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1.

Since this is the first time Jim and Mason will be conducting a financial forecast for
Oats R Us, how do you think they should proceed? Which approaches or models can
they use? What are the assumptions necessary for utilizing each model?
Jim and Mason should begin their planning with a reasonable sales forecast. The sales forecast
ought to be based on clearly stated assumptions about future economic conditions. Next, they
should prepare pro forma financial statements by either assuming that the key items vary
proportionately with sales or remain constant (as the case may be). Based on their asset
utilization rate, they would be able to determine the asset requirements for growth. Some of
the funds required to finance growth would be raised from spontaneous sources such as
accounts payables and accruals and from future retained earnings. The remaining funds
necessary for growth could then be raised from external sources such as new debt and stock
offering.
Jim and Mason can use one of the following approaches:
1.

2.

Pro Forma Approach where most of the income statement and balance sheet
items are assumed to maintain a constant proportion to sales, but individual
items can be forecasted using statistical techniques and feedback effects
involving changes in interest costs etc. can be included.
EFN Formula Method This is simple to use but does not allow the inclusion
of feedback effects.

2. If Oats R Us is operating its fixed assets at full capacity, what growth rate can it
support without the need for any additional external financing?
Here are the steps:
1.
Calculate the percent of sales figure for each balance sheet item, as well as the net
profit margin, and the retention rate.
2.
Using the External Funds Needed (EFN) formula (shown below), set EFN to 0,
plug in the required data, and solve for the change in sales that could be achieved
without any external financing.
EFN = (Ao/So)*(Change in sales) (Lo/So)*(Change in Sales) - Net Margin*(S o + Change
in sales)*Retention Rate
Where, So = Current sales;
New Sales = S1 = (So + Change in sales)
Retention Rate = 1 Payout Ratio

Income Statement Percent of Sales

For the Year Ended Dec. 31st, 2004

Sales
Cost of Goods Sold
Gross Profit
Selling and G&A Expenses
Fixed Expenses
Depreciation Expense
Earnings Before Interest and Taxes
Interest Expense
Earnings Before Taxes
Taxes @ 40%
Net Income
Retained Earnings

% of
Sales
2004 2003
100% $ 3,760,000
82.5% 3,045,600
17.5% 714,400
5.9% 250,000
1.9% 90,000
0.5% 25,000
9.2% 349,400
1.4% 66,000
7.8% 283,400
3.1% 113360
4.7% 170,040
60.0%
102,024

2004
$
4,700,000
3,877,500
822,500
275,000
90,000
25,000
432,500
66,000
366,500
146600
219,900
131,940

% of
Sales
2003 2002
100% $ 3,000,000
81.0% 2,400,000
19.0% 600,000
6.6% 215,000
2.4% 90,000
0.7% 25,000
9.3% 270,000
1.8% 66,000
7.5% 204,000
3.0% 81600
4.5% 122,400
60.0%
73,440

%
of
Sales
2002
100%
80.0%
20.0%
7.2%
3.0%
0.8%
9.0%
2.2%
6.8%
2.7%
4.1%
60.0%

Balance Sheet
For the Year Ended Dec. 31st, 2004

Assets
Cash and Cash Equivalents
Accounts Receivable
Inventory
Total Current Assets
Plant & Equipment
Accumulated Depreciation
Net Plant & Equipment
Total Assets
Liabilities and Owner's Equity
Accounts Payable
Notes Payable
Other Current Liabilities
Total Current Liabilities
Long-term Debt
Total Liabilities
Owner's Capital
Retained Earnings
Total Liabilities and Owner's Equity

Ao/So
Net Profit Margin
Retention Rate

2004
60,000
250,416
511,500
821,916
560,000
175,000
385,000
1,206,916

%
of
Sales
2004
2003
1.3%
97,376
5.3%
175,000
10.9% 390,000
17.5% 662,376
11.9% 560,000
3.7%
150,000
8.2%
410,000
25.7% 1,072,376

%
of
Sales
2003
2002
2.6%
48,000
4.7%
150,000
10.4% 335,000
17.6% 533,000
14.9% 560,000
4.0%
125,000
10.9% 435,000
28.5% 968,000

%
of
Sales
2002
1.6%
5.0%
11.2%
17.8%
18.7%
4.2%
14.5%
32.3%

135,000
275,000
43,952
453,952
275,000
728,952
155,560
322,404
1,206,916

2.9%
5.9%
0.9%
9.7%
5.9%
15.5%
3.3%
6.9%
25.7%

4.0%
7.3%
1.3%
12.7%
6.6%
19.3%
4.1%
5.1%
28.5%

4.3%
8.3%
1.5%
14.1%
10.0%
24.1%
5.2%
2.9%
32.3%

25.679%
4.678%
60%

151,352
275,000
50,000
476,352
250,000
726,352
155,560
190,464
1,072,376

128,000
250,000
46,000
424,000
300,000
724,000
155,560
88,440
968,000

Current Sales
Lo/So
Change in Sales

$4,700,000
2.872%
$659,591.40

EFN = Increase in Assets -

EFN=
0=

Increase in internal equity

25.679 %*( Change in So) 2.87*(Change in So) - [4.678%*0.6*($4.7 + Change in So)]


22.807 %*( Change in So) 0.0280*(Change in So) - $131,919.60

Change in So = $131,919.6/0.2000 = $659,591.40


Growth rate that can be supported with no external funds = 659,591.40/4,700,000 = 14.033%

EFN=

Increase in
Assets

0.00 =

169,376.48

Increase in
Spontaneous
Finances
18,943.47

Increase
in
Internal equity
$150,433.01

Alternative method
Compute the Internal growth rate.
Internal growth rate = (ROA x Retention Rate)/[1 - (ROA x Retention Rate]
= (18.2% x 0.6)/[1-(18.2% x 0.6)] = 12.26%