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Financial analysis and planning are useful both to help
anticipate future conditions and, more importantly as a
starting point for planning actions that will influence the
future course of events.
Learning objectives
After learning this chapter, you should be able to:
1. Distinguish the concept of financial analysis, planning
and
forecasting.
2. Construct the sources and uses of cash flows statement.
3. Construct the cash budget.
4. Develop the pro forma financial statement i.e. the pro
forma
balance sheet and income statement.
5. Analyse/interpret the companys performance based on ratio
and cash flows analysis.
Financial Forecasting
GOAL
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4.0 INTRODUCTION
Financial forecasting concentrate on the expected outcomes from
decisions committed by
the firm's management and is a crucial part of the planning
process. In essence, forecasting
concern with the future or the financial consequences of present
day decision committed by
a financial manager. It is more of a prediction of the expected
outcomes and therefore aids
decision-maker to fully use the resources at hand to ensure the
planned objectives are met.
It is crucial that all various departments' forecasts are
consistent with each other; that is the
basis of forecast must be based on common forecast variables
such as inflation, general
level of economic activity, and level of interest to name a few.
This is to ensure the various
departments or units will work towards common objective and
internal conflicts can be
avoided.
The information-collected will provides managers the basis for
planning and coordination of
firm's scare resources to maximize the shareholders' wealth.
Forecasting is therefore
important to ensure that the firm is able to operate without any
unnecessary delays or shut
down due to mismanagement of resources. For example, in case of
funds' shortages the
company may have to discontinue its operations and other
complications that may lead to
technical insolvency and bankruptcy. This chapter will focus on
forecasting of cash and
funds requirements for the firm over a specified period.
4.1 CASH FLOW ANALYSIS The cash flow cycle shows how the actual
net cash flows into and out of the firm during a
specified period. It concerns only with the actual movement of
the cash; and as such
expenses on depreciation and sales on credit do not constitute
as cash flows.
Figure 4-1; illustrate in details the cash flow cycle within a
firm. It shows the effect of various
transactions that causes the cash movement that tends to
increase or decrease the funds
accordingly. The shaded rectangle represents the balance sheet
accounts where else clear
rectangles represent income statement items. Please refer to
Chapter 11 for additional
materials on cash management.
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Figure 4.1 Cash and Materials Flows 4.2 CASH FLOW CONCEPT Cash
flow means the difference between the number of dollars that came
in and the number
of dollars that went out.
Based on balance sheet identify, the value of a firms assets is
equal to the value of its
liabilities plus the value of its equity. Similarly, the cash
flow from the firms assets must
equal the sum of the cash flow to creditors and the cash flow to
stockholders.
Therefore, the cash flow identify is known as
Sales Inventories
Depreciation
Cash Sales Net fixed Assets
Accounts receivable
Collection of receivable
Issue shares
EQUITY Preferred equity Common equity
Retained earnings
Capital budgeting
Cash and marketable securities
Pay dividends, Taxes and dividends
Borrow funds
Use of labor and buy materials
Accounts payables and accruals
Payments to reduce payables and accruals
Loan repayments
DEBT Notes payable
Long-term borrowings Bonds
Cash flow from assets = cash flow to creditors + cash flow to
stockholders
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a. Cash Flow from Assets
It involves three components: operating cash flow, capital
spending and
change in net working capital
(i) Operating cash flow
It refers to the cash flow that results from the firms
day-to-day
activities of producing and selling. Normally it consists
of:
Most of the time the firm must have a positive operating cash
flow to
show that a firms cash inflows from its business operations
are
sufficient to cover its everyday cash outflows. If a company is
having a
negative operating cash flow it means that the company is in
trouble.
(ii) Capital Spending
It refers to the net spending on fixed assets. The common
items
involve are:
If the net capital spending is positive, it means that the money
spend
to purchase fixed assets is than the money received from the
sale of
fixed assets. On the other hand, if net capital spending is
negative, it
means that the firm sold off more assets than it purchased.
Earnings before interest and taxes (EBIT)
+ Depreciation
- Taxes
Ending net fixed assets
- Beginning net fixed asset
+ Depreciation
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(iii) Change in networking capital
It measures the net change in current assets over current
liabilities for
the period being examined. So, change in net working capital is
equal
to
This change in net working capital is often referred to as the
addition
to networking capital.
b. Cash Flow to Creditors and Stockholders
It represents the net payments to creditors and owners during
the year. The
calculation for cash flow to creditors is equal to interest paid
less net new
borrowing and cash flow to stockholders (bondholders) is
dividends paid less
net new equity raised.
An example of Cash Flow Suppose that a company started the year
with RM2,130 in current assets and
RM1,620 in current liabilities, and the corresponding ending
figures were
RM2,260 and RM1,710. Beginning net fixed assets were RM500 and
ending
net fixed assets were RM750.
During the year, the company had sales of RM600 and cost of
goods sold of
RM300. Depreciation was RM150 and interest paid was RM30. Taxes
were
RM41 and dividends paid were RM30. Suppose we also know that
the
company did not sell any new equity for the year. To calculate
cash flow from
assets based on the above example, we should start with:
(i) Operating cash flow (OCF)
OCF = EBIT + Dep Taxes
= RM150 + RM150 RM41
= RM259.00
Ending net working capital
- Beginning net working capital
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(ii) Net Capital Spending = Ending Net Fixed Assets
- Beginning net Fixed Assets
+ Depreciation
= RM750 RM500 + RM150
= RM400.00
(iii) Change in Net Working Capital (NWC)
= Ending net working capital
- Beginning net working capital
= [RM2260 RM1710] [RM2130 RM1620]
= RM550 RM510
= RM40.00
Therefore, putting all the information together, we have cash
flow assets
= Operating cash flow (OCF)
- net capital spending
- Change in NWC
= RM259 RM400 RM40
= -RM181
Next, to calculate cash flow to stockholders and creditors.
Since there is no
new equity has been raised, therefore cash flow to stockholders
is just equal
to cash dividend paid = RM30. From the cash identity, we know
that:
Cash Flow from assets = Cash flow to creditors
+ Cash flow to stockholders
- RM181 = Cash flow to creditors + RM30
Therefore, cash flow to creditors
= -RM181 RM30
= -RM211
Since cash flow to creditors is RM211 and interest paid is RM30,
then we can
determine net new borrowing
Cash flow to creditors = Interest paid
- net new borrowing
-RM211 = RM30 (net new borrowing)
:. Net new borrowing = (RM30 + RM211)
= -RM241
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This amount shows that the company must have borrowed RM241
during the
year to help finance the fixed asset expansion.
4.3 THE STATEMENT OF CASH FLOWS Those activities that bring in
cash are called sources of cash. Those activities that involve
spending cash are called uses (or applications) of cash. We can
summarize the sources and
uses of cash in the form of a financial statement and is called
the statement of cash flows.
To get started, consider the balance sheets for a company in
Table 4.1. Then trace the
changes in the firms balance sheet to see how the firm obtained
its cash and how the firm
spent its cash during some time period.
Next, identify either the changes is a use of cash or source of
cash. By using a simple
technique, any increase in an asset account or a decrease in
liability account is a use of
cash. On the other hand, any decrease in an asset account or an
increase in a liability
account is a source of cash.
To further trace the flow of cash through the firm during the
year, we need an income
statement as shown in Table 4.2. So an addition to retained
earnings in the balance sheet is
just the difference between the net income and the dividend.
Table 4.1 Era Mewah Balance Sheet as at 31/12/97 and 31/12/98
(000s)
ASSETS
31/12/97 (RM000)
31/12/98 (RM000)
Cash Account receivable Inventory Current assets Plant and
equipment Less : Accumulated Depreciation Net plant and equipment
Total assets
200450550
1,200
2,200
1,0001,2002,400
150 425 625
1,200
2,600
1,200 1,400 2,600
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LIABILITIES AND OWNERS EQUITY
31/12/97
(RM000) 31/12/98 (RM000)
Account payable Notes payable current (9%) Current liabilities
Bonds Owners equity Common stock Paid in capital Retained earnings
Total owners equity Total liabilities and owners equity
200
0
200600
300600700
1,600
2,400
150 150
300 600
300 600 800
1,700
2.600
Table 4.2 Era Mewah Income Statement (Year Ended 31/12/98)
1998 (RM000s)
Sales Cost of goods sold Gross profit Operating expenses
Depreciation Net operating income Interest expenses Net income
before taxes Taxes (40%) Net income Dividend To retained
earnings
1,450
850 600
40
200 360
60 300 120 180
80 100
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By referring to the balance sheets and income statement we can
gather the sources and
uses of cash.
Era Mewah Balance Sheet as at 31/12/97 and 31/12/98
ASSETS 1997
(RM000) 1998
(RM000) Changes Sources Use
Cash Account receivable Inventory Current assets *Plant and
equipment Less: Accumulated Depreciation Net plant and equipment
Total assets
200450550
1,2002,2001,000
1,2002,400
150425625
1,2002,6001,200
1,4002,600
-50-25+75
+400+200
9 9 9
9 9
* For the fixed assets, we will take the gross for consideration
not the net in order to find the current figure of fixed asset
sold/purchase
LIABILITIES AND OWNERS EQUITY 1997
(RM000) 1998
(RM000) Changes Sources Use
Account payable
Notes payable-current (9%)
Current liabilities Bonds Owners equity Common stock Paid-in
capital ** Retained earnings Total owners equity Total liabilities
and Owners equity
200
0
200 600
300 600 700
1,600
2,400
150
150300600
300600800
1,700
2,600
-50
+150
no change no change no change neither a sources nor a use
9
9
From the income statement, the sources will be:
a) NPAT or net income = RM180,000
b) Depreciation = RM200,000
and the use will be:
Payment or dividend = RM80,000
** Retained earnings is neither a source nor a use because the
current amount of retained
earnings is already being included in the net profit after taxes
or net income.
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ERA MEWAH Cash Flow Statement
For The Year Ended 31/12/98
Beginning cash balance RM200.00
Net Income RM180.00
Plus: Depreciation RM200.00
Accounts receivable RM 25.00
Less: Inventory (RM 75.00)
Accounts payable (RM 50.00)
Net cash flow from operating activity RM280.00
(Cash flow from Investment)
Purchase of Gross
Plant & Equipment (RM400.00)
Net cash flow investment activity (RM400.00)
(Cash flow from Financing)
Dividend paid (RM 80.00)
Plus: Notes payable RM150.00
Net cash flow from financing activity RM 70.00
Net activity decrease in cash (RM 50.00)
Ending cash balance RM150.00
The statement of cash flows presented here is based on an
indirect method. The basic idea
is to group all the changes in the financial statements into
three categories: operating
activities, financing activities and investment activities.
Analysis: the major sources of cash are from the depreciation,
net income and notes payable
whereas the major use will be purchasing fixed assets i.e. plant
and equipment.
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What is the difference? For the sources and uses of cash
statement, we categories sources & Uses of cash in terms
of operations, working capital and long-term financing.
ERA MEWAH Sources and Uses of Cash Statement
For the year ended 31/12/98 (000)
Cash beginning of year RM200.00
Sources of cash
Operations:
Net Income RM180.00
Depreciation RM200.00
RM380.00 Working Capital:
Dec. in accounts receivable RM 25.00
Inc. in notes payable RM150.00
Total Sources of cash RM555.00
Uses of cash
Working Capital:
Inc. in inventory RM 75.00
Dec. in accounts payable RM 50.00
Long-term Financing:
Fixed-term Financing:
Fixed asset acquisitions RM400.00
Dividends paid RM 80.00
Total uses of cash RM605.00
Net deduction in cash RM 50.00
Cash, end of year RM150.00
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4.4 CASH BUDGETING
The cash budgeting is a detail financial forecasting technique
that identifies the cash receipts
(inflows) and disbursements (outflows) relative to its amount
and timings of occurrence. For example, let assume that all sales
are on credit and collected equally in the month of
sales and one month after. Thus, for July's sales, the cash
budgets will recognize 50% of the
cash flow involved in July and the balance is in August.
Thus, cash budget represents cash forecasting set forth the
estimates of cash receipts and
disbursements over a specified period of time. It will give
indications to the management of
any shortages or excess cash. It helps the financial managers to
manage cash more
effectively in order to maximize the firm's value. The
development of cash budgets follows
certain steps:
1. Determine the amount and timing of cash receipts. The cash
inflows are normally
from cash sales, account receivable and other non operating
income; such as receipt
of rental properties and dividends received from holding of
other companies common
stock.
2. Determine the amount and timing of cash disbursement. All
cash outflows
whether it from operations and/or other bulk purchases such as
the purchases of
machinery.
3. Determine the net cash flow. The net cash flows equals to
total receipts minus total disbursement.
4. Prepare the cash reconciliation accounts. It takes into
account the net cash flow,
beginning cash balance and minimum cash requirement to determine
the firm's cash
position after each budgeting period. The cash reconciliation
will provide necessary
information for the firm to develop its short-term financing or
investment strategies.
To illustrate the preparation of cash budget, consider the
following examples. Pearls
Furniture deals with custom-made furniture in which orders
received one month before
delivery or sales. Therefore, sales for the following periods
can be predicted with relative
accuracy. The company regularly prepares a monthly cash budget
for a two-month's period
for planning and controlling purposes. Actual sales for the last
four months, along with
forecasted sales for the next four months of 19X2, are presented
below (thousands of RM):
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January 360.00 March 320.00 May 290.00 July 350.00 February
400.00 April 310.00 June 330.00 August 400.00
As a practice, Pearls Furniture: 1. Requires 20 percent deposit
on all orders one month before sales or delivery, and the
balance can be collected equally in the month of sales and one
month after.
2. Cost of goods sold consists of wood products that equal 30
percent of sales.
3. The materials are purchased one month before it is used and
20 percent is paid in
the month of purchase and the balance one-month after.
4. The nature of the operations incurs a high labor cost that
accounts for 40 percent of
sales and it is paid for in the month, which it occurs.
5. Other monthly fixed expenses are;
a. Rent RM5,500,
b. General and administrative RM20,000, and
c. Depreciation charges RM6, 500.
d. Selling expenses is equal to 10 percent of sales each
month.
6. Pearls also plans to purchase new equipment for RM50,000 in
late June in which
RM30,000 will be finance by bank loan with a monthly payment of
RM570; of which
RM70 is the interest. The old machine to be replaced can be sold
for RM2, 000.
7. Income taxes for the first half of the year are estimated at
RM20,000 and will be paid
in June.
8. On May 31, Pearls expects to have cash balance of RM15,000,
and the company
likes to maintain a minimum cash balance of RM10,000.
9. The company has a credit line with 12 percent interest per
annum.
A complete cash budget for Pearls based on the above variables
is presented in Table 4.1.
Students should try to comprehend its development before class
lecture and discuss any
misunderstanding and problems encountered with the lecturer
during class discussions.
Table 4-1 shows that in the two months period, Pearls will
experience cash shortages in the
month June due to the planned purchase of the machine. This
indicates the company may
have to resort to:
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1. short-term borrowings (credit line) to cover the deficit,
or
2. postpone the purchase until July, or
3. try to increase revenues and simultaneously reduces expenses
to avoid cash
shortages.
The company will have cash excess in July that provides the
opportunity for the firm to invest
in marketable securities or made an early loan's repayment as it
sees fit. If the strategy is to
borrow money to cover the cash deficits, the firm will have to
negotiate line of credit facilities
of RM5, 700 for June and repays back in July. Under normal
circumstances, the interest on
short-term loan must be serviced monthly as shown in other
non-operating expenses for
July.
Table 4.3 Pearls Furniture: Completed Cash Budget for June and
July
(In thousands of RM) JUNE JULY Monthly sales tn 330.00 350.00
Notes
OPERATING RECEIPTS Deposits (20% of sales t n+1) 70.00 80.00
Collection of receivable:
Month of transaction (40% of sales t n) 132.00 140.00
1-month lag (40% of sales t n-1) 116.00 132.00
2-month lag (t n-2) 0.00 0.00 Not applicable Total operating
receipts 318.00 352.00 Item 1
OPERATING EXPENDITURES Purchases (30% of sales t n+1) 105.00
120.00
Payment on raw material purchases:
Month of transaction (20% of purchases) 21.00 24.00
1-month lag (80% of purchases t n-1) 79.20 84.00
2-month lag (t n-2) 0.00 0.00 Not applicable
Direct labor (40% of sales) 132.00 140.00
Overhead (excludes depreciation) 5.50 5.50
Operating expenses
(selling and Adm. Exp.) 53.00 55.00
Total operating expenditure 290.70 308.50 Item 2
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FACILITIES, TAXES AND OTHERS Plant and equipment expenditures
20.00a 0.00 Refer to note a Taxes paid 20.00 0.00
Principle payment of debt 0.00 0.50c Refer to note c Dividend
paid 0.00 0.00
Other non operating expenses (interest) 0.00 0.127d Refer to
note d
Less: Other non operating income 2.00b 0.000 Refer to note b
Total other expenditure 38.00 0.627 Item 3
NET CASH FLOW 10.70 42.873 Item 4 = 1 2 3
CASH RECONCILIATION Net cash flow 10.70 42.873
Plus: Beginning cash balance 15.00 4.300 Ending cash of t
n-1
Ending cash balance 4.30 47.173
Less: Minimum cash balance 10.00 10.000 Minimum cash
Cash excess ( deficit) 5.70 37.173
Note: a Cash paid for the machine; b Disposal of old machine c
Principal payment on loan; d Interest for monthly payment and for
June's borrowings: RM0.127 = 0.07 + RM5.70 (0.12 / 12)
For further illustrate the cash management strategies, consider
the following cash positions
for a particular firm:
Month 1 2 3 4
Cash excess ( deficit) RM20,000 RM20,000 RM60,000 RM10,000
For this particular company, the financial manager can invest
RM20,000 temporarily in
January, but must negotiate a credit line of RM60,000 to support
its cash requirements for
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the four months' periods to avoid technical insolvency. The firm
will borrow RM20,000 in
February and increase its borrowings to the maximum amount of
RM60,000 in March.
Consequently the company will pay back all of the borrowings and
can plan for short term
investments in marketable securities amounted to RM10,000 for at
least one month
depending on the cash position in the following periods.
The development of cash budget, therefore will provides
management insight of the cash
position and appropriate strategies can be developed to deal
with any of the cash positions,
whether it is a deficit or otherwise.
4.5 PRO-FORMA FINANCIAL STATEMENTS
The most widely used method for forecasting the financial
requirements is the percent of
sales method. It is different from the cash budget as it focuses
on funds forecasting. It uses
pro-forma financial statements, particularly balance sheet with
certain information from
income statement to forecast the funds' requirements for the
firm for a particular period.
This method works under the assumption that:
1. The firm's investment in certain assets will vary directly
with sales;
2. All spontaneous items in the balance sheet can be expressed
as a percentage of
sales; and
3. That percentage will remains constant over a reasonable range
of sales.
The company will have to rely on both, internal and external
financing to support the funds'
requirement. Internal sources of financing represent funds that
are generated from
spontaneous liabilities such as accounts payable and accrual,
and from retained earnings.
On the other hand, external sources refer to funds from bonds,
common stock, preferred
stock, commercial papers, note payable to name a few.
4.5.1 Spontaneous items.
The spontaneous items represent the balance items that are vary
directly with
sales activity. As such, the changes must be spontaneous and
arise as a
result of the firm's operations without any prior management
effort for
arrangements. In essence, all current assets are spontaneous,
and fixed
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asset will only spontaneous if the firm is operating at full
capacity. On the
other hand, retained earnings and liabilities such as account
payable and
accruals are spontaneous, as it will generate more funds as the
firm's
activities increased with the increase in sales.
4.5.2 Non-spontaneous items.
On the other hand, non-spontaneous items will remain constant
regardless of
the sales activity. Fixed assets are regarded as non-spontaneous
if the firm is
operating below its capacity. Notes payable, long-term debt and
equity are
also non-spontaneous as the firm must negotiate and arrange for
more
borrowings and issues respectively.
The preceding example deals with a simplified version of percent
of sales
method; that is disregarding certain limitations on essential
financial ratios
and other financing constraints. Let assume that Sabilla
Products plan to
determine the funds' requirement and additional funds needed for
fiscal year
of 19X2. The company's current financial data are as
follows:
1. Current sales (S0) is RM101 millions,
2. Expected sales (S1) are to increase by 50 percent,
3. Cost of goods sold (COGS) 70% of sales,
4. Other operating expenses' 14% of sales,
5. Net profit margin (NPM) of 9.60%,
6. Dividend payout ratio (DPR) 25%,
7. Marginal tax rate (T) 40%
In addition, the company is operating at full capacity as of
19X1. A complete
balance sheet for the company is presented in Table 4.4.
Table 4.4 Sabilla Products: Balance Sheet as of December 31,
19X1 (millions of RM)
Assets Liabilities and Equity Cash 2.7 Notes payable 1.6
Accounts receivable 15.1 Accounts payable 5.4
Inventory 21.2 Accruals 8.4
Net plant 19.8 Long-term debt 10.2
Equity 33.2
Total assets 58.8 Total liab. & equity 58.8
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There are several ways to solve for additional funds needed
(AFN) by the firm to support the sales increased. The most common
is pro forma balance sheet approach and an AFN
formula.
4.5.3 Pro forma Balance Sheet
There are several steps involved in developing pro forma balance
sheet
statement under percent of sales method:
1. Determine the sales growth. The sales growth is stated in
percentage, that is the ratio of change in sales from previous
period;
change in sales (S1 S0) divided by old sales (S0).
2. Determine the spontaneous items. All spontaneous items in
balance sheet must be identified disregarding the retained
earnings
account.
3. Project the pro forma balance sheet values. All
non-spontaneous
items will remains as of previous values in the balance sheet.
On the
other hand, spontaneous items are adjusted by a factor of one
plus
sales growth. For example 1.5 (=1 + 0.50) for Sabilla
Products.
4. Calculate the new level of retained earnings. New level of
retained
earnings represents old retained earnings in the balance sheet
plus
new retained earnings provided from the forecasted sales.
5. Determine the additional funds needed (AFN). An additional
fund
needed is a balancing item that represents the difference
between
total assets and total liabilities and equity in the pro forma
balance
sheet.
Using the above procedures, pro forma income statement and
balance sheet
in Table 4.3 and 4.4 can be developed, respectively. It shows
that the
company needs RM11.592 millions of external funds to support the
expected
sales growth of 50 percent. The funds needed can be raised from
external
sources such as bank loans, issuing bonds, or new preferred or
common
shares.
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Table 4-5 Sabilla Products: Pro forma Income Statement 19X2
(millions of RM)
Net Sales 151.500 101 00 (1.50)
Less: Cost of goods sold 106.050 151.50 (0.70)
Gross profit 45.450
Less: Other expenses 21.210 151.50 (0.14)
Operating profit 24.240
Taxes 9.696 24.24 (0.40)
Net profit 14.544
Dividends 3.636 14.544 (0.25)
Additions to retained earnings 10.908 14.544 (1 0.25)
Table 4-6 Sabilla Products: Pro forma Balance Sheet 19X2
(millions of RM)
Assets Liabilities and Equity
Cash 2.7(1.5) 4.050 Notes payable 1.600
Acc. Rec. 15.1(1.5) 22.650 Acc. Payable 5.4(1.5) 8.100
Inventory 21.2(1.5) 31.800 Accruals 8.4(1.5) 12.600
Net plant 19.8(1.5) 29.700 Long-term debt 10.200
Equity (33.2 + 10.908)a 44.108
AFNb 11.592 Total assets 88.200 Total liab. & equity
88.200
Note: a Expected net income with sales growth of 50%:
Net income = S1 (NPM)
= RM151.5 (0.096)
= RM14.544
New retained earnings = Net income (1 DPR)
= RM14.544 (1 0.25)
= RM10.908
b Additional Funds Needed (AFN) is considered as a balancing
item;
that is to balance the total assets and total liabilities and
equity.
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Note that the value of new retained earnings from 19X2 is added
directly to
equity accounts since equity represents the summary of the firms
preferred
stock, common stock, paid in capital and retained earnings'
accounts. It is
necessary however to increase the retained earnings account only
if equity
accounts are itemized.
The balance sheet method as shown in Table 4.7 is relatively
slow, especially
if the pro forma balance sheet is not required. The simplified
method shown in
Table 4-7 will result in the same answer, but less time
consuming.
It will further illustrate the concepts of total funds'
requirements to support the
sales increase, and differentiate between the internal generated
funds and
external sources of funds. The calculations in Table 4.7, shows
that the firm:
1. Needs RM29.40 millions of funds for investment in current and
fixed
assets to support the sales increased.
2. Internally generated funds or funds from operations provide
RM17.808
millions of the amount needed, and
3. The balance off RM11.592 millions must be met by raising
external
funds.
Table 4.7 Sabilla Products: External Funds Requirements 19X2
(millions of RM)
Sales growth: 50%
Current sales: RM101 millions
Total spontaneous assets: RM58.80 millions
Total funds' requirement 58.80 (0.50) 29.400
Less internal funds:
Account payable 5.40 (0.50) 2.700
Accruals 8.40 (0.50) 4.200
Retained earnings (refer to Table 10.4) 10.908 17.808
Additional funds needed or external funds 11.592
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4.5.4 Additional Funds Needed Formula
Another method to solve for additional fund needed is to use a
formula; that equals to
required increase in assets less increase in spontaneous
liabilities less increase in
retained earnings, less depreciation plus miscellaneous
financing requirements:
AFN = (SA0 / S0)S (SL0 / S0)S (S1)(NPM)(1 DPR) Dep1 + OF1
Where SA0 : Amount of spontaneous assets that vary with
sales.
S0 : Current sales.
S1 : Projected sales (total) for the following period.
S : Change in sales; S1 minus S0 SL0 : Amount of spontaneous
liabilities that vary with sales.
NPM : Net profit margin
DPR : Dividend payout ratio.
OF1 : Other financing requirements for investment purposes
Dep1 : Funds provided by the depreciation charges, if any.
Substituting the available financial information for Sabilla
Products, and assuming
that there is no other additional other investment, additional
fund needed:
AFN = (RM58.80 / RM101.00)(RM151.50 RM101.00)
((RM5.40 + RM8.40) / RM101.00)(RM151.50 RM101.00)
(0.096)(RM151.50)(1 0.25) 0 + 0
= RM11.592
As shown, both methods give similar results; that is external
financing requirements
amounted to RM11.592 millions that must be arranged for 19X2 to
support expected
sales increase. The above calculations' states that the
depreciation is zero. This is
based on the basic rule of thumb, in which if all assets vary
with sales, depreciation
shielded funds were not available as it will be used to replace
a portion of the existing
assets. Else, if only current assets vary with sales, the
depreciation charges must be
included to offset the total financing requirements.
The funds forecasting provide necessary information for the
management to arrange
financing requirements before hand in expectation of the sales
increase. This will
ensure the availability of funds on time and in sufficient
amount to support the firm's
operations.
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QUESTION 1
You are given the following balance sheets for Syarikat Ikhlas
for 2001 and 2002:
Balance Sheet As At December 31 (RM000)
2001 2002
Assets:
Cash
Marketable securities
Accounts receivable
Inventory
Fixed assets
200
300
800
1200
3300
250
400
600
1300
4000
Total Assets 5800 6550
Liabilities and Equity:
Accounts payable
Notes payable
Other current liabilities
Long-term debt
Common stock
Paid-in capital
Retained earnings
300
200
1000
1000
3000
150
150
400
300
900
1200
3200
300
250
Total Liabilities and Equity 5800 6550
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Income Statement for the Year Ending December 31, 2002
(RM000)
Sale
Less : Cost of goods sold
Gross Profit Less : Operating expenses
EBIT
Less : Interest
EBT
Less : Tax
Net Profit After Taxes Less : Dividend Payment
To Retained Earnings
1200
500
700
200
500
100
400
160
240
140
100
Using the above financial information:
a) Construct the cash flow statement for year 2002
(15 marks)
b) Explain the three (3) strategies used for efficient cash
management. (5 marks)
QUESTION 2
a) Referring to the balance sheets and the income statement
given in Question 1,
calculate the liquidity, activity and profitability ratios for
Syarikat Ikhlas for year 2002.
(13 marks)
b) Analyze the companys financial performance according to these
three types of
ratios.
(7 marks)
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86 | P a g e
QUESTION 3
a) FAP Company expects its projected revenues and payments for
the first half
of year 2003 to be as follows:
Sales (RM) Purchases (RM)
January
February
March
April
May
June
10,000
20,000
30,000
25,000
35,000
40,000
8,000
18,000
25,000
20,000
30,000
25,000
Fifty percent of the companys sales are on credit. Based on past
experiences
it shows 50 percent of credit sales are collected in the month
after sales, and
the remainder is collected in the second month after it
occurred.
The company pays 100 percent of purchases one month after
purchases.
Besides this, the company pays RM15,000 per month for wages and
salary.
On March 31, 2003, FAP Company has RM10,000 as the ending cash
and
the company maintains RM5,000 as its minimum operating cash.
Prepare a cash budget for the second quarter of year 2003.
(18 marks)
b) Explain briefly the differences between spontaneous and
discretionary items
in the preparation of a Pro-Forma balance sheet.
(2 marks)