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Additional funds needed (AFN)
Required asset increase : (A*/S0) ∆S
Spontaneous liability increase : (L*/S0) ∆S
Increase in retained earnings : MS1 (RR)
A* = Current Assets
L* = Current Liabilities
S0 = Sales Current
S1 = Expected sales (Current sale + increase in sale)
∆S = Increase in sales
M = Profit Margin (net income / total sales)
RR = Dividend Payout % (Dividend/ Net income)
RR is also equal to (1- payout ratio)
FORMULA AFN = (A*/S0) ∆S - (L*/S0) ∆S - MS1 (RR)
Q 4 (a): Philips Company’s sales are expected to increase from $5 million in 2016 to $6 million in
2017 or by 20%. Its assets totaled $3 million at the end of 20016. Philips is working at full capacity,
so its assets must grow at the same rate as projected sales. At the end of 2016, current liabilities
were $1 million, consisting of $250,000 of accounts payable, $500,000 of notes payable, and
$250,000 of accruals. The after-tax profit margin is forecasted to be 8%, and the forecasted payout
ratio is 55%. By applying the AFN formula to forecast Philips’s additional funds needed for the
coming year.
Answer:-
FORMULA AFN = (A*/S0) ∆S - (L*/S0) ∆S - MS1 (RR)
=> (3000,000/5000,000)1,000,000-(1000,000/5000,000)1,000,000-(0.08)(6,000,000)(1-0.55)
=> (0.6) ($1,000,000) - (0.2) ($1,000,000) - ($480,000) (0.45)
=> $600,000 - $200,000 - $216,000= AFN $184,000
Thus the additional funds needed for coming year = $184,000
Q 4 (b): Assume that the company pays no dividends. Under these assumptions, what would be the
additional funds needed for the coming year?
Answer:-
AFN = (A*/S0) ΔS - (L*/S0) ΔS - MS1 (1–Payout)
(3000,000/5000,000)1,000,000-(1000,000/5000,000)1,000,000-(0.08)(6,000,000)(1-0)
=> $600,000 – $200,000 – $480,000 =
AFN -$80,000
1. AFN Equation Method :
8-5 8-6
2013 Balance Sheet 2013 Income Statement
(Millions of $) (Millions of $)
Sales $2,000.00
Cash & sec. $ 20 Accts. pay. & Less: COGS (60%) 1,200.00
accruals $ 100 SGA costs 700.00
Accounts rec. 240 Notes payable 100
Inventories 240 Total CL $ 200 EBIT $ 100.00
Total CA $ 500 L-T debt 100 Interest 10.00
Common stk 500 EBT $ 90.00
Net fixed Retained Taxes (40%) 36.00
assets 500 earnings 200 Net income $ 54.00
Total assets $1,000 Total claims $1,000 Dividends (40%) $21.60
Add’n to RE $32.40
8-7 8 - 10
AFN (Additional Funds Needed): Assets must increase by $250 million.
Key Assumptions What is the AFN, based on the AFN
equation?
Operating at full capacity in 2013.
Each type of asset grows proportionally AFN = (A*/S0)S - (L*/S0)S - M(S1)(RR)
with sales.
Payables and accruals grow proportionally = ($1,000/$2,000)($500)
with sales. - ($100/$2,000)($500)
2013 profit margin ($54/$2,000 = 2.70%)
and payout (40%) will be maintained.
- 0.0270($2,500)(1 - 0.4)
Sales are expected to increase by $500 = $184.5 million.
million.
2. AFN PRO FORMA :
Income statement
2013 Factor 2014
Current Forecasted
Sales 2000 25% 2500
COGS (60%) (1200) (1500)
SGA (35%) (700) (875)
EBIT 100 125
Interest (10%) (10) (20)
EBT 90 105
Taxes (40%) (36) (42)
Net income 54 63
Dividend (40%) (21.6) (25.2)
Retained Earnings $32.4M $37.8M
Balance Sheet
2013 Factor 2014
Current Expected
Cash & Sec. 20 1% 25
Acc/ Rec. 240 12% 300
Inventories 240 12% 300
Total Current Assets 500 25% 625
Total Fixed Assets 500 25% 625
Total Assets $1000M $1250M
Acc/Pay & Accruals 100 25% 125
Notes Pay 100 - 100
Current Liability 200 225
Long term Debt 100 - 100
Common Stock 500 - 500
Retained Earnings 200 37.8 237.8
Total Claims $1000M 25% 1062.8M
AFN = Total Assets forecasted – Total Claims forecasted
AFN = $1250-$1062.8 = $187.2M
8 - 31 8 - 29
Equation AFN = $184.5 How will the AFN be financed?
vs.
Pro Forma AFN = $187.2. Additional notes payable =
Why are they different? 0.5 ($187.2) = $93.6.
Equation method assumes a Additional L-T debt =
constant profit margin. 0.5 ($187.2) = $93.6.
Pro forma method is more flexible.
More important, it allows different
items to grow at different rates.
8 - 30
2014 Balance Sheet (Claims)
w/o AFN AFN With AFN
AP/accruals $ 125.0 $ 125.0
Notes payable 100.0 +93.6 193.6
Total CL $ 225.0 $ 318.6
L-T debt 100.0 +93.6 193.6
Common stk. 500.0 500.0
Ret. earnings 237.8 237.8
Total claims $1,062.8 $1,250.0
