Financial Forecasting and Planning: Balance Sheet

Chapter 17
Financial Forecasting and Planning
17-1. We are to estimate the total financing needed (total assets) and net funding requirements (discretionary
financing needed) for the next year (2011) for Zapatera Enterprises. We’ll start with total assets.
We’re told that the firm’s 2011 sales will be $15M, and that the proportion of sales represented by
operating expenses, current assets, net fixed assets, and current liabilities will be the same as for
2010. Thus, we can create Zapatera’s pro forma balance sheet for 2011 by using its 2010 values as
references.
When finding the 2011 values, we calculate ($15M) ∗ (appropriate %) for current assets, net fixed
assets, and current liabilities (where the “appropriate %” values are 25%, 50%, and 25%, respectively).
The percentages we use are the same proportions of sales that Zapatera had for 2010; for example,
the current asset proportion was found as ($3M/$12M) = 25%. Long-term debt, common stock,
and paid-in capital keep the same values that they had in 2010, since these amounts are assumed
not to vary with sales. Finally, 2011 retained earnings is found as:
2011 retained earnings = 2010 retained earnings + 2011 net income − 2011 dividends
= $1,200,000 + $2,000,000 − $0
= $3,200,000.
(See footnote b to Table 17.1 for another example of the retained earnings calculation.)
Substituting our estimates into the balance sheet form, we find the following for 2011:
% of % of
2010 sales 2011 sales
sales $12,000,000 $15,000,000
net income $1,200,000 10.00% $2,000,000 13.33%
BALANCE SHEET
% of % of
2010 sales 2011 sales NOTES
current assets $3,000,000 25% $3,750,000 25% 2011 same % of sales as 2010
net fixed assets $6,000,000 50% $7,500,000 50% 2011 same % of sales as 2010
TOTAL ASSETS $9,000,000 $11,250,000
accounts payable $3,000,000 25% $3,750,000 25% 2011 same % of sales as 2010
long-term debt $2,000,000 $2,000,000 2011 same as 2010
TOTAL LIABILITIES $5,000,000 $5,750,000
common stock $1,000,000 $1,000,000 2011 same as 2010
paid-in capital $1,800,000 $1,800,000 2011 same as 2010
retained earnings $1,200,000 $3,200,000 RE 2011 = RE 2010 + NI 2011 - DIVS 2011
COMMON EQUITY $4,000,000 $6,000,000
TOTAL LIABILITIES & OWNERS' EQUITY $9,000,000 $11,750,000 TOTAL FINANCING PROVIDED
($500,000) DISCRETIONARY FINANCING NEEDED (plug)
$11,250,000 TOTAL FINANCING NEEDED = TOTAL ASSETS
©2011 Pearson Education, Inc. Publishing as Prentice Hall

Solutions to End of Chapter Problems—Chapter 17 427
A strange thing has happened! Our “discretionary financing needed” is negative! There is
therefore a problem with our assumptions. What is it?
The discretionary financing needed can be written as:
DFN = Δ total assets − Δ total liabilities − Δ owner’s equity.

(This is equivalent to equation 17-1, but we have only focused on the changes here.)
For Zapatera, our assumptions allow us to substitute into this expression as follows:
DFN = (75%) ∗ (Δ sales) − (25%) ∗ (Δ sales) − (net income2011)
Since the firm’s sales have risen by ($15M − $12M) = $3M, we have:
DFN = (75%) ∗ ($3M) − (25%) ∗ ($3M) − ($2M)

= $1.5M − $2M
= ($500,000).
Zapatera has managed to increase its profit margin from 10% to 13.33%, and, as a result, has
generated all of the money that it needs to fund its increase in sales—and more!
If we prefer to consider an example where the firm’s DFN is not negative, we could assume that
Zapatera’s current assets increased by another $0.5M, or that the firm paid out $0.5M as dividends.
We could also change our assumption about the firm’s profit margin. For example, if instead of
assuming that Zapatera’s profit margin increased to 13.33%, we could assume it stayed at 10%.
In this case, the firm would internally generate exactly the cash it needed:
% of % of
2010 sales 2011 sales
sales $12,000,000 $15,000,000
net income $1,200,000 10.00% $1,500,000 10.00%
BALANCE SHEET
% of % of
2010 sales 2011 sales NOTES
current assets $3,000,000 25% $3,750,000 25% 2011 same % of sales as 2010
net fixed assets $6,000,000 50% $7,500,000 50% 2011 same % of sales as 2010
TOTAL ASSETS $9,000,000 $11,250,000
accounts payable $3,000,000 25% $3,750,000 25% 2011 same % of sales as 2010
long-term debt $2,000,000 $2,000,000 2011 same as 2010
common stock $1,000,000 $1,000,000 2011 same as 2010
paid-in capital $1,800,000 $1,800,000 2011 same as 2010
retained earnings $1,200,000 $2,700,000 RE 2011 = RE 2010 + NI 2011 - DIVS 2011
COMMON EQUITY $4,000,000 $5,500,000
$0 DISCRETIONARY FINANCING NEEDED (plug)
The graph below illustrates Zapatera’s situation. Unlike Figure 17.1, which plots DFN against sales
growth rate, we are plotting DFN against the profit margin (net income as a percentage of sales).
When NI is 10% of sales, Zapatera needs no additional discretionary financing, as just shown. When
the percentage is 13.33%, as it was in our initial scenario, Zapatera’s DFN is negative—it generates
more than enough cash to finance its assets. Only when NI is less than 10% of sales will the firm
need to seek additional discretionary financing.

428 Titman/Keown/Martin • Financial Management, Eleventh Edition
$1,000,000
$500,000
$0
4% 6% 8% 10% 12% 14% 16% 18% 20%
DFN
DFN (sales = $15M)
($500,000)
($1,000,000)
($1,500,000)
NI as % of sales
17-2. Sambonoza expects to have sales of $4,000,000 next year; its net income will be 5% of sales, or (5%)
∗ ($4M) = $200,000. Since the firm pays out half of its net income in dividends (per assumption #2),
it will pay $100,000 in dividends and retain the other $100,000.
Now that we know the firm’s retained earnings for the year, we can determine it common equity
balance at the end of the year. It started with $800,000 (per assumption #2). Adding $100,000 next
year will therefore mean that Sambonoza will end up with common equity of $900,000.
Using these assumptions, we can estimate Sambonoza’s financing needs as follows:
next % of
year sales
sales $4,000,000
net income $200,000 5%
dividends $100,000 payout ratio = 50%
assumption #2
BALANCE SHEET
next % of
year sales NOTES
current assets $800,000 20% assumption #1
net fixed assets $1,000,000 assumption #1
TOTAL ASSETS $1,800,000
payables/trade credit $400,000 10% assumption #3

long-term debt $0 assumption #3
TOTAL LIABILITIES $400,000
COMMON EQUITY $900,000 CE next year = CE this year + NI next year - DIVS next year
$1,300,000 TOTAL FINANCING PROVIDED
$500,000 DISCRETIONARY FINANCING NEEDED (plug)
Sambonoza’s assets will equal $1.8M. However, its spontaneous financing—trade credit and
payables—plus its retained earnings for the year (discretionary funding) and initial discretionary
funding only generate $1.3M. The firm needs $500,000 more in financing to support its assets.

17-3. A. Tulley Appliances will have total assets (total financing needs) of $11,766,667 next year, up
from $10M this year. The details of this calculation are shown below:
this % of next % of
year sales year sales
sales $15,000,000 $20,000,000
net income $750,000 5% $1,000,000 5%
dividends $500,000 given
BALANCE SHEET
this % of next % of
year sales year sales NOTES
current assets $5,000,000 33.33% $6,666,667 33.33% next year same % of sales as this year
net fixed assets $5,000,000 $5,100,000 FA only rise by $100,000
TOTAL ASSETS $10,000,000 $11,766,667
accounts payable $1,500,000 10% $2,000,000 10% next year same % of sales as this year
long-term debt $2,000,000 $2,000,000 next year same as this year
common stock/paid-in capital $2,500,000 $2,500,000 next year same as this year
retained earnings $4,000,000 $4,500,000 RE next year = RE this year + NI next year - DIVS next year
COMMON EQUITY $6,500,000 $7,000,000
$766,667 DISCRETIONARY FINANCING NEEDED (plug)
B. We were told that Tulley’s sales for next year would be $20M—$5M higher than this year’s.
Since their profit margin remains at 5%, this implies net income of (5%) ∗ ($20M) = $1M, of
which $500,000 will be paid out as dividends (this value was given). Tulley will therefore add
($1M − $500,000) = $500,000 to its common equity next year, for a total of $7M (before any
additional discretionary financing—the focus of this problem).
Tulley’s current assets now represent 1/3 of its sales. Since we do not expect this proportion to
change, we project (1/3) ∗ ($20M) = $6.67M in current assets for next year. Adding to this our
fixed assets, $100,000 higher this year at $5.1M, we find that Tulley’s total assets (and total
financing needs) are $11.767M.
Some of Tulley’s required financing will arise spontaneously. This year, accounts payable
represented 10% of their sales; keeping this relationship constant, this implies that next year’s
A/P will be (10%) ∗ ($20M) = $2M. Tulley’s also plans to retain $500,000, as noted above.
However, these funding sources are insufficient to finance all of Tulley’s assets: The firm is
still $766,667 short. This amount, then, represents the firm’s discretionary financing needs.
C. What if Tulley is unwilling to “resort to the use of discretionary financing” (which we will
assume here does not include its expected earnings retention)? If it is unwilling to look for
external financing, then it must generate all of the cash it needs internally. That is:
DFN = Δ total assets − Δ total liabilities − Δcommon equity = 0
Δ total assets = Δ total liabilities + Δ common equity
Δ total assets = (Δ CL + Δ LTD) + Δ common equity
(ΔCA + ΔFA) = [(10%) ∗ (Δ sales) + $0] + [(5%) ∗ ($15M + Δ sales) − $500,000]
[(33.333%) ∗ (Δ sales) + $100,000]
= (10%) ∗ (Δ sales) + $750,000 + (5%) ∗ (Δ sales) − $500,000
[(33.333%) ∗ (Δ sales) + $100,000]
= (15%) ∗ (Δ sales) + $250,000
(18.333%) ∗ (Δ sales) = $150,000
Δ sales = $818,182

Plugging this sales increase into our pro forma balance sheet, we verify that Tulley need not
resort to external financing now:
this % of next % of
year sales year sales
sales $15,000,000 $15,818,182 adding $818,182
net income $750,000 5% $790,909 5%
dividends $500,000 given
BALANCE SHEET
this % of next % of
current assets $5,000,000 33.33% $5,272,727 33.33% next year same % of sales as this year
net fixed assets $5,000,000 $5,100,000 FA only rise by $100,000
TOTAL ASSETS $10,000,000 $10,372,727
long-term debt $2,000,000 $2,000,000 next year same as this year
common stock/paid-in capital $2,500,000 $2,500,000 next year same as this year
retained earnings $4,000,000 $4,290,909 RE next year = RE this year + NI next year - DIVS next year
COMMON EQUITY $6,500,000 $6,790,909
$0 DISCRETIONARY FINANCING NEEDED (plug)
We can illustrate Tulley’s situation by plotting the discretionary financing needed against the
firm’s sales:
$700,000
$500,000
$300,000
$15,818,182
$100,000
DFN
DFN
$9,000,000 $11,000,000 $13,000,000 $15,000,000 $17,000,000 $19,000,000 $21,000,000
($100,000)
($300,000)
($500,000)
($700,000)
sales
Note that, as we just demonstrated algebraically, Tulley needs no additional discretionary

financing when sales equal $15,818,182.

17-4. We can create the pro forma balance sheet for Carlos Menza, Inc. as follows. First, we need to
remember how the given ratios are created; going back to Chapter 4, then, we have:
average collection period = (A/R)/(annual credit sales/365) eq. 4-3

TA turnover = sales/(total assets) eq. 4-8
FA turnover = sales/(net plant & equipment) eq. 4-9
inventory turnover = COGS/inventory eq. 4-4
current ratio = current assets/(current liabilities) eq. 4-1
debt ratio = total liabilities/(total assets) eq. 4-6
Given our sales of $4M, we can use these ratios to determine:
COGS = (75%) ∗ (sales) = (75%) ∗ ($4M) = $3M

TA = (sales)/(TA turnover) = ($4M)/(2) = $2M
FA = (sales)/(FA turnover) = ($4M)/(5) = $800,000
A/R = (sales/365) ∗ (ACP) = ($4M/365) ∗ (9) = $98,630.14
inventory = COGS/(inventory turnover) = ($3M)/(3) = $1M
total liabilities = (TA) ∗ (debt ratio) = ($2M) ∗ (50%) = $1M
current liabilities = (current assets)/(current ratio) = ($1.2M)/(2) = $600,000
Plugging these figures into the balance sheet template, we find that Carlos Menza’s balance sheet
looks like this:
this
year NOTES
sales $4,000,000 given
COGS $3,000,000 75% of sales
BALANCE SHEET
this
year NOTES
cash $101,370 (plug)
inventory $1,000,000 inventory = (COGS)/(inventory turnover)
A/R $98,630 A/R = (sales/365)*(ACP)
net fixed assets $800,000 FA = (sales)/(FA turnover)
TOTAL ASSETS $2,000,000 TA = (sales)/(TA turnover)
current liabilities $600,000 CL = (CA)/(current ratio)
long-term debt $400,000 (plug)
TOTAL LIABILITIES $1,000,000 TL = (TA)*(debt ratio)
COMMON EQUITY $1,000,000 (plug)
TOTAL LIABILITIES & OWNERS' EQUITY $2,000,000 TL&OE = TA

17-5. In Section 17.2, we learn that “accounts payable and accrued expenses . . . are the only liabilities
that typically vary directly with sales.” The Ziegen analysis in Table 17.1 is consistent with this
assertion: A/P and accrued expenses vary with sales, but notes payable and long-term debt do not.
We can easily imagine why the first two accounts would vary with sales: As the firm sells more
items, it must use more materials and labor to create those items or to rebuild inventory. Materials
may be purchased using trade credit, increasing A/P; labor use implies accrued wages payable.
On the other hand, discretionary financing like notes payable and long-term debt require explicit
decisions and actions by management. These funding sources do not vary spontaneously with sales.
As for the assets, we would expect current assets to vary directly with sales. As the firm makes
more sales, it would not be surprising for its cash balance to rise. A build-up of cash will lead
management to park some in marketable securities. As noted above, inventories will probably
also rise to support the higher level of sales. Thus we put the current assets accounts in the
“yes” column. (This is consistent with the text examples, such as that worked in Table 17.1).
Our last account is “plant and equipment.” The text examples, such as Ziegen, show “net fixed
assets” varying with sales. We would need more assets to generate higher sales—more machines,
for example, or another assembly line. The difference here is that these assets will not arise
spontaneously, as accounts receivable and cash would. Interpreting the problem in the broader
sense—more assets are required to support more sales—and not requiring these assets to arise
1
spontaneously, we will classify “plant and equipment” as a “yes.”
YES NO
cash X current asset
notes payable X current liability
marketable securities X current asset
plant & equipment X fixed asset
accounts payable X current liability
inventories X current asset
long-term debt X long-term liability
1
This is consistent with the situation of the Armadillo Dog Biscuit Company, discussed in Problem 17-7. However,
Problem 17-6 illustrates the other interpretation for fixed assets—Thompson Trucking Company’s fixed assets are
assumed not to vary with sales.

17-6. A. If TTC is going to expand its sales from $50M to $80M, it will need an additional $3M in
notes payable, as shown below:
this next
year year
sales $50,000,000 $80,000,000
BALANCE SHEET
this % of next % of
current assets $10,000,000 20% $16,000,000 20% next year same % of sales as this year
net fixed assets $15,000,000 $15,000,000 FA remain unchanged
TOTAL ASSETS $25,000,000 $31,000,000
notes payable $0 $3,000,000 PLUG: discretionary financing needed
bonds payable $10,000,000 $10,000,000 bonds payable remain unchanged
COMMON EQUITY $10,000,000 $10,000,000 common equity remains unchanged; no additions tor retained earnings

B. Assuming that the firm’s current assets remain at 20% of sales ($10M/$50M), then it will
need $16M to support its higher sales level. This $6M increase will be generated partially by
a spontaneous increase in A/P of $3M (assuming that A/P remains at 10% of sales). However,
since bonds payable and common equity remain fixed—the latter since TTC retains none of its
earnings—the other $3M will need to be financed through notes payable.
C. The percent-of-sales method is a good starting point for analysis. However, its assumptions
may be inappropriate for the situation at hand, making its predictions inaccurate. The financial
manager must be prepared to “tweak” the basic method to suit her purposes.
The method’s limitation stems from the basis of its appeal: its simplicity. It assumes that the
current relationships between various accounts and sales will remain the same, but this need
not be the case. In fact, the business may not be scalable. There may, for example, be “break
points” within some of its relationships—volumes beyond which the fundamental relationships
change. For example, the firm may be close to exhausting the capacity of its main suppliers;
increasing sales volume could require using new suppliers, whose prices might be higher or
whose trade payables terms may not be as generous. (Assuming that the firm operates efficiently,
greatly expanding sales would require it to move up its marginal cost curve.) On the other
hand, there might be some “slack” in the firm’s operations, allowing it to increase sales
without proportionate increases in operating costs.
Financial analysis is difficult, and a manager must start somewhere. The percent-of-sales
method is a good place to start. However, the savvy manager will recognize that it is not the
appropriate place to stop.
17-7. A. Armadillo’s projected balance sheet for next year is shown below. We have assumed that
current assets remain at 40% ($2M/$5M) of sales, with fixed assets at 60% ($3M/$5M). Both
accounts therefore rise to support the new, higher level of sales. Accounts payable and accrued
expenses also rise; their proportion to sales remains the same as this year’s. Long-term debt is
unchanged, but the common equity account rises by the total amount of net income, since no
dividends are paid.
Armadillo’s spontaneous sources of financing are insufficient to support its sales growth,
so the firm will need to create a note payable for $1.11M.
this next
year year
sales $5,000,000 $7,000,000
net income $300,000 6% $490,000 7%
BALANCE SHEET
this % of next % of
net fixed assets $3,000,000 60% $4,200,000 60% next year same % of sales as this year
TOTAL ASSETS $5,000,000 $7,000,000
accounts payable $500,000 10% $700,000 10% next year same % of sales as this year
accrued expenses $500,000 10% $700,000 10%
notes payable $0 $1,110,000 PLUG: discretionary financing needed
CURRENT LIABILTIIES $1,000,000 $2,510,000
long-term debt $2,000,000 $2,000,000 LTD remains unchanged
common stock $500,000 $500,000
retained earnings $1,500,000 $1,990,000 RE next year = RE this year + NI next year - DIVS next year ($0)
COMMON EQUITY $2,000,000 $2,490,000 common equity rises by net income amount; all NI retained

B. The new financing will change Armadillo’s financial situation. Comparing its current ratio
(current assets/current liabilities) and its debt ratio (total liabilities/total assets) between this
year and next year, we find:
this next
year year
current ratio = 2.00 1.12
debt ratio = 0.600 0.644
The firm has decreased its ratio of current, liquid assets to current liabilities, since it added
$1.11M in notes payable to its current liabilities. (The dollar increase in current assets—
$800,000—was proportionally smaller than the increase in current liabilities.) Its debt ratio
also rose: Although its assets rose by $2M (40%), its liabilities rose by $1.51M (50.33%). The
$490,000 increase in common equity was much smaller than the increase in debt, so that
Armadillo supported its increase in sales more heavily with debt. This choice resulted in a
deterioration of its debt ratio.
C. If Armadillo had increased sales more slowly, it could have funded more of its growth with
retained earnings, reducing its reliance on debt. For example, the spreadsheet below shows the
impact of the first year’s growth to $6M, assuming that NI still represents 7% of those sales:
this next
year year
sales $5,000,000 $6,000,000
net income $300,000 6% $420,000 7%
BALANCE SHEET
this % of next % of
net fixed assets $3,000,000 60% $3,600,000 60% next year same % of sales as this year
TOTAL ASSETS $5,000,000 $6,000,000
accounts payable $500,000 10% $600,000 10% next year same % of sales as this year
accrued expenses $500,000 10% $600,000 10%
notes payable $0 $380,000 PLUG: discretionary financing needed
CURRENT LIABILTIIES $1,000,000 $1,580,000
long-term debt $2,000,000 $2,000,000 LTD remains unchanged
common stock $500,000 $500,000
retained earnings $1,500,000 $1,920,000 RE next year = RE this year + NI next year - DIVS next year ($0)
COMMON EQUITY $2,000,000 $2,420,000 common equity rises by net income amount; all NI retained
this next
year year
current ratio = 2.00 1.52
debt ratio = 0.600 0.597
In this case, Armadillo only has to borrow $380,000, and is able to increase common equity to
$2.42M. Its current ratio still deteriorates, but not as drastically; its debt ratio actually improves
a bit. It will be more easily able to support the projected sales level of $7M in this scenario. (It’s
pretty straightforward: the firm now has two years in which to accumulate earnings and add to
common equity, so that its debt need not rise as much.)

17-8. Fishing Charter plans to increase its sales by $500,000. This will require the firm to invest
(30%) ∗ ($500,000) = $150,000 in new assets. Where will this $150,000 come from?
One source of financing is retained earnings. Since the firm will reinvest 1% of its sales, this will
provide (1%) ∗ ($500,000) = $5,000. In addition, spontaneous liabilities (accounts payable, accrued
expenses) provide (15%) ∗ ($500,000) = $75,000. Thus, the firm needs ($150,000 − $5,000 −
$75,000) = $70,000 in discretionary financing.
We could also have determined this using the given percentages: Since assets rise by 30% of sales,
but spontaneous financing rises by only 15% and retained earnings only rises by 1%, the firm still
needs (30% − 15% − 1%) = 14% of sales, or (14%) ∗ ($500,000) = $70,000.
17-9. A. Harrison Electronics’ financial analyst’s projections make it very easy to find the firm’s
discretionary financing needed. All we need to do is find the difference between the projected
assets, which we’re given, and the total financing provided (also given). We therefore have the
following:
BALANCE SHEET
10% 20% 40% NOTES
current assets $13,200,000 $14,400,000 $16,800,000
net fixed assets $19,800,000 $21,600,000 $25,200,000
TOTAL ASSETS $33,000,000 $36,000,000 $42,000,000
accounts payable $2,200,000 $2,400,000 $2,800,000

accrued expenses $2,200,000 $2,400,000 $2,800,000
notes payable $1,500,000 $1,500,000 $1,500,000 no change
CURRENT LIABILTIIES $5,900,000 $6,300,000 $7,100,000
long-term debt $6,500,000 $6,500,000 $6,500,000 no change
TOTAL LIABILITIES $12,400,000 $12,800,000 $13,600,000
common stock (par) $1,000,000 $1,000,000 $1,000,000 no change
paid-in capital $2,000,000 $2,000,000 $2,000,000 no change
retained earnings $15,550,000 $15,600,000 $15,700,000
COMMON EQUITY $18,550,000 $18,600,000 $18,700,000
TOTAL FINANCING PROVIDED $30,950,000 $31,400,000 $32,300,000
DISCRETIONARY FINANCING NEEDED $2,050,000 $4,600,000 $9,700,000
TOTAL FINANCING NEEDED = TOTAL ASSETS $33,000,000 $36,000,000 $42,000,000
The firm needs significant amounts of financing in all of the scenarios. The spreadsheet below
expresses the analyst’s dollar amounts as proportions of total assets, to facilitate our comparisons
among the scenarios.

BALANCE SHEET
10% % of TA 20% % of TA 40% % of TA
current assets $13,200,000 40% $14,400,000 40% $16,800,000 40%
net fixed assets $19,800,000 60% $21,600,000 60% $25,200,000 60%
TOTAL ASSETS $33,000,000 100% $36,000,000 100% $42,000,000 100%
accounts payable $2,200,000 7% $2,400,000 7% $2,800,000 7%

accrued expenses $2,200,000 7% $2,400,000 7% $2,800,000 7%
notes payable $1,500,000 5% $1,500,000 4% $1,500,000 4%
CURRENT LIABILTIIES $5,900,000 18% $6,300,000 18% $7,100,000 17%
long-term debt $6,500,000 20% $6,500,000 18% $6,500,000 15%
TOTAL LIABILITIES $12,400,000 38% $12,800,000 36% $13,600,000 32%
common stock (par) $1,000,000 3% $1,000,000 3% $1,000,000 2%
paid-in capital $2,000,000 6% $2,000,000 6% $2,000,000 5%
retained earnings $15,550,000 47% $15,600,000 43% $15,700,000 37%
COMMON EQUITY $18,550,000 56% $18,600,000 52% $18,700,000 45%
TOTAL FINANCING PROVIDED $30,950,000 94% $31,400,000 87% $32,300,000 77%
DISCRETIONARY FINANCING NEEDED $2,050,000 6% $4,600,000 13% $9,700,000 23%
TOTAL FINANCING NEEDED = TOTAL ASSETS $33,000,000 100% $36,000,000 100% $42,000,000 100%
B. Given these comparisons, we can see that some of the sources of financing for Harrison are:
Long-term debt: The firm’s long-term debt is only slightly larger than its current liabilities and
is significantly less than its common equity. It is possible that Harrison could borrow more
long-term money. (In the 10% case, LTD is 20% of assets; it’s 18% or 15% in the 20% and
40% growth cases, respectively.)
Notes payable: If Harrison prefers to borrow short term, it could take out another note payable.
In the given projections, it has not raised its N/P at all in support of its much higher sales. (In
the 10% growth scenario, N/P is 5% of assets; in the other two cases, it is 4%.)
Retained earnings: The firm increases its RE slightly as it increases its sales, by not by nearly
as much as we expect that it could. (RE is 47% of total assets in the 10% case; it is only 37%
in the 40% case. There is significant opportunity here for increasing discretionary financing,
assuming the company is profitable and currently choosing to pay significant dividends in lieu
of retaining earnings; a decision that can be modified if the firm would prefer to use internal
sources of funds to grow versus borrowing additional amounts.)
Common stock: The firm could always issue new common stock. (It may be unwilling to do
so, however, if it’s afraid that the sale could signal that its stock is overvalued.)

17-10. A. In order for Caswell Publishing to increase its sales so drastically, it will need significant
discretionary financing. Since it wishes to increase total assets to $60,000,000, but will have
only $34,000,000 provided, it will need to find another $24,000,000. The balance sheets below
express the values we were given as percentages of total assets. Comparing the two years in
these relative terms may help us identify some promising sources of financing for Caswell.
BALANCE SHEET
2010 % of TA 2011 % of TA
current assets $12,000,000 40% $24,000,000 40%
net fixed assets $18,000,000 60% $36,000,000 60%
TOTAL ASSETS $30,000,000 100% $60,000,000 100%
accounts payable $2,000,000 7% $4,000,000 7%

accrued expenses $2,000,000 7% $4,000,000 7%
notes payable $1,500,000 5% $1,500,000 3%
CURRENT LIABILTIIES $5,500,000 18% $9,500,000 16%
long-term debt $6,500,000 22% $6,500,000 11%
TOTAL LIABILITIES $12,000,000 40% $16,000,000 27%
common stock (par) $1,000,000 3% $1,000,000 2%
paid-in capital $2,000,000 7% $2,000,000 3%
retained earnings $15,000,000 50% $15,000,000 25%
COMMON EQUITY $18,000,000 60% $18,000,000 30%
TOTAL FINANCING PROVIDED $30,000,000 100% $34,000,000 57%
DISCRETIONARY FINANCING NEEDED $26,000,000 43%

TOTAL FINANCING NEEDED = TOTAL ASSETS $60,000,000 100%
The bold, boxed numbers in the far right column identify 2011 values that are significantly
smaller than their 2010 counterparts, based on the company’s pro forma balance sheet which
reflects anticipated asset growth from the new business. These values suggest that Caswell
could look for financing from:
Notes payable: The firm has not yet increased its N/P, despite doubling sales. If it were to go
back to having 5% of assets in N/P, it would borrow an additional $1.5M here.
Long-term debt: Similarly, the firm has not yet increased its long-term borrowing. If it were to
go back to its 22% LTD/TA ratio, it would borrow an additional $6.7M here. There is additional
debt capacity here as a 22% ratio is quite low. Depending on the amount of earnings the firm
can/will retain (see next item), the decision will be either to borrow additional funds or issue
additional common stock.
Retained earnings: The firm has apparently not retained any of its new, higher earnings, despite
doubling sales. RE should be $15M higher in 2011, based on its 2010 ratio of RE to total assets.
I would recommend increasing retained earnings to some degree to provide discretionary
financing—it is the lowest flotation-cost funding source.
Common stock: Caswell could issue stock to raise funds, should it prefer not to borrow
additional money or decrease dividends.

17-11. A. The spreadsheet below calculates Sharpe’s cash needs for the first seven months of 2011:
NOVEMBER DECEMEBER JANUARY FEBRUARY MARCH APRIL MAY JUNE JULY AUGUST
sales (forecast for 2011) $220,000 $175,000 $90,000 $120,000 $135,000 $240,000 $300,000 $270,000 $225,000 $150,000
CASH RECEIPTS
sales for cash (10%) JAN: $9,000 $12,000 $13,500 $24,000 $30,000 $27,000 $22,500
first month after sale (60%) DECEMBER: $105,000 $54,000 $72,000 $81,000 $144,000 $180,000 $162,000
second month after sale (30%) NOVEMBER: $66,000 $52,500 $27,000 $36,000 $40,500 $72,000 $90,000
TOTAL CASH RECEIPTS $180,000 $118,500 $112,500 $141,000 $214,500 $279,000 $274,500
CASH DISBURSEMENTS
raw materials $72,000 $81,000 $144,000 $180,000 $162,000 $135,000 $90,000
rent $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000
other expenditures $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 $20,000
tax prepayments $22,500 $22,500
TOTAL CASH DISBURSEMENTS $102,000 $111,000 $196,500 $210,000 $192,000 $187,500 $120,000
NET CHANGE IN CASH

NET CHANGE IN CASH FOR PERIOD $78,000 $7,500 ($84,000) ($69,000) $22,500 $91,500 $154,500
PLUS: BEGINNING CASH BALANCE $22,000 $100,000 $107,500 $23,500 $15,000 $15,000 $67,509
LESS:INTEREST ON SHORT-TERM BORROWING $0 $0 $0 $0 ($605) ($386) $0
LESS: SHORT-TERM BORROWING REPAYMENTS ($21,895) ($38,605) $0
EQUALS: ENDING CASH BALANCE BEFORE S-T BORROWING $100,000 $107,500 $23,500 ($45,500) $15,000 $67,509 $222,009
NEW FINANCING NEEDED

FINANCING NEEDED FOR PERIOD $0 $0 $0 $60,500 $0 $0 $0
ENDING CASH BALANCE $22,000 $100,000 $107,500 $23,500 $15,000 $15,000 $67,509 $222,009
CUMULATIVE BORROWING $0 $0 $0 $60,500 $38,605 $0 $0
Some details on these calculations are:

• The cash receipts for January, highlighted with boxes, give an example of how Sharpe’s
sales are paid over time. First, 10% of a month’s sales are paid in that month; for January,
this means that the firm receives (10%) ∗ ($90,000) = $9,000 from January sales. Next,
60% of a month’s sales are received the following month; thus, in January, Sharpe receives
60% of December’s sales, or (60%) ∗ ($175,000) = $105,000. Finally, 30% of a month’s
sales are received two months later, so in January, Sharpe receives 30% of November
sales: (30%) ∗ ($220,000) = $66,000.
• Raw materials are ordered two months ahead, then paid the following month. Thus, to
support March sales, Sharpe must pay (60%) ∗ ($135,000) = $81,000 in February.
• Financing needed for the month is the difference between the cash the firm brings in and
what it must pay out. For example, in May, the firm’s payments from sales total $214,500.
Its required disbursements are $192,000. The firm therefore does not require new borrowing
in May. However, it does have outstanding short-term borrowing from the prior month,
and will therefore need not only to pay interest on those borrowings—12% ∗ (1/12) ∗
($60,500) = $605—but it will also use any “extra” cash to pay down its debt. Since it must
maintain a $15,000 cash balance, it cannot repay the full $60,500 that it has outstanding; it
therefore repays as much as it can, $21,895, leaving the required $15,000 cushion.

The chart below helps us to visualize Sharpe’s short-term cash needs. As long as its cash receipts
(the black curve) are above its cash disbursements (the dark gray curve), the firm does not need
to seek short-term liquidity. However, the relatively high cash outflows in March and April
mean that Sharpe must borrow to pay its bills on time.
$300,000
$250,000
$200,000
cash receipts
$150,000
cash disbursements
short-term cumulative borrowings
$100,000
$50,000
$0
JANUARY FEBRUARY MARCH APRIL MAY JUNE JULY
B. Since Sharpe will have $222,009 at the end of July, it will have enough to repay its $200,000
loan and still maintain its $15,000 cash cushion.
17-12. A. Harrison’s cash situation under the expected sales forecast looks like this:
NOVEMBER DECEMEBER JANUARY FEBRUARY MARCH APRIL MAY JUNE JULY AUGUST
CASH RECEIPTS
CASH DISBURSEMENTS
raw materials $78,000 $97,500 $195,000 $178,750 $130,000 $130,000 $117,000
rent $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000
NET CHANGE IN CASH

NET CHANGE IN CASH FOR PERIOD $60,500 ($4,000) ($127,500) ($37,750) $90,000 $85,000 $75,500
LESS:INTEREST ON SHORT-TERM BORROWING $0 $0 $0 ($690) ($1,074) ($185) $0
EQUALS: ENDING CASH BALANCE BEFORE S-T BORROWING $82,500 $78,500 ($49,000) ($18,440) $20,000 $86,300 $161,800

FINANCING NEEDED FOR PERIOD $0 $0 $69,000 $38,440 $0 $0 $0
CUMULATIVE BORROWING $0 $0 $69,000 $107,440 $18,514 $0 $0

(Calculations for Harrison are similar to those for Sharpe Corporation in Problem 17-11;
please see the answer to the Sharpe problem for details.)
$300,000
$250,000
$200,000
cash receipts
$150,000
cash disbursements
$100,000
$50,000
$0
The chart at above illustrates these relationships, and shows that Harrison must use its short-term
borrowings in March, April, and May.
Since Harrison is concerned with evaluating its cash situation if its expected sales vary by
20%, both higher and lower, we will recalculate these values for both of these cases. First,
we look at the worst case, where sales are lower by 20% in each month:
(SALES FALL BY 20% ) NOVEMBER DECEMEBER JANUARY FEBRUARY MARCH APRIL MAY JUNE JULY AUGUST
CASH RECEIPTS
CASH DISBURSEMENTS
raw materials $62,400 $78,000 $156,000 $143,000 $104,000 $104,000 $93,600
rent $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000
NET CHANGE IN CASH

NET CHANGE IN CASH FOR PERIOD $72,100 $700 ($112,500) ($36,200) $66,000 $57,500 $54,400
LESS:INTEREST ON SHORT-TERM BORROWING $0 $0 $0 ($377) ($743) ($90) $0


$250,000
$200,000
$150,000
cash receipts
cash disbursements
$100,000
$50,000
$0
(Note that we have left November’s and December’s sales the same, since those are historical,
not projected.)
Surprisingly, when sales fall, Harrison’s dependence on short-term borrowings does not
increase. The firm still must borrow in the same three months that it does under the expected
case, but now the amounts are smaller. The difference comes from the cost of goods sold—
when sales fall, Harrison need not prepay 65% of as large a sales amount. This savings on
materials conserves cash.
Now, looking at the higher sales levels:
(SALES RISE BY 20% ) NOVEMBER DECEMEBER JANUARY FEBRUARY MARCH APRIL MAY JUNE JULY AUGUST
CASH RECEIPTS
CASH DISBURSEMENTS
raw materials $93,600 $117,000 $234,000 $214,500 $156,000 $156,000 $140,400
rent $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000
NET CHANGE IN CASH

NET CHANGE IN CASH FOR PERIOD $48,900 ($8,700) ($142,500) ($39,300) $114,000 $112,500 $96,600
LESS:INTEREST ON SHORT-TERM BORROWING $0 $0 $0 ($1,003) ($1,406) ($280) $0

Harrison still has cash-flow problems in the same three months, March through May, but now
its borrowing needs are higher. Again, this is because its cost of goods sold are 65% of sales—
higher sales means more payments for materials. We are observing the “it takes money to
make money” phenomenon—while we might expect that lower sales would mean more need
to borrow, it turns out to be exactly the opposite.

B. Under none of the three cash flow scenarios will Harrison have enough cash in June to repay
the entire $200,000 note. It will need to find another alternative for the unpaid portion—
renegotiating the loan or refinancing it.
$350,000
$300,000
$250,000
$200,000
cash receipts
cash disbursements
$150,000 short-term cumulative borrowings
$100,000
$50,000
$0

Financial Forecasting and Planning: Balance Sheet

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Chapter 17

Financial Forecasting and Planning

©2011 Pearson Education, Inc. Publishing as Prentice Hall

DFN = Δ total assets − Δ total liabilities − Δ owner’s equity.

DFN = (75%) ∗ (Δ sales) − (25%) ∗ (Δ sales) − (net income2011)

DFN = (75%) ∗ ($3M) − (25%) ∗ ($3M) − ($2M)

©2011 Pearson Education, Inc. Publishing as Prentice Hall

DFN (sales = $15M)

payables/trade credit $400,000 10% assumption #3

©2011 Pearson Education, Inc. Publishing as Prentice Hall

©2011 Pearson Education, Inc. Publishing as Prentice Hall

Note that, as we just demonstrated algebraically, Tulley needs no additional discretionary

©2011 Pearson Education, Inc. Publishing as Prentice Hall

average collection period = (A/R)/(annual credit sales/365) eq. 4-3

COGS = (75%) ∗ (sales) = (75%) ∗ ($4M) = $3M

©2011 Pearson Education, Inc. Publishing as Prentice Hall

©2011 Pearson Education, Inc. Publishing as Prentice Hall

©2011 Pearson Education, Inc. Publishing as Prentice Hall

©2011 Pearson Education, Inc. Publishing as Prentice Hall

©2011 Pearson Education, Inc. Publishing as Prentice Hall

accounts payable $2,200,000 $2,400,000 $2,800,000

©2011 Pearson Education, Inc. Publishing as Prentice Hall

accounts payable $2,200,000 7% $2,400,000 7% $2,800,000 7%

©2011 Pearson Education, Inc. Publishing as Prentice Hall

accounts payable $2,000,000 7% $4,000,000 7%

DISCRETIONARY FINANCING NEEDED $26,000,000 43%

©2011 Pearson Education, Inc. Publishing as Prentice Hall

NET CHANGE IN CASH

NEW FINANCING NEEDED

Some details on these calculations are:

©2011 Pearson Education, Inc. Publishing as Prentice Hall

NET CHANGE IN CASH

NEW FINANCING NEEDED

©2011 Pearson Education, Inc. Publishing as Prentice Hall

NET CHANGE IN CASH

NEW FINANCING NEEDED

©2011 Pearson Education, Inc. Publishing as Prentice Hall

NET CHANGE IN CASH

NEW FINANCING NEEDED

©2011 Pearson Education, Inc. Publishing as Prentice Hall

©2011 Pearson Education, Inc. Publishing as Prentice Hall

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