ALFIN Mills Inc.’s Financial Forecasting

Pro – forma financial statements

In this analysis, the Pro – form financial statements of the company will be prepared using the percentage of sales method. The first step when using this approach is to express the items in the financial statements as a percentage of the sales. The calculations are presented in the table below.

ALFIN Mills Inc.

Income statement

For the year ending December 31, 2005 (000USD)

ALFIN Mills Inc

Balance sheet

As of December 31, 2005 (000 USD)

After expressing the various balances as a percentage of sales as shown above, the new sales level will be calculated as illustrated below.

Expected new sales level = $2,025,000 * (20% + 100%)

= $2,025,000 * 1.2

= $2,430,000

The final stage when coming up with the Pro – forma statement is multiplying the new sales computed above by the percentages estimated earlier. The Pro – forma financial statements are presented in the table below.

ALFIN Mills Inc.

Pro – Forma income statement

For the year ending December 31, 2006 (000USD)

ALFIN Mills Inc

Balance sheet

As of December 31, 2005 (000 USD)

Part two of the table

Discussion on whether the company will require additional funding

As can be observed from the Pro – forma statements in the tables above, the value of total assets for the year 2006 exceeds the value of total shareholders’ equity and liabilities. This gives the indication that the company will require additional funding. The estimation of the amount of EFN required is presented in the table below.

Based on the table above, the amount of total assets exceeds the amount total liabilities and shareholder’s equity by $33,750 thousand. This represents the amount of EFN that the company will require. The EFN is less than the amount of the loan. Therefore, the loan of $40 million will adequately finance the 20% increase in sales.

Calculation of EFN at 30% and 10%

External financing needs (EFN) = [(A/S * (ΔS) – L/S * (ΔS)] – [(M) * (St) * (1-D)]

The second part of the formula [(M) * (St) * (1-D)] will be affected by the interest expense of $90,000 because it does not depend on sales. The table presented below shows the calculations of the values in the formula.

30% increase

EFN = [(A/S*(ΔS) – L/S *(ΔS)] – [(M)*(St)*(1-D)]

= [(0.38 * 607,500) – (0.07 * 607,500)] – [0.09 * 2,632,500 * (1 – 0.60)]

= (230,850 – 42,525) – 101,250

= $87,075

10% increase

EFN = [(A/S*(ΔS) – L/S *(ΔS)] – [(M)*(St)*(1-D)]

= [(0.38 * 202,500) – (0.07 * 202,500)] – [0.09 * 2,227,500 * (1 – 0.60)]

= (76,950 – 14,175) – 82,350

= ($19,575)

Discussion of the results

A 30% increase in sales results in a higher amount of EFN than a 20% increase in sales. The difference can be explained by a number of reasons. A 30% increase in sales results in higher cost of sales, selling and general expenses, taxes, and total assets than a 20% increase in sales. Further, from the calculations, it can be observed that a 10% increase in sales will not require external funding. This implies that the company has spare capacity after a 10% increase in sales.

Question four

Maximum growth in sales

The calculations of the maximum growth in sales that the company can achieve without EFN are presented below.

EFN at 20% = $33,750

EFN at 10% = ($17,415)

Interpolation will be used to estimate the percentage

= 10% + (20% – 10%) * 17,415 / (33,750 + 17,415)

= 10% + 10% (17,415 / 51,165)

= 13.4%

The results mean that the company can increase the volume of sales up to 13.4% without the need for EFN.

How changes on various balances affects EFN

Reduction of accounts receivable collection period

A reduction of the collection period reduces the balance of accounts receivable in the balance sheet. This reduces the total assets and EFN (Mankiw 98).

Reduction of the accounts payable period

A reduction of the period of payment of the suppliers reduces the balance of accounts payable in the balance sheet. This reduces the total liabilities and EFN.

Increase in sales volume

An increase in the amount of sales without a corresponding increase in the fixed asset balance results in an increase in the balance of other items that depend on sales such as accounts receivable. This results in an increase in EFN.

Cash Budget

Cash budget, commonly used internally, is prepared to ascertain whether the total cash receipts expected in a given period adequately covers the expenses for that particular period. The first step entails computing the total receipts as illustrated in the table presented below (Collier 47). This will be based on the policy of accounts receivable collection period of the company.

ALFIN Mills Inc.

Total receipts

For a four month period (January to April) 2006

The second step entails calculating the total projected payments for the same period as presented in the table below.

ALFIN Mills Inc.

Total payment to suppliers

For a four month period (January to April) 2006

The final stage entails coming up with the cash budget as illustrated in the table presented below.

ALFIN Mills Inc.

Cash budget

For a four month period (January to April) 2006

It can be observed that in the month of January and February, the amount of the cash inflows exceeded the amount of the cash outflows. The total line of credit required by the company in the first two months amounts to $190,496 thousand. The value exceeds the loan of $40 million. Thus, the company is likely to face financial difficulties in 2006.

Works Cited

Collier, Paul. Accounting for managers, London: John Wiley & Sons Ltd, 2009. Print.

Mankiw, Gregory. Principles of Economics, USA: Cengage Learning, 2011. Print.