Bus fin ch.6 Concept

The first, and most critical, step in constructing a set of forecasted financial statements is the sales forecast

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A typical sales forecast, though concerned with future events, will usually be based on recent historical trends and

events as well as on forecasts of economic prospects.

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Errors in the sales forecast can be offset by similar errors in costs and income forecasts. Thus, as long as the errors are

not large, sales forecast accuracy is not critical to the firm.

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As a firm's sales grow, its current assets also tend to increase. For instance, as sales increase, the firm's inventories

generally increase, and purchases of inventories result in more accounts payable. Thus, spontaneously generated funds

arise from transactions brought on by sales increases.

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The term "spontaneously generated funds" generally refers to increases in the cash account that result from growth in

sales, assuming the firm is operating with a positive profit margin.

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A rapid build-up of inventories normally requires additional financing, unless the increase is matched by an equally

large decrease in some other asset.

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If a firm wants to maintain its ratios at their existing levels, then if it has a positive sales growth rate of any amount, it

will require some amount of external funding.

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To determine the amount of additional funds needed (AFN), you may subtract the expected increase in liabilities,

which represents a source of funds, from the sum of the expected increases in retained earnings and assets, both of which are uses of funds.

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When developing forecasted financial statements there are some inputs that management controls such as the growth

rate and operating costs/sales ratio, while other inputs such as the tax rate and interest rate are not under its control.

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If a firm with a positive net worth is operating its fixed assets at full capacity, if its dividend payout ratio is 100%, and

if it wants to hold all financial ratios constant, then for any positive growth rate in sales, it will require external financing.

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