External Financing Needed (EFN)
Identifying the funds which must be raised in order to support the forecasted sales level is one of the key outputs of the forecasting process. This amount is known as the External Financing Needed (EFN) or Additional Funds Needed (AFN).
In this section, we shall develop approaches which allow the EFN to be identified quickly through the use of an equation. We shall also extend this approach to consider the case when the firm has excess capacity in its fixed assets. The calculations presented on this page are based on the Balance Sheet and Income Statement below.
The equation used to calculate EFN when fixed assets are being utilized at full capacity is given below. (Please note that this equation is based on the same assumptions that underly the Percentage of Sales Method. Namely that the Profit Margin and the Retention Ratio are constant.)
When the firm is utilizing its assets at full capcacity, A*0 will equal Total Assets. L*0 typically consists of Accounts Payable (and if present Accruals). The logic of underlying this equation can be explained as follows.
The incresed in Liabilities and Retained Earnings in the equation are considered "spontaneous" because the occur essentially automatically as a consequence of the firm conducting its business.
If the firm has excess capacity in its Fixed Assets then the Fixed Assets may not have to increase in order to support the forecasted sales level. Moreover, if the Fixed Assets do need to increase in order to support the forecasted sales level, then they will not have to increase by as much as would be required if they were being used at full capacity.
When a firm has excess capacity in its Fixed Assets the first step is to determine the sales level that the existing Fixed Assets can support. This can be determined by dividing Current Sales by the percentage of capacity at which the Fixed Assets are presently being utilized. This sales level is called Full Capacity Sales, SFC.
If Forecasted Sales are less than Full Capacity Sales, then fixed assets do not need to increase to support the forecasted sales level. On the other hand, if Forecasted Sales are greater than Full Capacity Sales, then Fixed Assets will have to increase. We shall consider these two cases below.
Case 1: S1 Less Than SFC
When the Forecasted Sales are less than or equal to Full Capacity Sales, EFN can be determined in one step using the above equation. The only adjustment is that A*0 now only consists of Total Current Assets since Fixed Assets do not need to increase to suppor the forecasted sales level.
Case 2: S1 Greater Than SFC
When the Forecasted Sales are greater than Full Capacity Sales, EFN can be determined in two steps. The first step, illustrated by the equation for EFN1 below, finds the EFN needed to get to Full Capacity Sales. The second step, illustrated by the equation for EFN2 below, finds the additional EFN to get from Full Capacity Sales to the Forecasted Sales. The total EFN is simply EFN1 plus EFN2.
© 2002 - 2010 by Mark A. Lane, Ph.D.