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Needed External Financing // Corporate Finance
- 1. Short-Term Financial Planning CHAPTER 13 - PROBLEM 1
- 2. How does Short-term Financial Planning differ from Long-Term Financial Planning? 1. Decisions can be easily reversed because of the shorter timeline. 2. Far less uncertain because we are dealing with one-year estimates rather than multiple estimates.
- 3. What’s the importance of creating short-term financial planning? 1. If sales increase, assets will increase, which in return will cause cash to run out rapidly 2. Forecasting the required necessary funding allows for strategic decisions to be made 3. Contingencies can be created – Act rather than React!
- 4. Deterministic vs. Stochastic Deterministic Single variable, single point estimate Stochastic Uses probability distribution for one or more variables
- 5. Assumptions for Deterministic Model 1. Regardless of dollar/percentage of increase in sales, total assets/sales, and current liabilities/sales will remain constant 2. Margin and dividend payout ratio will remain at its current level 3. Additional assets are required to support additional sales and that the proportion of this increase will stay
- 6. Part A: Needed External Funds formula NEF = (TA/S0) x ΔS – (CL/S0) x ΔS – [S1 x m x (1 – dpo) NEF – Needed External Financing TA – Total Assets S0 – Initial Sales ΔS - Change in Sales CL – Current Liabilities S1 – Forecasted Sales m – Profit Margin dpo – Dividend Payout Ratio
- 7. Computing variables: ΔS = 5,500,000 * 30% = 1,650,000 S1 = 5,500,000 * 130% = 7,150,000 (TA/S0) x ΔS =(3,000,000/5,500,000) * 1,650,000 =900,000 (CL/S0) x ΔS =(500,000/5,500,000) * 1,650,000 =150,000
- 8. Computing formula: m = Net Profit / Sales = 479,800/5,500,000 = 8.723636% dpo = Dividends / Net Profit = 400,000/479,800 = 0.83368 NEF = (TA/S0) x ΔS – (CL/S0) x ΔS – [S1 x m x (1 – dpo) = 900,000 – 150,000 – 103,740.43 = 646,259.57 Thus, Summit Inc will require approximately $646,260 in external financing. The financing required can be attained through new debt or equity sources.
- 9. Part B: Methods to reduce reliance on external funds 3 Main Methods: 1. Increase Accounts Payable Balance 2. Increase Net Profit Margin 3. Reduce amount and percentage of dividend
- 10. Increase AP balance 1. Negotiate longer credit terms 2. Stretch payments Cost of foregoing any available discounts: Kd=(d%/100-d%) * [365/(fdate – ddate)]
- 11. Increase net profit margin Income Statement 2012 Sales 5,500,000 Cost of Goods Sold 3,500,000 Gross Profit 2,000,000 Operating Expenses 1,000,000 Interest 170,000 Taxes 350,200 Net Profit 479,800 Dividends 400,000 1. Decrease Operating Expenses Technology Management Unnecessary Expenses 2. Decreasing Cost of Goods Sold Discounts from suppliers Increase efficiency of supply chain management
- 12. Reduce dividends Third portion of the NEF formula By reducing dividend to zero, your increased equity can be used to finance your growth New NEF with no dividends is over 80% lower How does sustainable growth affect dividend? Sustainable growth using current policies: 8.67% Current expected growth rate: 30%
- 13. Conclusion Importance of Short-Term Financial Planning Understanding the method to calculate ‘Needed External Financing’ during periods of expansion Determining alternatives to external sources of financing --- We will now take questions ---