Instead of preparing a set of forecasted financial statements, you can also calculate your external financing needs (EFN) by using a formula that looks at three changes:
1. Required increases to assets given a change in sales. Formula = (A/S) x (Δ Sales).
2. Required increases to liabilities given a change in sales. Note: Long term debt does not increase with a change in sales and is typically excluded.
3. Required increases to retained earnings as a result of income less any distributions
The complete formula (EFN) is expressed as:
EFN = (A/S) x (Δ Sales) - (L/S) x (Δ Sales) - (PM x FS x (1-d))
A / S: Assets that change given a change in sales, expressed as a percentage of sales.
Δ = Symbol for Change
ΔSales: Change in sales between the last reporting period and the forecasted sales.
L / S: Liabilities that change given a change in sales, expressed as a percentage of sales.
PM: Profit Margin on Sales; i.e. net income / sales.
FS: Forecasted Sales
d: dividend payout percent
(1 - d): Percent of earnings retained after paying out dividends; d is the dividend payout ratio.
Example 1 - Calculation of the EFN:
Total Assets last year = $ 6.5 Million
Total Sales last year = $ 21.0 Million
Total Current Liabilities last year = $ 2.1 Million
Profit Margin = 4% of sales
Forecasted Sales = $ 24.5 Million
Dividend Payout Ratio or d = 60%
A / S = $ 6.5 / $ 21.0 = 31%
L / S = $ 2.1 / $ 21.0 = 10%
Change in Sales or ΔSales = $ 24.5 - $ 21.0 = $ 3.5
EFN = (.31 x $ 3.5) - (.10 x $ 3.5) - ((.04 x $ 24.5) x (1 - .60))
EFN = $ 1.085 - $ .35 - ($ .98 x .40)
EFN = $ .735 - $ .392
EFN = $ .343