Additional Funds Needed Method

Topics: Balance sheet, Generally Accepted Accounting Principles, Accounts receivable Pages: 2 (537 words) Published: July 23, 2013
Additional Funds Needed Method:

Most companies expect growth in sales, which means its assets also must grow. Asset growth requires additional funds, so the firm may have to raise additional external capital if it has insufficient internal funds. If we assume that none of the firm’s ratios will change, we can use a simple approach, the Additional Funds Needed (AFN) method, to forecast financial requirements.

Required Increase in Assets
In a steady-state situation in which no excess capacity exists, the firm must have additional plant and equipment, more delivery trucks, higher inventories, and so forth if sales are to increase. In addition, more sales will lead to more accounts receivable, and those receivables must be financed from the time of the sale until they are collected. Therefore, both fixed and current assets must increase if sales are to increase. Of course, if assets are to increase, liabilities and equity must also increase by a like amount to make the balance sheet balance.

Spontaneous Liabilities
The first sources of expansion funding are the “spontaneous” increases that will occur in a company’s accounts payable and accrued wages and taxes. The company’s suppliers give it 10 days to pay for inventory purchases, and since purchases will increase with sales, accounts payable will automatically rise. For example, if sales rise by 10% then inventory purchases will also rise by 10%, and this will cause accounts payable to rise spontaneously by the same 10%. Similarly, because the company pays workers every two weeks, more workers and a larger payroll will mean more accrued wages payable. Finally, higher expected income will mean more accrued income taxes, and its higher wage bill will mean more accrued withholding taxes. No interest normally is paid on these spontaneous funds, but their amount is limited by credit terms, contracts with workers, and tax laws. Therefore, spontaneous funds will thus be used to the extent possible, but there...
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