Question

The Manning Company has financial statements as shown next, which are representative of the company’s historical average. The firm is expecting a 30 percent increase in sales next year, and management is concerned about the company’s need for external funds. The increase in sales is expected to be carried out without any expansion of fixed assets, but rather through more efficient asset utilization in the existing store. Among liabilities, only current liabilities vary directly with sales.

Income Statement
Sales	$	270,000
Expenses		217,400
Earnings before interest and taxes	$	52,600
Interest		8,800
Earnings before taxes	$	43,800
Taxes		16,800
Earnings after taxes	$	27,000
Dividends	$	10,800

Balance Sheet
Assets			Liabilities and Stockholders' Equity
Cash	$	6,000	Accounts payable	$	28,400
Accounts receivable		54,500	Accrued wages		2,100
Inventory		61,000	Accrued taxes		4,600
Current assets	$	121,500	Current liabilities	$	35,100
Fixed assets		98,000	Notes payable		8,800
			Long-term debt		24,000
			Common stock		122,000
			Retained earnings		29,600
Total assets	$	219,500	Total liabilities and stockholders' equity	$	219,500

Using the percent-of-sales method, determine whether the company has external financing needs, or a surplus of funds. (Hint: A profit margin and payout ratio must be found from the income statement.) (Do not round intermediate calculations.)
  

Answer 1

Solution:
	The company has external financing needs of $4,860
Working Notes:
	First we calculate profit margin and payout ratio
	Profit margin= Earnings after taxes / Sales
	Profit margin= 27,000/ 270,000
	Profit margin= 0.10 = 10%
	Payout ratio= Dividends / Earnings after taxes
	Payout ratio=10,800/27,000
	Payout ratio=0.40 = 40%
	Projected sales = current sales x (1+ % increase)
	Projected sales = 270,000 x (1+ 0.30)
	Projected sales = 351,000
	Change in sales = Projected sales - current sales
	Change in sales =351,000 - 270,000
	Change in sales =81,000
	As due to increase in sales change current liabilities and current assets
	Increase in current assets due change in sales
	= (current current assets/current sales) x Change in sales
	= (121500/270000) x 81000
	= 36,450
	Increase in current liabilities due change in sales
	= (current current liabilities/current sales) x Change in sales
	= (35,100/270000) x 81000
	= 10,530
	Profit on projected sales net of payment of dividend
	= projected sales x profit margin x (1-dividend payout ratio)
	=351,000 x 10% x (1-0.40)
	=351,000 x 0.10 x 0.60
	=21,060
	Required net fund
	= Increase in current assets due change in sales - Increase in current liabilities due change in sales - Profit on projected sales net of payment of dividend
	=36,450 - 10,530 - 21,060
	=4,860
Notes:	Required net fund positive means the company required external funding by 4,860 .
Please feel free to ask if anything about above solution in comment section of the question.