth proportionate to sales. For example investment in assets in factories, etc,

Fixed Assets which are not connected with sales will not grow proportionate to sales. For example investment in corporate office building, Investment in Land, etc

c. Spontaneous liabilities are liabilities which generate out of sales. For example Current Liabilities and Accrued operating expenses. These liabilities generate mainly due to operations of the firm. Hence it is reasonable to assume they grow proportion of sales or COGS.

Spontaneous liabilities are also know as Current Liabilities

Examples include Accounts payable, Accrued expenses, Income tax payable, etc