The equation for computing Fuling’s external Financing Needed (EFN) is given below:
Where S 0 = current sales
S 1 = forecasted sales = S 0 (1 + g) = 1000(1+0.25) = 1,250
g = forecasted growth in sales
A* 0 = assets at time 0
L* 0 = liabilities at time 0
PM = profit margin
b = retention ratio = 33.3%
In the event that sales grow by 25%, the current sales will be $1,250. Current assets is 20% to sales. Therefore, current assets $200. Therefore:
= 200/1000(1,250 – 1000) = 50
= 225/1000(1250-1000) = 56.25
= since the profit margin is constant, it will be (1) (1,250) (0.333) = 416.25
EFN = 50 – 56.25 – 416.25 = $ 422.5
The EFN value of 422.5 means that the company must access external funding to meet the expected growth in sales. The external funding will enable it to acquire more fixed assets that will be required for the expected growth in sales (Besley & Brigham, 2014).
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Based on Fuling’s EFN, it is evident that the firm does not have excess capacity in its fixed assets. To support the expected growth, the company must increase it fixed assets to support the forecasted sales growth of 25%. Acquiring Bunzl Distribution USA will be an effective strategy for the company because it would allow it to increase its fixed assets to support the expected growth. Bunzl current assets and liabilities are necessary because the supply chain capabilities of the company would enable Fuling to meet the expected growth in liabilities. To calculate the firm’s capacity, the current sales value is divided by the % of fixed assets being utilized (Besley & Brigham, 2014). Therefore:
Full Capacity Sales (S FC ) = S 0 /% of capacity = 1000/1 = 1,000.
It is clear that the forecasted sales ($1,250) is greater than the full capacity. Therefore, fixed assets must be increased to meet the expected growth.
B.
If sales subsequently grow by 50% and the assets remain 20% of sales, the EFN will be calculated as shown below:
= 200/1000(1500-1000) = 100
= 225/1000(1500-1000) = 115.5
= 1(1500) (0.333) = 495
EFN = 100 – 115.5- 495 = $510.5
To plan for an expected growth of 50% in sales, Fuling needs to consider several aspects of its financial policy. First, the company must consider its profit margin. The profit margin is the percentage of sales that remain fatter all expenses are deducted (Steinmetz & Brooks, 2013). The profit margin ratio shows how a company can effectively convert sales into income. It is also used by creditors to determine the ability of the company to pay its debts (Tracy, 2012). Investors are also interested in the profit margin because it indicates that a firm has enough dividends to distribute. Currently, Fuling’s profit margin is 1. Therefore, it must increase its profit margin by adopting strategies such as cutting wastes, increasing the prices of its products, and reducing discounting Needles, B., (Powers & Crosson, 2013).
Additionally, Fuling needs to revise its dividend policy. The current fixed dividend ratio of 33.3% is significantly high, and the Company may not be left with funds necessary to meet the exacted growth in sales after paying investors. Reducing the dividend ratio will be necessary to secure more funds to support the expected 50% in growth.
The company’s ability to generate sales from its assets is another consideration.
Assets turnover ratio = net sales/ average total assets = 1500/300 = 5
An assets turnover ratio of 5 means that the company is utilizing its assets effectively, and there is no need to increase its assets. An EFN of $510.5 implies that the company needs to access additional funding to support the expected growth in sales.
References
Besley, S., & Brigham, E. F. (2014). Principles of finance . Australia: South-Western.
Needles, B., Powers, M., & Crosson, S. (2013). Financial and Managerial Accounting. Hoboken: Cengage Learning.
Steinmetz, L. L., & Brooks, W. T. (2013). How to sell at margins higher than your competitors: Winning every sale at full price, rate, or fee . Hoboken, N.J: Wiley.
Tracy, A. (2012). Ratio Analysis Fundamentals: How 17 Financial Ratios Can Allow You to Analyse Any Business on the Planet . RatioAnalysis.net.
