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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

200
450
550
1,200
2,200
1,000
1,200
2,400


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
200
600
300
600
700
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
200
450
550
1,200
2,200
1,000
1,200
2,400
150
425
625
1,200
2,600
1,200
1,400
2,600
-50
-25
+75
+400
+200














* 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
150
300
600
300
600
800
1,700
2,600

-50

+150

no change

no change
no change
neither a sources nor a use








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 J uly's sales, the cash budgets will recognize 50% of the
cash flow involved in J uly 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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J anuary 360.00 March 320.00 May 290.00 J uly 350.00

February 400.00 April 310.00 J une 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 J une 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 J une.
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 J une 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 J uly, or
3. try to increase revenues and simultaneously reduces expenses to avoid cash
shortages.

The company will have cash excess in J uly 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 J une and repays back in J uly. Under normal circumstances, the interest on
short-term loan must be serviced monthly as shown in other non-operating expenses for
J uly.
Table 4.3 Pearls Furniture: Completed Cash Budget for June and July


(In thousands of RM) JUNE JULY
Monthly sales t
n
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 20.00
a
0.00 Refer to note a
Taxes paid 20.00 0.00
Principle payment of debt 0.00 0.50
c Refer to note c

Dividend paid 0.00 0.00
Other non operating expenses (interest) 0.00 0.127
d Refer to note d

Less: Other non operating income 2.00
b
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 J une'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
J anuary, 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 (S
0
) is RM101 millions,
2. Expected sales (S
1
) 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 (S
1
S
0
) divided by old sales (S
0
).

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
AFN
b
11.592
Total assets 88.200 Total liab. & equity 88.200

Note: a Expected net income with sales growth of 50%:


Net income =S
1
(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 =(SA
0
/ S
0
)S (SL
0
/ S
0
)S (S
1
)(NPM)(1 DPR) Dep
1

+OF
1


Where SA
0
: Amount of spontaneous assets that vary with sales.
S
0
: Current sales.
S
1
: Projected sales (total) for the following period.
S : Change in sales; S
1
minus S
0

SL
0
: Amount of spontaneous liabilities that vary with sales.
NPM : Net profit margin
DPR : Dividend payout ratio.
OF
1
: Other financing requirements for investment purposes
Dep
1
: 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.
Chapter 4 Financial Forecasting

84 | P age



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





Financial Forecasting Chapter 4

85 | P age

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)




Chapter 4 Financial Forecasting

86 | P age

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)
J anuary
February
March
April
May
J une
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)