Finance Firm With Sales Of 5000 Has The Following Balance Sh

Financea Firm With Sales Of 5000 Has The Following Balance Sheetass

Finance a firm with sales of $5,000 has the following balance sheet: Assets, Liabilities, and Equity as of xx/xx/xx

Assets

• Accounts receivable: $1,300
• Inventory: $1,600
• Plant: $1,700
• Total assets: $4,600

Liabilities and Equity

• Accounts payable: $1,200
• Long-term debt: $2,500
• Equity: $900
• Total liabilities and equity: $4,600

The firm earns 20 percent on sales and expects sales to rise to $5,500. The increase in sales may require additional financing. Accounts receivable and inventory will increase, and trade accounts will also spontaneously increase with the sales increase. Management expects to distribute 75% of earnings.

Paper For Above instruction

Analyzing the financing needs of a firm as sales increase is essential to ensure adequate liquidity and solvency. This case involves projecting the firm's balance sheet with sales growth from $5,000 to $5,500, applying the percent of sales method, and determining if external financing is necessary. The solution highlights the calculations involved in estimating spontaneous assets and liabilities, assessing the new financing requirement, and constructing a pro forma balance sheet.

Assessment of Spontaneous Changes with Sales Growth

The proportional relationship between sales and certain assets and liabilities implies that as sales grow, accounts receivable, inventory, and accounts payable will change correspondingly. Given the initial values, the following calculations determine their adjustments:

1. Accounts receivable: Previous accounts receivable ($1,300) / sales ($5,000) = 0.26 or 26%. Applying this percentage to the new sales of $5,500 yields: $5,500 * 0.26 = $1,430.
2. Inventory: Previous inventory ($1,600) / sales ($5,000) = 0.32 or 32%. The new inventory requirement: $5,500 * 0.32 = $1,760.
3. Accounts payable: Previous accounts payable ($1,200) / sales ($5,000) = 0.24 or 24%. The new accounts payable: $5,500 * 0.24 = $1,320.

These calculations suggest that with a 10% increase in sales, accounts receivable increase by $130, inventory by $160, and accounts payable by $120, compared to their initial values.

Calculation of Projected Earnings

The firm earns a 20% profit margin on sales, so the projected earnings at sales of $5,500 are:

Profit = 20% of $5,500 = $1,100.

Management intends to distribute 75% of earnings, which equals:

Dividends = 75% of $1,100 = $825.

The retained earnings, therefore, will be:

Retained earnings = $1,100 - $825 = $275.

Determining the External Financing Need

The total projected assets consist of the current assets, which include accounts receivable, inventory, and other spontaneous assets, plus the fixed assets. Since fixed assets (plant) are not considered spontaneous, they are assumed to remain unchanged unless explicitly stated.

Projected spontaneous current assets:

• Accounts receivable: $1,430
• Inventory: $1,760

Assumed fixed assets: $1,700 (unchanged).

Total projected assets:

• $1,430 (accounts receivable) + $1,760 (inventory) + $1,700 (plant) = $4,890.

The projected liabilities are:

• Accounts payable: $1,320
• Long-term debt: assumed to remain at $2,500 unless new debt is issued.

Equity will increase by retained earnings ($275), leading to total equity of:

$900 + $275 = $1,175.

Total projected liabilities and equity:

• Accounts payable: $1,320
• Long-term debt: $2,500
• Equity: $1,175

Total liabilities and equity sum to:

$1,320 + $2,500 + $1,175 = $4,995.

Comparing total projected assets ($4,890) with total liabilities and equity ($4,995), there is a shortfall of $105. This indicates that the firm requires external financing of $105 to support sales of $5,500.

Constructing the Pro Forma Balance Sheet

The pro forma balance sheet for sales of $5,500 incorporates the above calculations:

• Assets:
• Cash: As determined by the excess or need for cash management; initially, cash is adjusted to ensure the desired level of $10,000. Since projected cash is not explicitly calculated here, assume the firm needs to hold the excess in cash if there are surplus funds or raise funds if there's a deficit.
• Accounts receivable: $1,430
• Inventory: $1,760
• Plant: $1,700 (unchanged)

• Liabilities and Equity:
• Accounts payable: $1,320
• Long-term debt: $2,500 + $105 (additional financing) = $2,605
• Equity: Previous equity plus retained earnings ($1,175), which is $900 + $275 = $1,175, totaling $1,175.

Since the firm requires external financing, it should issue long-term debt of $105, and any excess cash should be held in cash, maintaining liquidity and operational flexibility.

Conclusion

In conclusion, projecting the balance sheet with sales growth involves calculating spontaneous assets and liabilities using the percent of sales method, estimating earnings, and determining the financing gap. The analysis shows that the firm needs approximately $105 in additional long-term debt to support increased sales, assuming fixed assets remain unchanged. Proactive financial planning ensures the firm maintains liquidity without over-leverage. Regular review and adjustments are necessary as actual sales and expenses fluctuate, emphasizing the importance of dynamic financial modeling in corporate finance.

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