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Pillai Institute of Management Studies and

Research (PIMSR),
New Panvel

Master of Management Studies (MMS)

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MMS – Semester - II
Subject : Financial Management (FM)

Lesson-8 : Financial Planning and


Financial Forecasting
Lecture date : 2.4.2018

by
Prof. K.G.S. MANI

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Lecture date : 2.4.2018
Lesson-8 : Financial Planning and Financial Forecasting
(1) Meaning of Financial Planning :
Financial Planning includes estimating the amount of capital to
be raised by the firm and proportionate amount of securities and
laying down the policies as to the administration of the financial
plan. There are two major areas of financial decision making.
Funds requirement decision is concerned with the estimation of
the total funds or capital requirements of the business
enterprises. The financial decision is concerned with the sources
from which the funds are to be raised. The business enterprise
not only gets the funds required at reasonable cost but it is also
necessary that the funds are received at proper time. Therefore,
it is necessary that the management of an enterprise takes care
of all these aspects right at the time of formation of the company
by having a proper financial planning.

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(2) Meaning of Financial Plan : Financial Planning results in
the formation of the financial plan. It is primarily a statement
estimating the amount of capital and determining its
composition. It states :
(i) the quantum of finance i.e. the amount needed for
implementing the business and securities to be issued to raise
the required amount. (Amount of External Funds Requirements
(EFR).
(ii) the patterns of financing i.e. the form and proportion of
various corporate securities to be issued to raise the required
amount. (Equity Shares, Preference Shares, Debentures, Long
Term Loans from Banks for investment in fixed assets and Bank
Borrowings (Short Term Loans) for Working Capital
requirements).
(iii) the policies to be pursued for the flotation of various
corporate securities particularly regarding the time of their
floatation.

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(3) Importance of Financial Plan : Financial plan once
prepared affects the business of the company. As such, the
financial plan should be prepared as carefully as possible. A
properly laid out financial plan ensures the success of the
business. By estimating requirements of capital precisely, the
available resources can be utilised properly. A faulty financial
plan failing to assess the requirements of capital may result into
inadequacy of capital. Thus, the situation of excessive capital or
inadequate capital may be avoided by a properly laid financial
plan as both these situations affect the business adversely.
Success or failure of production and distribution function
depends upon the correctness of financial plan. A properly
prepared financial plan relieves the top management of the
detailed and time-consuming procedures, once it is made known
to all levels of the management.

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(4) Essential Principles for formulating a good Financial
Plan :
The following are the essentials of a good financial plan :
(i) Simplicity : The financial plan should be simple so that it can
be managed easily. The types of securities in the capital
structure should be the minimum. Large number of securities
may give rise to unnecessary suspicion in the minds of the
investors and create unnecessary complications.
(ii) Long Term view : Financial plan should be formulated and
conceived by the promoters/management keeping in view the
long term needs of the corporation rather than finding out the
easiest way of obtaining the original capital. This is because the
original financial plan would continue to operate for a long
period even after the formation of the company.
(iii) Foresight : Financial plan should be prepared keeping in view
the future requirements of capital for the business. Of course, it
is a difficult task since it requires technological improvements,
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demand forecast, resource availability and other secular
changes should be kept in view while drafting the financial plan.
A plan visualised without foresight may bring disaster for the
company in case it fails to meet the requirements for both fixed
and working capital.
(iv) Flexibility : Financial plan should have a degree of flexibility. It
means there should be scope for making changes in the plan in
future if there is a need. The plan can be reviewed from time to
time depending upon the circumstances.
(v) Economy : Cost of rising capital should be minimum. It should
not put heavy burden on the company. It may be possible by
using proper debt-equity mix.
(vi) Liquidity : Liquidity means ability of the company to make
available the ready cash, whenever required to make
disbursements. Adequate liquidity in the financial plan gives it a
degree of flexibility also. It may act as a shock absorber in the

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event of business operations deviating from the normal course.
This may help to maintain liquidity and also goodwill of the firm.
(vii) Contingencies : The financial plan should keep in view the
requirements of funds for the future contingencies. However,
capital should not be kept idle for unforeseen conditions. The
promoter’s foresight will considerably reduce the risk.
(viii)Optimum Use : A proper balance should be maintained
between the long-term and short-term funds. The business
should not have shortage of funds at any point of time. At the
same time, it should not have idle funds. There should be an
optimum use of funds.

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(5) Components of a Financial Plan :
Proforma statements are part of a financial plan. While there is
considerable variation in the scope, degree of formality and
level of sophistication in financial planning across firms, most of
the financial plans have certain common elements. These are as
under :
(i) Economic assumptions : The financial plan is based on certain
assumptions about the economic environment (interest rate,
inflation rate, growth rate, exchange rate, and so on).
(ii) Sales forecast : The sales forecast is typically the starting
point of the financial forecasting exercise. Most financial
variables are related to the sales figures.
(iii) Proforma statements : The heart of a financial plan are the
proforma (forecast) Profit and loss accounts and proforma
balance sheets.

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(iv) Asset requirements : Firms need to invest in plant and
equipment and working capital. The financial Plan spells out
the projected capital investments and working capital
requirements over a period of time.
(v) Financing plan : Suitable sources of financing have to be
thought of for supporting the investment in capital expenditure
and working capital. The financing plan delineates the
proposed means of financing.
(vi) Cash budget : The cash budget shows the cash inflows and
outflows expected in the budget period.

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(6) Benefits of Financial Planning :
Financial planning has the following benefits :
(i) Identifies advance actions to be taken in various areas.
(ii) Seeks to develop a number of options in various areas that can
be exercised under different conditions.
(iii) Facilitates a systematic exploration of interaction between
investment and financial decisions.
(iv) Clarifies the links between present and future decisions.
(v) Forecasts what is likely to happen in future and hence helps in
avoiding surprises which may involve investing funds.
(vi) Ensures that the strategic plan of the firm is financially viable.
(vii) Provides benchmarks against which future performance of the
company may be measured.

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(7) Capital Requirements :
The capital requirements of a business enterprise / company
can be classified into two main categories namely, (i) Fixed
capital requirements, (ii) Working capital requirements.

(i) Fixed Capital : Fixed Capital means the capital which is


meant for meeting the permanent or long term needs of the
business. In other words, fixed capital is required for the
acquisition of those assets that are to be used over a long
period. Fixed capital required for acquisition of the following
assets :

(a) Tangible Assets are those assets which could be seen and
they have value in the business. Tangible assets are land,
buildings, plant, machinery, furniture and fixtures, vehicles,
Motor cars, miscellaneous fixed assets.

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(b) Intangible Assets are those assets which could not be seen
but they have value in business. Intangible assets such as
goodwill, patents, copyrights, trademarks, Sales & promotion
costs, Large Advertisement expenses, etc.

These funds are required not only while establishing a new


company but also for expanding, diversifying and maintaining
intact the existing business of the company.

(c ) Fictitious assets are those assets which appear on the


assets side of the Balance Sheet and they do not have any
value. Examples – Preliminary expenses, Share issue expenses
paid to Merchant Bankers, Discount on issue of shares, Profit &
Loss account debit balance (Loss).

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Factors determining fixed capital :
Amount of fixed capital requirements of a business depends
basically on the following factors :
(i) Nature of business
(ii) Size of business
(iii) Type of products
(iv) Diversity of production lines
(v) Method of production
(vi) Method of acquisition of fixed assets

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(ii) Meaning Working Capital : The term working capital refers to
the capital required for day-to-day operations of the business
enterprise / company. It is represented by the excess of current
assets over current liabilities. It is necessary for any organisation
to run successfully its affairs, to provide for adequate working
capital. It is important that proper estimation of working capital
requirements is a must for running the business efficiently and
profitably. The forecasts regarding working capital are made
keeping in these points in view.
Factors determining working capital requirements :
(i) Production policies
(ii) Nature of the business
(iii) Length of manufacturing process (Working capital cycle)
(iv) Credit policy
(v) Rapidity of turnover
(vi) Seasonal fluctuations
(vii) Fluctuations of supply

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(8) Meaning of Financial Forecasting : The term forecasting is
the formal process of predicting future events which are going to
affect significantly the functioning of an organisation. It implies
the technique of determining in advance the requirement and
utilisation of funds for a future period. It is also a technique of
systematic presentation of data in the form of financial
statement and ratios. Financial forecasting provides the basic
information on which systematic planning is based on. In the
financial forecasting, the future estimates are made through
proportion of statements like, projected Profit and Loss
statement (Income statement), projected balance sheet,
projected cash flow statement, and funds flow statement, cash
budget preparation of projected financial statements with the
help of ratios. Financial forecasting helps making decisions like
capital investment, annual production level, operational efficiency
required, requirement of working capital, assessment of cash
flow, raising of long term funds, estimation of funds requirement
of business, estimated growth in sales, etc.
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Techniques of Financial forecasting : Financial forecasting is
the first stage in the financial planning. Therefore, the
forecasting techniques should not only be simple but also give
precise results. There is a revolution in the forecasting
techniques due to the induction of computers. Computers
provide figures with speed and accuracy. The following are the
important techniques that are employed in financial forecasting :

(i) Percentage sales method : Sales have a significant effect


on the financial needs of a business. Hence, different items of
expenses, assets and liabilities can be expressed as a percentage
of sales. Financial data can be projected on the basis of sales.
It is a simple technique of forecasting. However, proper
understanding of the relationship of sales level changes with the
balance sheet items is necessary before any financial forecast is
made.

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(ii) Days Sales method : Days sales method is a traditional
technique used to forecast the sales by calculating the number
of day’s sales and establishing its relationship with the balance
sheet items to arrive at the forecasted balance sheet. It is useful
for forecasting funds requirements of a firm.
(iii) Simple Linear Regression method : The simple regression
analysis provides estimates of values of the dependent variables
from values of independent variables. The device used to
estimate the funds is a the regression line. For financial
forecasting sales are taken as an independent variable and then
the values of each item of asset are forecasted. Every time only
one item of asset level can be determined. Thereafter, all
forecasted figures are put into the projected balance sheet.
(iv) Multiple Regression method : Multiple regression method is
applied when behaviour of one variable is dependent on more
than one factor. Therefore, financial forecasting is assumed that
sales are a function of several variables. It is a future application

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and extension of the simple regression method for multiple
variables. Multiple regression method is a better technique for
computing the amount of different items. Computations can be
easily made with the help of a computer.
(v) Projected funds flow statement : The funds flow statement is a
statement of a source and application of funds. It analyses the
changes taking place between two balance sheets. A projected
funds flow statement shows the data relating to source of funds
and their possible application in fixed assets or repayment of
debt. The funds flow statement establishes the relationship
between sources and application of funds and its impact on the
working capital. It is an important tool extensively used in
financial forecasting.
(vi) Projected cash flow statement : Projected cash flow statement
shows the cash flows arising from the operating activities,
investing activities and financial activities. It can be used in
forecasting the financial requirements of the company. Projected

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cash flow statement is a detailed projected statement of income
realised in cash and cash expenditures including revenue and capital
nature. It focuses on the cash inflow and cash outflow of various
items represented in the income statement and the balance sheet.
(vii) Projected Profit & Loss Statement(or)Income statement)
A projected income statement can be prepared on the basis of
forecast of sales and anticipated expenses for the future period. Any
one or more techniques can be used to estimate the expenses. The
relationship between sales and expenses can be established and
accordingly the expenses and income can be estimated. The
difference is either profit or loss for the future period.
(viii) Projected Balance Sheet :
A projected balance sheet can also be prepared on the basis of
future estimates of assets, liabilities and any other items. The long
term needs of capital, assets, working capital can be estimated with
reference to estimated sales. The difference between the assets
and liabilities can be assumed as cash balance or bank overdraft or
any other logical missing items.
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(9) Benefits of Financial Forecasting: Financial forecasting is
very much useful for a business organisation/company. It helps
the finance manager in the following ways :
(i) It provides useful information for financial decision making.
(ii) It acts as a control device for firm’s financial discipline.
(iii) It helps for successful financial planning.
(iv) It enables the preparation and adopting of financial plans
according to the changes in economic environment and
business situation.
(v) It enables the company to make optimum utilisation of funds.
(vi) It facilitates the company (firm) to plan for its growth and
financial needs.
(vii) It makes the company (firm) to adopt appropriate financial
policies.
(viii)It provides warning to the management when the events of the
firm are going out of control.

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(10) Approaches to Financial Planning : There are two
approaches to financial planning (i) Traditional Approach, (ii)
Modern approach
(i) Traditional Approach : The traditional approach had limited
role of financial management to raising and administering of
funds needed by the company to meet its financial
requirements. It broadly covers the following aspects :
(a) Arrangement of funds from financial institutions.
(b) Arrangement of funds through financial instruments.
(c) Looking after the legal and accounting relationship between
company and its sources of funds.
Thus, the traditional approach includes the whole gamut of
raising funds externally. The role of finance manager was also
limited. It was expected to keep accurate financial records,
prepare reports on the company’s status and performance and
manage cash.

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(ii) Modern Approach : The modern approach to financial
planning is an analytical way of looking at the financial
problems of a firm. The important contents of the modern
approach are as follows :
(a) Total volume of funds required by the company (firm).
(b) The specific assets to be acquired by the firm.
(c) The method of financing the firm’s requirements.

The modern approach to financial planning relates to the four


broad decision areas of financial management. These are as
follows :
(a) Funds requirement decision,
(b) Financing decision,
(c) Investment decision,
(d) Dividend decision
(e) Liquidity decision.
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(11) Proforma Profit and Loss Account :
The proforma profit and loss account is the form of income
statement which is estimated on the basis of objectives and certain
variables. The statement provides details regarding anticipated
sales revenues and expenses for a future period. It is a firm’s plan
of future business operations. It is as per form of profit and loss
account but the figures are estimated and therefore it is known as
proforma or sample or estimated profit and loss account. There are
two commonly used methods for preparing the proforma profit and
loss account namely (i) percentage of sales method, (ii) budgeted
expenses method, (iii) Combination method.

(i) Percentage of Sales method : The percentage of sales method


for preparing the proforma profit and loss account is fairly simple.
Basically this method assumed that the future relationship between
various elements of costs to sales will be similar to their historical
relationship. When using this method, a decision has to be taken

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about which historical cost ratios to be used - whether these ratios
pertain to the previous year or the average of two or more previous years.
(ii) Budgeted Expenses method : The percentage of sales method, though
simple, is too rigid and mechanistic. For deriving the proforma profit and
loss account, all elements of costs and expenses bore a strictly
proportional relationship to sales. The budgeted expense method on the
other hand, calls for estimating the value of each item on the basis of
expected developments in the future period for which the proforma profit
and loss account is being prepared. Obviously this method requires
greater effort on the part of management because it calls for defining
likely developments.
(iii) Combination method : It appears that a combination of the two
methods described above often works best. For certain items, which have
a fairly stable relationship with sales, the percentage of sale method is
quite adequate. For other items, where future is likely to be very different
from the past, the budgeted expenses method which calls for managerial
assessment of expected future developments is more suitable. A
combination method of this kind is neither simple as percentage sales
method or difficult as budgeted expenses method.

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FINANCIAL PLANNING & FORECASTING :
Proforma Profit and Loss Account for Spaceage Electronics Limited
for 2016 based on "Percentage of Sales Method" :

Problem-1 :
Note : (i) Data are historcal and amount in Rupees
(ii) Projected (Proforma) Profit & Loss Account of 2016
assuming sales of Rs 1,400 lakhs

(iii) Projected figures are always for the future date only
(Rupees in lakhs)

Particulars 31.3.2014 31.3.2015 Average Projected


percen- P & L on
tage of 31.3.2016
sales (%)
Net Sales 1200 1280 100.00 1400.00
Cost of goods sold 775 837 65.39 910.00
Gross Profit 425 443 35.00 490.00
Selling expenses 25 27 2.10 29.40
General and administration
expenses :
Depreciation 75 80 6.30 88.20
Operting profit 272 282 22.03 312.20
Non-operting surplus / 30 32 2.50 35.00
deficit
Profit before interest and tax 302 314 24.80 347.20
Interest on bank loans 60 65 5.00 210.00
Interest on debentures 58 60 4.80 67.20
Profit before tax 184 189 15.00 210.00
Tax 82 90 6.90 96.60
Profit after tax 102 99 8.10 113.40
Dividends 60 63
Retained earnings 42 36

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(12) Proforma Balance Sheet :
Proforma balance sheet is generally prepared in conjunction with the
proforma of Profit and Loss account (income statement). It includes
the details of firm’s anticipated assets and liabilities on a future date.
Certain assumptions are made while preparing proforma balance
sheet. The estimates balance sheet may not tally. Therefore, the
difference between assets and liabilities is assumed as some missing
items. The projections of various items on the assets side and
liabilities side of the balance sheet may be derived as follows :
(i) Employ the percentage of sales method to project the items on the
assets side, except ‘investments’ and ‘miscellaneous expenditures and
losses’.
(ii) Estimate the expected values for ‘investments’ and ‘miscellaneous
expenditures and losses’ using specific information applicable to them.
(iii) Use the percentage of sales method to derive the projected values of
current liabilities and provisions.
(iv) Obtain the projected value of reserves and surplus by adding the
projected retained earnings to the reserves and surplus figure of the
previous period.
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Problem -2 :
Proforma Balance Sheet for Spaceage Electronics Limited
for 2016 based on "Percentage of Sales Method" :

Note : (i) Data are historcal and amount in Rupees


(ii) Proforma Profit & Loss Account of 2016 assuming
sales of Rs 1400 lakhs
(iii) Projected figures are always for the future date only

Particulars 31.3.2014 31.3.2015 Average Pprojected


percentage P & L on
of sales 31.3.2016
Net Sales 1200 1280 100.00 1400.00
Assets :
Fixed Assets (net) 800 850 66.50 931.00
Investments 30 30 No change 30.00
Current assets, loans and
advances :
Cash and bank 25 28 2.10 29.40
Receivables 200 212 16.60 232.40
Inventories 375 380 30.40 425.60
Pre-paid expenses 50 55 4.20 58.80
Miscellaneous expenditures and 20 20 No change 20.00
losses
Total 1500 1575 1727.20

Liabilities :
Share Capital
Equity 250 250 No change 250.00
Preference 50 50 No change 50.00
Reserves and surplus 250 286 Proforma 345.60
Income
statement
Secured Loans :
Debentures 400 400 No change 400.00
Bank borrowings 300 305 24.40 341.60
Unsecured Loans :
Bank borrowings 100 125 9.10 127.40
Current liabilities and provisions
:
Trade creditors 100 112 8.50 119.00
Provisions 50 47 3.90 54.60
External Funds requirement Balancing 39.00
(balancing figures) figure
TOTAL 1500 1575 1727.20

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Problem-3 : (assignment)
The P & L account and Balance Sheet of Deepam
Silks for years 1 and 2 are as follows :
(Amount in lakhs)
Profit and Loss account Year-1 Year-2
Net Sales 600 720
Cost of goods sold 450 500
Gross Profit 150 220
Selling expenses 50 60
General and Admn. Exp. 36 40
Depreciation 30 40
Operting Profit 34 80
Non-operating surplus/deficit 10 -8
Profit before interest & tax 44 72
Interest 10 12
Profit before tax 34 60
Tax 14 26
Profit after tax 20 34
Dividends 12 15
Retained earnings 8 19

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Balance Sheet Year-1 Year-2
Fixed Assets (net) 240 270
Investments 10 10
Current Assets, loans and
advances :
Cash and bank 5 6
Receivables 80 90
Inventories 125 144
Loans and advances 25 30
Miscellaneous expendisures 15 10
and losses
Total 500 560

Liabilities :
Share Capital :
Equity 100 100
Preference 20 20
Reserves and surplus 150 169
Secured Loans:
Bank borrowings 60 80
Unsecured Loans :
Public deposits 0 1
Current liabilities and
borrowings :
Trade creditors 125 130
Provisions 45 50
Total : 500 560

Prepare the projected P & L Account and


Balance Sheet for Year-3 under percentage sales
method (taking sales as base figure for calculation)

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Problem-4 :
Following is the summariesed Balance Sheet of Pragati Limited as on 31.12.2008

Liabilities Amount (Rs) Assets Amount (Rs)


Share Capital 8,00,000 Fixed Assets 4,50,000
Reserves 11,80,000 Stocks 11,50,000
Bank Overdraft 5,80,000 Debtors 16,00,000
Creditors 6,40,000
32,00,000 32,00,000
Creditors are equal to the last month's purchase and debtors are equal to
the last two month's sales. For the half year ending 31.12.2008, sales amounted
to Rs 50,42,000 and gross profit earned at a uniform rate was Rs 10,08,000.
Overdraft is repaid within 6 months.

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The following estimates are available :
(1) With effect from 1.1.2009 goods purchased will cost 25% higher and
sale price will be increased by 20%
(2) Sales and purchases are spread evenly throughout the year.
(3) Credit terms for purchases and sales will remain unchanged.
(4) Value of closing stock of 30.6.2009 is expected to be 10% higher
than on 31.12.2008.
(5) all expenses will be paid within the month in which they accrue and are
estimated at Rs 64,000 per month.
(6) No fixed assets are proposed to be acquired or sold during the period.
You are required to prepare proforma balance sheet of Prograti Limited
for the half year ended on 30.6.2009.

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Solution - 4 :
Working Notes :
(i) Purchases (Sundry Creditors) = Rs 6,40,000 x 1.25 x 6 =
Rs 48,00,000
(ii) Sales = 50,42,000 x (120 / 100) = 60,50,400
(iii) Closing stocks = 11,50,000 x 1.10 = 12,65,000
(iv) Creditors = 6,40,000 x 1.25 = 8,00,000
(v) Debtors = 60,50,400 x (2 / 6) = 20,16,800
(vi) It is assumed that bank overdraft is repaid within six months

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(a) Proforma Income Statement for the half year ended 30.6.2009
Particulars Amount (Rs) Particulars Amount (Rs)
To Opening stocks 11,50,000 By Sales 60,50,400
To purchases 48,00,000 By Closing Stocks 12,65,000
To Gross Profit 13,65,400
73,15,400 73,15,400
To expenses (64,000 x 6) 3,84,000 By Gross Profit b/d 13,65,000
To Net Profit 9,81,400
13,65,400 13,65,400

(b) Proforma Balance Sheet as on 30.6.2009


Liabilities Amount (Rs) Assets Amount (Rs)
Share Capital 8,00,000 Fixed Assets 4,50,000
Reserves 11,80,000 Stocks 12,65,000
Profit & Loss Account 9,81,400 Debtors 20,16,800
Creditors 8,00,000 Cash and Bank 29,600
(balancing figure)
37,61,400 37,61,400

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Problem-5 : (assignment)
Manish Ltd is launching a new project for
manufacture of a unique component.
At full capacity of 24,000 units, cost of
production will be as follows :
Particulars Amount (Rs)
Materials 80 per unit
Labour 20 per unit
Variable expenses 20 per unit
Fixed manufcturing and 20 per unit
Administrative expenses
Depreciation 10 per unit
Total 150 per unit
The selling price per unit is expected to be at
Rs 200 and the selling expenses per unit
will be Rs 10. In the first two years
production and sales are expected to be
as follows :
Year Production (units) Sales (units)
1 15,000 14,000
2 20,000 18,000

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To estimate working capital requirements
the following additional information are
provided :
(1) Stock of raw material is equal to
3 months average consumption.
(2) Work in progress in NIL
(3) Debtors are equal to one month's
average sales.
(4) Creditor for supply of materials is
equal to two months average purchase
of the year.
(5) Creditors for expenses will be one
month's average of all expenses during
the year.
(6) Cash balance is to be maintained at
Rs 20,000
(7) Stock of finished goods is taken at
average cost.
You are required to prepare :
(a) Projected statement of Profit / Loss
(b) Projected statement of working capital

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Solution-5 :
Working Notes :
(i) Calculation of stock of raw-materials :
1st year = 15,000 x 80 x (3 / 12) =
12,00,000 x 3 / 12 = Rs 3,00,000
2nd year = 20,000 x 80 (3/12) =
16,00,000 x 3/12 = Rs 4,00,000

(ii) Calculation of stock of finished goods :


1 year = Producton - Sales = Closing Stock
2nd year = 15,000 - 14,000 = 1,000 units
The cost of production = 1000 + 20,000 - 18,000 = 3,000
Particulars 1st year (Rs) 2nd year (Rs)
Raw-materials = 15,000 x 80 12,00,000 16,00,000
Labour = 15,000 x 20 3,00,000 4,00,000
Variable expenses = 15,000 x 20 3,00,000 4,00,000

Mfg & Admn. Exp. = 24,000 x 20 4,80,000 4,80,000


Depreciation = 24,000 x 10 2,40,000 2,40,000
Total cost 25,20,000 31,20,000

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Particulars Amount (Rs)
Cost per unit (i) 1st year 168
(25,20,000 / 15,000) =
Cost per unit : 2nd year :
Opening stock 1,68,000
Add : Cost of production 31,20,000
Total 32,88,000
No. of units 21,000
Average cost per unit 156.57
Value of stocks = 156.57 x 4,69,710
3000 =

(iii) Calculation of Debtors :


1st year = 14,000 x 200 / 12 = 2,33,333
2nd year = (18,000/12) x (200 x 1) x 1 =
3,00,000

(iv) Creditors for material = 12,00,000


15,000 x 80 =
Closing stocks 3,00,000
15,00,000
Average consumption =
15,00,000 / 12 = 1,25,000
2 months consumption = 2 x 125,000 =
2,50,000

2nd year = Material 16,00,000


consumed = 20,000 x 80 =
Add : closing stock ( 4,00,000
3months)
Total = 20,00,000
Less : Opening stock 3,00,000
Average = 17,00,000

Creditors for 2 months = 2,83,333


17,00,000 x 2/12 =

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(v) Creditors for expenses :
Particulars 1st year (Rs) 2nd yr (Rs)
Labour 3,00,000 4,00,000
Variable expenses 3,00,000 4,00,000
Mfg. & Admn. Expenses 4,80,000 4,80,000
Selling expenses 1,40,000 1,80,000
Total 12,20,000 14,60,000
Creditors for expenses 1,01,667 1,21,667

(a) Projected Statement of Profit / Loss


Particulars 1st Yr (Rs) 2nd Yr (Rs)
Production (units) 15,000 20,000
Sales (units) 14,000 18,000
Closing stocks 1,000 3,000
Sales at Rs 200 each (14,000 x 28,00,000 36,00,000
200) and 18000 x 200 )
Cost of production :
Materials at Rs 80 each 12,00,000 16,00,000
Labour at Rs 20 each 3,00,000 4,00,000
Variable expenses 3,00,000 4,00,000
Mfg & Admn expenses (Fixed 4,80,000 4,80,000
24,000 units at Rs 20)
Depreciation at Rs 10 for 24,000 2,40,000 2,40,000
units
Cost of Production 25,20,000 31,20,000
Add : Opening Stock of finished 0 16,80,000
goods
Total 25,20,000 32,88,000
Less : Closing stocks of F.G. 1,68,000 4,69,710
Cost of goods 23,52,000 28,18,290
Add ; Selling expenses 1,40,000 1,80,000
Cost of Sales 24,92,000 29,98,290
Profit 3,08,000 6,01,710
Sales 28,00,000 36,00,000

39
(b) Projected Statement of Working Capital
Particulars 1st Yr (Rs) 2nd Yr (Rs)
(i) Current Assets :
Stock of raw-materials 3,00,000 4,00,000
Stock of Finished Goods 1,68,000 4,69,710
Debtors 2,33,333 3,00,000
Cash balance 20,000 20,000
Total Current Assets 7,21,333 11,89,710

(ii) Current Liabilities :


Creditors for materials 2,50,000 2,83,333
Creditors for expenses 1,01,667 1,46,667
Total current liabilities 3,51,667 4,05,000
Estimate of Working Capital 3,69,666 7,84,710

40
Problem - 6 :
(assignment)
Balance Sheet of Maya Limited as on
31.3.2009 is as under : (Rs in lakhs)
Liabilties Rs Assets Rs
Share capital Fixed Assets
12% Pref. shares 10 At cost 50
Equity sh. (Rs 10) 20 Less : Dep: 16 34
General Reserves 6 Stocks 6
12% Debentures 6 Debtors 8
Creditors 8 Cash / Bank 2
50 50
The company wishes to forecast balance sheet as on
31.3.2010. The following additional particulars are
available :
(i) Fixed assets costing Rs 10 lakhs have been installed
on 1st April 2009 but the payment will be made
on 31.3.2010.
(ii) Fixed assets turnover ratio on the basis of gross
value
of fixed assets would be 1.5
(iii) Stock Turnover Ratio would be 14.4 (calculated on
the basis of average stocks).
( Note : Cost of Goods Sold /
Average Stocks = Stock
Turnover Ratio)

41
(iv) Break-up of cost and profit would be as under :
Materials 40%
Labour 25%
Manufacturing exp 10%
Office & Selling exp 10%
Depreciation 5%
Profit 10%
100
Profit is subject to interest and tax at 30%
(v) Debtors would be 1/9 of sales
(vi) Creditors would be 1/5 of materials consumed
(vii) In March 2010. a dividend at 10% on Equity
capital would be paid.
(viii) 12% Debentures 2,50,000 have been issued
on 1st April 2009.
(ix) Additional depreciation provided Rs 4.50
lakhs
Prepare the forecast balance sheet as on
31.3.2010.

42
Solution - 6 :
Working Notes : (Rs in lakhs)
(1) Fixed Assets as on 31.3.2009 : 50
Additions during the period : 10
Total : 60

(2) Fixed Assets Turnover Ratio = Sales / Fixed Assets


Fixed Assets = 60, Fixed Assets Turnover Ratio = 1.5
Sales = 60 x 1.5 = Rs 90 lakhs

(3) Cost of goods sold =


Materisl + Labour + Mfg exp. + Depreciation =
40% + 25% + 10% + 5% = 80% =
80% of sales = 80% of 90 akhs = Rs 72 lakhs

(4) Total depreciation = 16 + 4.5 = Rs 20.5 lakhs

(5) Average stocks =


Cost of goods sold / Stock Turnover Ratio =
72,00,000 / 14.4 = Rs 5,00,000

(6) Stocks on 31.3.2010


=
(Openings stocks + Closing stocks) / 2 =
Average stocks
(cross multiply)
2 x Average Stocks - Opening Stocks =
2 x 5,00,000 - 6,00,000 =
10,00,000 - 6,00,000 = Rs 4,00,000

43
(7) Debtors as on 31.3.2010 =
1/9 x Sales = 1/9 x 90 lakhs = Rs 10 lakhs

(8) Creditors on 31.3.2010 =


1/5 of meterials consumed =
1/5 x (40% of 90 lakhs) =
1/5 x 36 = Rs 7,20,000

(9) Calculation of cash and bank balances:


Dr Cash / Bank Account
Cr
Particulars Rs Particulars Rs
To balance b/d 2,00,000 By Debenture 1,02,000
interest
To Debentures 2,50,000 By Fixed Assets 10,00,000
To Cash Operating 12,70,000 By Pref. Dividend 1,20,000
Profit (Note 10)
By Equity Dividend 2,00,000
By Balance c/d 2,98,000
17,20,000 17,20,000

44
(10) Cash Operating Profit :
(Rs in lakhs)
Trading Profit = 10% of 9.00
90 lakhs
(+) Depreciation 4.50
13.50
Add : Decrease in 2.00
Current Assets (Stock)

15.50
Less : Increase in
Current Assets
(Debtors) = 2.00
Less : Decrease in 2.80
Current Liabilities =
0.80
Cash Operating Profit 12.70

(11) Calculation of Net Profit


Net Profit = 10% of 9,00,000
Sales
Less : Debenture 1,02,000
Interest
Balance 7,98,000
Less : Provision for tax 2,39,000
30%
Balance 5,58,000
Less : (i) Preference
Dividend = 1,20,000

(ii) Equity Dividend = 3,20,000


2,00,000
Balance 23,86,000

45
Forecast Balance Sheet of Maya Limited as on
31.3.2010 (Rs in lakhs)
Liabilities Rs in lakhs Assets Rs lakhs
12% Pref. Share Capital 10.000 Fixed Assets :
Equity share capital (Rs 20.000 Cost : 60.00
10 each)
Reserves & Surplus : Less : Dep : 20.50 39.500
Current Reserve 6.000 Current Assets :
Profit & Loss a/c 2.386 Stocks : 4.00
Secured Loans : Debtors : 10.00
12% Debentures 8.500 Cash : 2.98 16.980
Current Liabilities :
Creditors = 7.20
Provision for tax : 2.394 9.594
56.480 56.480

46
Methods of Financial Forecasting :
(i) Assessment of External Funds Requirements (EFR) :
The funds requirement assessment is done with the help of
formula for ascertaining the funds required to purchase assets or
for meeting working capital requirement. The formula is as under :

Formula :
External Funds Requirement (EFR) :
EFR = [ (A/S) –(L/S)] Delta S – MS1 (1 – D)

Explanations : A/S = Total Assets / Sales,


L/S = Current Liabilities and provisions / Sales
S = Sales of current year, S1 = Projected sales of next year,
Delta S = Expected increase in sales over years (S1 - S)
M = Net Profit Margin
D = Dividend Pay out Ratio

47
Note : While computing External Funds Requirements (EFR), the
expected charges in investments, miscellaneous expenditures and
scheduled repayments of term loans and debentures are assumed
as ZERO.

(ii) Internal Growth Rate :


Internal Growth Rate is the maximum growth rate a company can
achieve without going for external financing. In this case, all the
financial requirements are met internally from the internal sources of
the firm. The Internal Growth Rate can be determined as follows :

Formula :
Internal Growth Rate (IGR) = (ROA x b) / (1 – (ROA x b)

ROA = Return on assets = (PAT / Total Assets) x 100


b = Retention Ratio = (1 – Dividend Payout Ratio)

48
Internal Growth Rate (IGR) :
In order to determine the Internal Growth Rate, the following
assumptions are made by the company :
(i) Retention Ratio is kept as per targeted rate
(ii) Earnings after tax are in direct proportion to sales
(iii) Increase in sales will result into the increase in assets of the firm in
direct proportion.
(iv) Company/Firm does not require to raise additional equity or debt.
(v) Company retains the earnings.

(iii) Sustainable Growth Rate (SGR) :


Sustainable growth rate is the maximum growth rate which can be
achieved by using internal sources as well as external sources of
funds without increasing the financial leverage. Sustainable Growth
Rate is a powerful planning tool used for achieving sales objective of

49
the firm with its opening efficiency and financial resources.
Maximum sales can be achieved in a year based on target operating
debt and dividend payout ratios. The lower the ratio, the more
efficiency utilisation of assets is made by the company.
Formula :
Sustainable Growth Rate (SGR) :
SGR = b (NP/S) x (1+ D/Eq) / (A/S) – [ (b x NP/S) (1 + D / Eq)]

Explanation :
b = Retention Ratio ( i.e. Retained E arnings Ratio)
NP / S = Net Profit to Sales
D/Eq = Debt / Equity Ratio
A/S = Total Assets to Sales Ratio
S = Annual Sales
(Note : Students should memorise all formula so that they can
work out the problems easily)
50
Sustainable Growth Rate is based on the following
assumptions :
(i) Net Profit to Sales Ratio remains constant.
(ii) Assets of the firm increase directly in proportion of sales.
(iii) Dividend payout ratio is as per target set by the firm.
(iv) Company (firm) has a target debt-equity ratio and intends to
maintain the capital structure as per target.
(v) Company (firm does not intend to issue further equity because it is
costly source of finance.

51
Points to remember :
While working out problems, the following points are important :
(i) To calculate the External Funds Requirements (EFR) with the help
of formula (given in previous slide) (To calculate EFR based on
certain ratios, parameters, conditions, etc as given in the problem).
(ii) Mode of raising funds – example : (a) Equity amount, Debt
instruments (Debentures, Bonds), (c ) Bank Long Term Loan.
(iii) Order of priority as given in the problem to be followed for raising
funds. (equity and then Debt or Debt and then equity as the case
may be, given in the problem)
(iv) Ratios such as debt/equity ratio (Long Term Debts/Equity amount),
Stock Turnover Ratio (Cost of goods sold / Average Stocks),
Return on Assets (PAT/Total Assets) x 100), Retention Ratio (b)
(1 minus dividend payout ratio), etc should be taken for calculation
(as given in the problem).

52
Problem - 7 : (MBA, May 1997)
(assignment)
Balance Sheet of Multinational Co Ltd as on 31.3.2010 is as under:
Liabilities Rs lakhs Assets Rs lakhs
Share Capital 200 Fixed Assets 500
Reserves & Surplus 140 Inventories 300
Long Term Loans 360 Debtors 140
Short term loans 200 Bills Receivables 100
Bills Payables 50 Cash and Bank 60
Creditors 70
Provision for tax 80
1100 1100
Sales for the year were Rs 600 lakhs for the year ended on
31.3.2010, sales are expected to increase by 20%. The profit
margin and dividend payout ratio are expected to be 4% and
50% respectively.
You are required to :
(a) Calculate the amount of External funds required
(b) Determine the mode of raising the funds on the basis of the
following conditions :
(i) Current ratio shold be at least 1.33
(ii) Ratio of fixed assets to long term loans should be 1.5
(iii) Long term debt to equity ratio should not exceed 1.05
(iv) Fund are to be raised in the order of short term
bank borrowings, long term loans and equities.

53
Solution - 7 :
(a) Calculation of amount of External Funds Required (EFR) :
Formula :
EFR = (A/S) - (L/S) x Delta S - MS1 x (1 - D)
Explanations :
A/S = Total Assets / Sales
L/S = Current Liabilities and Provisions / Sales
S = Sales of current year
S1 = Projected sales of next year
Delta S = Expected increase in sales over current year (S1 - S)
M = Net Profit Margin
D = Dividend Payout Ratio

A = Total Assets = Rs 1100 lakhs


L = Current Liabilities and Provisions = 50 + 70 + 80 = Rs 200 lakhs
S = Sales for the current year = Rs 600 lakhs
S1 = Projected sales for the next year =
(600 + 20% of 600) = Rs 720 lakhs
Delta S = Expected increase in sales =Rs 120 lakhs (20%
of Rs 600 lakhs)
M = Profit margin = 4% or 0.04
D = Dividend pay-out ratio = 50% or 0.50

54
External Funds Required (EFR) =
(1100 / 600) - (200/600) x 120 - (0.04 x 720) x (1 - 0.50) =
900/600 x 120 - (28.8 x 0.50) =
180 -. 14.40 = Rs 165.60 lakhs
External Funds Required (EFR) = Rs 165.60 lakhs

(b) Determination of mode of raising funds :


(i) Calculation of short term borrowings (STB) :
Current ratio should be 1.33
CR = Current Assets / Current Liabilities
1.33 = (300 + 140 + 100 + 60) x 1.2 / (200 x 1.2) + STB
1.33 / 1.00 = 720 / (240 + STB)
1.33 (240 + STB) = 720
319.20 + 1.33STB = 720
1.33 STB = 720 - 319.20
1.33 STB = 400.80
STB = 400.80 / 1.33
STB = Rs 301.35 lakhs

Short term borrowing desired : Rs 301.35 lakhs


Existing STB : Rs 200.00 lakhs
Additional STB required : Rs 101.35 lakhs

(ii) Calculation of Long term Loans (LTL) (or)


Long Term Debt :
Ratio of fixed assets to long term loans = 1.5
1.5 = (Fixed Assets x 1.2) / Long Term loans
1.5 = 500 x 1.2 / LTL
1.5 x LTL = 500 x 1.2
1.5 LTL = Rs 600 lakhs
LTL = 600 / 1.5 = Rs 400 lakhs

55
Long Term Loans desired : Rs 400 lakhs
Less : Existing LTL : Rs 360 lakhs
Additional LTL required : Rs 40 lakhs

(iii) Calculation of Equity Share Capital :


(Rs in lakhs)
External funds required (EFR): 165.60
Less : (i) Short term borrowings: 101.35
(ii) Long Term borrowings : 40.00 141.35
Balance to be raised as Equity : 24.25

However, long term debt to equity ratio should not


exceed 1.05 times
Long term Debt to Equity Ratio =
Long Term Debt / (Equity + Reserves and Surplus) =
(360 + 40) / (200 + 24.25) + (140 + 20% of 140) =
400 (224.25 + 140 + 28)
=
400 (224.25 + 168) = 400 / 392.25 = 1.02 times

Long Term Debt to Equity Ratio is less than 1.05


Thus, the External Funds to be raised is as under :
(i) Short term loans ; Rs 101.35 lakhs
(ii) Long Term Loans : Rs 40.00 lakhs
(iii) Equity share capital : Rs 24.25 lakhs
Total : Rs 165.60 lakhs

56
Problem - 8 :
Sustainable Growth Rate (SGR) :

IPCL has an equity capital of Rs 12 lakhs and total


debt of Rs 8 lakhs. The sales of the company for the
last year were Rs 30 lakhs. It has target assets to sales
ratio of 0.667 and a target net profit margin of 4%.
It has a target Debt Equity Ratio of 0.667 and target
earnings retention rate of 0.75. Calculate the
Sustainable Growth Rate (SGR) of the company.

57
Solution - 8 :
Sustainable Growth Rate (SGR) :
b(NP / S) x (1 + D / Eq) / (A/S) - [ b (NP / S) x (1 + D / Eq)]

Explanations :
b = retention ratio
NP/S = Net Profit to Sales
D / Eq = Debt Equity Ratio
A / S = Assets to Sales Ratio
S = Annual Sales

Following are given :


b = 0.75 or 75%
Net Profit Margin =
NP / S = 4% or 0.04
D / Eq = Debt Equity Ratio = 0.667
S = Rs 30 lakhs
A / S = 0.667
Sustainable Growth Rate (SGR) =
(0.75 (0.04) (1 + 0.667) / 0.667 - (0.75) (0.04) (1 + 0.667) =
(0.03) (1.667) / 0.667 - [(0.03) (1.667)] =
0.05 / (0.667 - 0.05) = 0.05 / 0.617 = 0.0810 = 8.10%

Sustainable Growth Rate (SGR) = 8.10%

58
Problem - 9 :
( assignment)
The following information is available for Sunshine Ltd
A/S = 0.8, DeltaS = Rs 60 lakhs, L/S = 0.5
M = 0.04, S1 = Rs 500 lakhs, D = 0.6
where, A/S = Current and fixed assets as a proportion
of sales
Delta S = Expected increase in sales
L/S = Current liabilities, provisions and bank borrowings
as a proportion of sales
M = Net Profit Margin
S1 = Projected Sales for the next year
D = Dividend Payout Ratio
There will be no change in the level of investment and
no requirement of the term loans in the next year.
(a) Estimate the external funds requirements (EFR) for
the next year.
(b) Suppose the growth rate of net profit margin is
10% for the company, for the next year, in the above
case, what then will be external funds requirements ?

59
Solution - 9 :
Formula :
EFR = (A/S) - (L/S) x Delta S - MS1 x (1 - D)
Explanations :
A/S = Total Assets / Sales
L/S = Current Liabilities and Provisions / Sales
S = Sales of current year
S1 = Projected sales of next year
Delta S = Expected increse in sales
over current year (S1 - S)
M = Net Profit Margin
D = Dividend Payout Ratio

A / S = 0.8
Delta S = Rs 60 lakhs
M = 0.04
S1 = Rs 500 lakhs
D = Dividend Payout = 0.6

EFR = [(0.8 x 60) - (0.5 x 60) ] - [(0.04 x 500) (1 - 0.6)] =


(48 - 30) - (20 x 0,4) = 18 - 8 = Rs 10 lakhs

(b) Estimation of External Funds Requirements for the


next year when growth rate of net profit margin is 10%
Growth rate in sles = G
therefore, S1 = S0 (1 + G)
therefore, Delta S = S0 x G
EFR / DeltaS = [A/S - L/S] - [MS0(1 + G) (1 - D) / S0G)

EFR / Delta S = [A/S - L/S] - [M(1 +G) (1 - D) / G]

EFR / 60 = (0.8 - 0.5) - [0.04 (1 + 0.10) (1 - 0.6) / 0.10 ] =


0.3 - 0.176 = 0.124 =
EFR = 0.124 x 60 = Rs 7.44 lakhs
External Fund Requirement (EFR) = Rs 7.44 lakhs

60
Problem - 10 : (MMS, MU, Nov. 2011)
(assignment)
Balance Sheet of Ponds India Limited as on
31.3.2015 is as follows :
Liabilities Rs lakhs Assets Rs lakhs
Share Capital 300 Fixed assets 750
Reserves 210 Inventories 450
Long Term Loans 540 Receivables 360
Short Term Loans 300 Cash and Bank 90
Payables 180
Provisions 120
1650 1650
Sales for the current year were Rs 900 lakhs. For the next year
ending 31.3.2016 they are expected to increase by 20%. The net
profit margin after taxes and dividend payout are expected to be
40% and 50% respectively. You are requird to :
(1) Quantify the amount of external funds required.
(2) Determine the mode of raising the funds given the
following paramters :
(a) Current Ratio should be 1.33
(b) Ratio of fixed assets to long term loans should be 1.5
(c ) Long Term debt to Equity Ratio should not exceed 1.06
(d) Funds required to be raised in the order of :
(i) Short term bank borrowings
(ii) Long term loans
(c ) Equities

61
Solution - 10 :
(a) Quantification of the amount of external
funds required (EFR) :
Formula :
EFR = (A/S) - (L/S) x Delta S - MS1 x (1 - D)
Explanations :
A/S = Total Assets / Sales
L/S = Current Liabilities and Provisions / Sales
S = Sales of current year
S1 = Projected sales of next year
Delta S = Expected increse in sales
over current year (S1 - S)
M = Net Profit Margin
D = Dividend Payout Ratio

EFR = [1650 / 900 - 300 / 900] x 180 - (0.40 x 1080) (0.50)


(1.5 x 180) - 216 = 270 - 216 = Rs 54 lakhs

62
(b) Determination of mode of borrowings :
(i) Short term borrowings (STB):
Current Ratio should be atleast 1.33
1.33 = (900 x 1.2) / (300 x 1.2) + short term borrowings
1.33 = 1080 / (360 + STB)
1.33 (360 + STB) = 1,080
(1.33 x 360) + (1.33 x STB) = 1080
427.80 + 1.33(STB) = 1080
1.33(STB) = 1080 - 427.80
1.33 (STB) = 601.20
STB = 601.20 / 1.33 = Rs 452.03 lakhs

Short term borrowings desired : Rs 452.03 lakhs


Less : Existing STB : Rs 300.00 lakhs
Additional STB required : Rs 152.03 lakhs
External funds required (EFR) Rs 54 lakhs should be
raised by short term borrowings.
Note : Remaining amount = 152.03
(-) 54.00 = 98.03 is to be raised by
way of debt / loan.

63
Problem -11 : (MMS, MU, Nov. 2013)
(important problem)
(assignment)
Balance Sheet of MGM Limited as at 31.3.2013 is given below
Liabilities Rs lakhs Assets Rs lakhs
Share Capital 4,200 Fixed Assets 8,870
Retained earnings 2,480 Inventories 3,480
Term Loan 3,920 Receivables 2,580
Short term Bank 2,490 Cash at bank 180
Borrowings
Accounts Payable 1,240
Provisions 780
15,110 15,110
Sales of the company for the year ending on 31.3.2013 were
Rs 31,410 lakhs. Its profit margin on sales was 7% and its
dividend payout ratio was 50%. The tax rate ws 34%. MGM Ltd
expects its sales to increase by 30% (i.e. by Rs 9,423 lakhs) in
the
year 2014. The ratio of assets to sales and spontaneous
current
liabilities to sales would remain unchanged. Likewise the
profit margin ratio, the tax rate and the dividend payout ratio
would remain unchanged.
Required :
(a) Estimate the external funds requirements (EFR) for the
year 2014.
(b) Prepare the following statements, assuming that the
external funds requirements would be raised from term loans
nd short-term bank borrowings in the ratio 1 : 2
(i) projected balance sheet and (ii) projected profit and
loss account for 2014.

64
Solution - 11 :
(a) Calculation of External Funds Requirements(EFR)
Formula :
EFR = (A/S) - (L/S) x Delta S - MS1 x (1 - D)
Explanations :
A/S = Total Assets / Sales
L/S = Current Liabilities and Provisions / Sales
S = Sales of current year
S1 = Projected sales of next year
Delta S = Expected increse in sales
over current year (S1 - S)
M = Net Profit Margin
D = Dividend Payout Ratio
(1 – D) = Retention of profit (b)

External Funds Requirement (EFR) =


( A/S - L/S) x DeltaS - MS1 (1 - D) =
(15,110 / 31,410) - (2,020 / 31,410) x
9,423 - 0.07 x 40,833 (1 - 0.5) = 2,498
EFR = Rs 2,498 lakhs

65
(b) (i) Projected Income Statement for the year
year ended 31.3.2014 (Rs in lakhs)
Particulars Rs lakhs
Sales 40,833
Profit before tax 4,330
Taxes (34%) 1,472
Profit after tax (7% on 2,858
sales)
Dividends (50%) 1,429
Retained 1,429
earnings(50%)

(b) (ii) Projected Balance Sheet as on 31.3.2014 (Rs in lakhs)


Liabilities Rs lakhs Assets Rs lakhs
Share capital 4,200 Fixed Assets (130%) 11,531
Retained earnings 3,909 Inventories (130%) 4,524
(2480 + 1429)
Term Loans (3,920 + 4,753 Receivables 3,354
2,498 x 1/3) (2580 x 130%)
Short term bank 4,155 Cash at bank 234
borrowings (2,490 + (180 x 130%)
2,498 x 2/3)
Accounts Payable 1,612
Provisions (780 x 130% 1,014
19,643 19,643

Note : Balance Sheet


tallies on both sides

66
Problem - 12 :
(assignment)
Following is abstracts of financial statements of Bosco
Limited for the year 2014-15. (Rs in lakhs)
Sales : 1,00,000
Profit after tax : 6,000
Current liabilities : 30,000
Bosco Ltd has maintained a dividend payout ratio
of 60%. The CFO of Bosco Ltd has projected increase
in sales of 10% for the year 2015-16. CFO also
projected that surplus funds of Rs 1,500 lakhs will be
available for the year 2015-16. What is the current
level of assets of Bosco Limited.

67
Solution - 12 :
External Funds requirements (EFR) =
Formula :
EFR = (A/S) - (L/S) x Delta S - MS1 x (1 - D)
Explanations :
A/S = Total Assets / Sales
L/S = Current Liabilities and Provisions / Sales
S = Sales of current year
S1 = Projected sales of next year
Delta S = Expected increse in sales
over current year (S1 - S)
M = Net Profit Margin
D = Dividend Payout Ratio

Now convert the formula as under :


MS1 (1 - D) - (A - L / S) x DeltaS = Surplus Funds

Example : EFR = 100 - 40 = 60


Surlus funds = (with change of signs)= 40 - 100 = (-) 60

0.06 x 1,10,000 x (1 - 0.60) -


[ (A - 30,000) / 1,00,000 ] x 10,000 = 1,500
i.e. 2,640 - (A - 30,000) / 10 = 1,500
A = 11,400 + 30,000 = Rs 41,400 lakhs
Total Assets (A) = Rs 41,400 lakhs

68
Problem - 13 : (MBA, Univ. of Delhi, modified)
(assignment)
Prakash Industries Limited is
commencing
a new program of a plastic component.
The
following cost information has been
ascertained for annual production of
12,000 units which is full capacity :
Particulars Cost per
unit (Rs)
Materials 40
Direct Labour 20
Fixed Manufacturing exp. 6
Depreciation 10
Fixed. Admn. Exp 4
Total 80
Selling price per unit is expecteed to be
Rs 96 and the selling expenses Rs 5 per unit,
80% of which is variable. In the first two
years of operations, production and sales
are expected to be as follows :
Year Production (unit Sales
(units)
1 6000 5000
2 9000 8500

To assess working capital requirements,


following additional information are
provided :
Stock of Materials : 2 month's average
Work in progress : NIL
Debtors : 1 month's average sales
Cash balance : Rs 10,000
Creditors for materials : 1 month's
average purchase
Creditors for expenses : 1 month's
average
of all expenses
Prepare : (i) Projected statement of Profit
and Loss account
(ii) Projected statement of working capital
requirements

69
Solution - 13 :
(i) Projected Statement of Profit and Loss account
Particulars Year-I (Rs) Year-II (Rs)
Sales 4,80,000 8,16,000
Costs :
Materials 2,40,000 3,60,000
Direct Labour 1,20,000 1,80,000
Fixed Mfg. exp (12,000 x 6) 72,000 72,000
Depreciation (12,000 x 10) 1,20,000 1,20,000
Fixed Admn exp. (12,000 x 4) 48,000 48,000
6,00,000 7,80,000
Add : Opening stocks of F.G. 0 1,00,000
6,00,000 8,80,000
Less : Closing stocks of F.G. 1,00,000 1,32,000
(1000 units @ 100) (1500 units @
88)
ADD : Selling expenses (variable) 20,000 34,000
Selling expenses (fixed) 12,000 12,000
Cost of sales 5,32,000 7,14,000
Profit / Loss -52,000 22,000

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(b) Projected Statement of Working Capital
Particulars Year-I Rs Year-II Rs
(a) Current Assets :
Stock of materials 45,000 67,500
Stock of finished goods 1,00,000 1,32,000
Debtors 40,000 68,000
Cash 10,000 10,000
Total 1,95,000 2,77,500
(b) Current Liabilities :
Creditors for materials 23,750 31,875
Creditors for expenses 22,667 28,833
Total : 46,417 60,708
Working Capital 1,48,583 2,16,792
Note :
(1) Fixed cost is full capacity of 12,000 units
(2) Closing stock of goods (units) = 6000 - 5000 =
1000 units and
1000 + 9000 - 8500 = 1500 units
(3) Value of closing stocks (1500) =
(1,00,000 + 7,80,000) / (1000 + 9000) = Rs 88 each

71
Problem - 14 : (MMS, MU, Dec 2008)
(assignment)
Balance Sheet for the current year of a Company is given
below. (Amounts in Rs lakhs)
Liabilities Rs lakhs Assets Rs lakhs
Equity capital 100 Land & Building 200
Retained earnings 120 Machinery 30
Term Loan 160 Furniture 30
Short term borrowings 120 Bills Receivables 100
Creditors 100 Debtors 60
Provisions 40 Stocks 180
Bank balance 40
640 640

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Other informations :
Sales : Rs 800 llakhs
Variable expenses : Rs 560 lakhs
Fixed Expenses Rs 160 lakhs
The following are the projections for the next year :
(1) Sales are expected to be Rs 1000 lakhs
(2) Fixed expenses will increase by 25%
(3) No change in the ratio of variable expenses to sales
(4) Interest expenses will be Rs 20 lakhs
(5) No change in fixed assets. Ignore depreciation.
(6) Bank balance and other current assets will increase
in proportion to sales
(7) Tax to be provided at 35%. This will be the only provision
next year.
(8) Creditors will increase in proportion to sales
You are required to prepare the projected income statement
projected balance sheet of the company for the next year.
If the company is rquired to raise funds (if the liability side is
less) they will be raised in the order of short term loans,
term loans and if required, equity capital, It is the policy of
the company to maintain current ratio of minimum 1.25 : 1
and ensure that the long term loans do not exceed 40% of
the total term funds. If the asset side is less than the
difference will be considered as cash balance available.

73
Solution - 14:
Working notes :
(1) Ratio of variable expenses to sales =
(560 / 800) x 100 = 70%

(2) Proportionate increse in sales =


(200 / 800) x 100 = 25%

(3) Total of Assets side = Rs 735


lakhs\
Total of Liabilities side= Rs 705 lakhs
Difference = Rs 30 lakhs

(4) Current ratio = (CA / CL) = 1.25 : 1


475 / CL = 1.25 / 1
1.25 (CL) = 475
CL = 475 / 1.25 = Rs 380 lakhs

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(a) Projected Income Statement for the next year
Particulars Rs lakhs
Sales 1000
Less : Variable exp (70%) 700
Contribution 300
Less : Fixed expenses : 160
plus 25% : 40 200
Profit before interest & tax 100
Less : Interest 20
Profit before tax 80
Less : Tax at 35% 28
Profit after tax (PAT) 52

(b) Project Balance Sheet of a company for next year


Liabilities Rs lakhs Assets Rs lakhs
Equity capital 100 Land & building 200
Retained earnings (120 + 52 172 Machinery 30
profit)
Term Loan 160 Furnitues 30
Short term borrowigs (120 + 150 Bills Receivables (100x 125
30) 1.25)
Creditors (100 x 1.25) 125 Debtors (60 x 1.25) 75
Provision for tax 28 Stocks (180 x 1.25) 225
Bank (40 x 1.25) 50
735 735

75
Problem – 15 (assignment)
(MMS, MU, Nov. 2013)
The Profit and Loss account of
KG Electronics
Limited for years 1 and 2 are given below.
Using the percentage of sales method, prepare
proforma profit and loss account for the year-3.
Assume that the sales will be 26,000 in year-3.
If dividends are raised to 500 what amount of
retained earnings can be expected for year 3 ?
Liabilities Year-1 Year-2
Net Sales 18,230 22,460
Cost of Goods Sold 13,210 16,100
Gross Profit 5,020 6,360
Selling expenses 820 890
General and Admn expenses 1,200 1,210
Depreciation 382 364
Operating profit 2,618 3,896
Non-operating surplus / (deficit) 132 82
Earnings before intererest & tax 2,750 3,978
Interest 682 890
Earnings before tax 2,068 3,088
Tax 780 980
Earnings after tax 1,288 2,108
Dividend (given) 320 450
Retained earnings 968 1,658

76
Solution - 15 :
Note : Assume sales for year-3 as Rs 26,000
Particulars Year-1 Year-2 Average Proforma P
% of & L A/c for
sales Year-3
Net Sales 18,230 22,460 100.00 26000.00
Cost of goods sold 13,210 16,100 72.07 18738.98
Gross Profit 5,020 6,360 27.93 7261.02
Selling expenses 820 890 4.23 1099.89
General & Admn. Exp 1,200 1,210 5.98 1556.09
Depreciation 382 364 1.86 483.09
Operting Profit 2,618 3,896 15.85 4121.95
Non-operaing surplus / 132 82 0.54 141.59
(deficit)
Earnings before interest 2,750 3,978 16.40 4263.55
and tax
Interest 682 890 3.85 1001.48
Earnings before tax 2,068 3,088 12.55 3262.07
Tax 780 980 4.32 1123.46
Earnings after tax 1,288 2,108 8.23 2138.61
Dividend (given) 320 450 500.00
Retained earnings 968 1,658

77
Problem -16 : (MMS, MU, Oct. 2010 and
Nov. 2012)
(assignment)
(IMPORTANT
PROBLEM)
The income statement of Modern Electronics
Limited for years-I and II are given below :
(Rs in lakhs)
Income Statement Year-I Year-II
Net Sales 2,400 2,670
Cost of goods sold 1,830 2,040
Gross profit 570 630
Selling expenses 180 195
General and Admn. Exp 180 156
Depreciation 150 192
Operating profit 60 87
Non-operting surplus / 24 30
(deficit)
Earnings before interest and 84 117
tax
Interest 30 33
Earnings before tax 54 84
Tax 21 30
Earnings after tax 33 54
Dividends 18 21
Retained earnings 15 33

Balance Sheet of Modern Electronics Limited as


of the end of year-I and II are given below :
(Rs in lakhs)
Assets Year-I Year-II
Fixed Assets (net) 900 1,140
Investment 60 60
Current assets, loans and
advances :
Cash and bank 36 42
Receivables 540 600
Inventories 519 576
Prepaid expenses 123 135
Miscellaneous expenditures 45 42
and losses
2,223 2,595

78
Liabilities (Rs in lakhs) Year-I Year-II
Share capital :
Equity 450 450
Reserves nd surplus 354 387
Secured loans :
Term loans 432 525
Bank borrowings 489 597
Current liabilities :
Trade creditors 378 501
Provisions 120 135
2,223 2,595

(a) Using the percentage of sales method


(except, assume that dividends are raised to 24,
depreciation to 180, interest to 36), prepare the
proforma income statement for year-III. Assume
that the sales will be Rs 3,060 lakhs in year-III.
(b) Assume that all items on the assets side,
except investment and miscellaneous
expenditures and losses, will grow proportionally
to sales. Likewise trade credit will be
proportional
to sales. Finally, estimate the amount of External
Financing Required (EFR) for year-III.
(c ) Tax rate expected is 35%. This will be the
only provision in the year-III.

79
Solution - 16 :
Working notes :
Working based on Percentage of Sales method (Rs lakhs)
Calculations Year-I (%) Year-II (%)
(i) Cost of goods sold (1830/2400) x 100 76.25 76.40
and (2,040 / 2,670) x 100
(ii) Selling expenses (180 /2400) x 100 7.50 7.30
and (195/2670) x 100
(iii) General & Admn. Exp. (180/2400) x 7.50 5.84
100 and (156/2670) x 100
(iv) Non-operting surplus (24 / 2400) x 1.00 1.23
100 and (30 /2670) x 100
(v) Interest (30 /2400) x 100 and (33/2670) 1.25 1.23
x 100

(a) Proforma Income Statement for the year - III


Particulars (Rs lakhs)
Net sales 3,060
Cost of goods sold (76.40% rounded off) 2,340

Gross Profit 720


Selling expenses (7.30% rounded off) 220
General & Admn. Exp 178
Depreciation 180
Operating profit 142
Non-operating surplus (1.23% rounded 38
off)
Earnings before interest taxes 180
Interest 36
Earnings before tax (PBT) 144
Tax (35% of EBT) 50
Earnings after tax (PAT) 94
Dividends 24
Retained earnings 70

80
Working notes :
Working based on Percentage of Sales method
Particulars (Rs in lakhs) Year-I (%) Year-II (%)
(i) Fixed assets (900/2400) x 100 and 37.50 42.70
(1140/2670) x 100
(ii) Cash and Bank (36 x 2400) x 100 1.50 1.57
and (42/2670) x 100
(iii) Receivables (540 /2400) x 100 and 22.50 22.47
600/2670) x100
(iv) Inventories (519/2400) 100 and 21.62 21.57
576/2670) x 100
(v) Prepaid expenses (123/2400 x 100) 5.12 5.05
and 135/2670) x 100
(vi) Trade Creditors (378/2400) x 100 15.75 18.76
and (501/2670) x 100
(vii) Retained earnings = Rs 387 - provisions + surplus =
387 - 135 + 70 = Rs 322 lakhs
(viii) Provisions of Rs 135 lakhs in second year are assumed
to be paid because tax is the only provision in the year-III

81
(b) Balance Sheet for the year-III (Rs lakhs)
Assets :
Fixed Assets (net) 42.7% of 1,306
sales
Investments 60
Current Assets, Loans and Advances:
Cash and Bank balances 1.50% 46
Receivables 22.47% 688
Inventories 21.57% 660
Prepaid expenses 5.05% 154
Miscellaneous expenenditures paid and 42
losses
Total : 2,956
Liabilities :
Share Capital :
Equity 450
Reserves and surplus 322
Secured Loans : (see below)
Term Loans : 525
Bank borrowings : 1035 1,560
Current Liabilities :
Trade creditors (18.76%) 574
Provisions (tax) 50
Total : 2,956
Note : Secured Loans = Total Assets - Other liabilities
2956 - 1396 = Rs 1560 lakhs

(c ) Amount of External Financing Required (EFR)


for year - III (Rs in lakhs)
Total Secured Loans : 1,560
Less : Total of second loans at the end 1,122
of year-II
External Financing Required (EFR) (net 438
amount)

82
THANK YOU

83

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