Financial Forecasting Using Afn Handouts

FINANCIAL FORECASTING USING AFN
AFN – “Additional Fund needed” It is a concept used most commonly in business looking to
expand operations and influence. Since a business that seeks to increase its sales level will
require more assets to meet that goal, some provision must be made to accommodate the change
in assets.
AFN is a way of calculating how much new funding will be required, so that the firm can
realistically look at whether or not they will be able to generate the additional funding and
therefore be able to achieve the higher sales level.
What advantages does the forecasted financial statement method have over the AFN
equation for forecasting financial requirements?
 The advantages of the forecasted financial statement method over AFN is that it allows the
user to have the opportunity to implement changes in the relationships between the various
accounts on the statements through the use of additional financial ratios.
What is the most correct implication of the additional funds needed (AFN)?
 If AFN is negative, then you must secure additional financing. If AFN is positive, then you
have extra funds to pay off debt. If AFN is positive, then you have extra funds to buy some
short-term investments.
What Is Financial Forecasting?
 Forecasting is determining what is going to happen in the future by analyzing what
happened in the past and what is happening now. It’s a planning tool that helps businesses
adapt to uncertainty based on predicted demand for goods or services.
 Financial forecasting is a financial plan that estimates the projected income and projected
expenses of a business, and a solid financial forecast contains both macroeconomic factors
and conditions that are specific to the organization. A thorough forecast includes but is not
limited to short- and long-term outlooks on conditions that could impact revenues and
contingencies for expenditures not currently viewed as necessary.
Benefits of Financial Forecasting

Some of the benefits of financial forecasting include:
 Assess the success of your efforts to determine the long-term viability or value of an activity
 Take control of your cash flow and purposefully direct your company
 Develop benchmarks for use in future forecasts
 Perform contingency planning during challenging financial times
 Anticipate the impact of new expenses
 Identify financial problem areas and their causes
 Reduce financial risk
 Create an environment of certainty and stability
 Make future budgeting much easier
Why Is Forecasting Important?
 Financial forecasts are an essential part of business planning, budgeting, operations,

funding — they simply help leaders and outside stakeholders make better choices.
 A financial forecast is an estimate of future financial outcomes for a company, and it’s an
integral part of the annual budget process. It informs major financial decisions, such as
whether to fund a capital project, undertake a staffing increase or seek funding. Businesses
use material information from their financial forecasts on their balance sheets and other
disclosures.
AFN equation
The simplified formula is:
AFN = Projected increase in assets – spontaneous increase in liabilities – any increase in retained
earnings.
The more formal equation for AFN is
AFN = (A*/S0)ΔS – (L*/S0)ΔS – MS1(RR)
A- Assets tied directly to sales
L-spontaneous liabilities that are affected by sales
S0=the previous year's sales
S1=total projected sales for next year
ΔS=the change in sales between S0 and S1
M=profit margin
MS1=projected net income
RR=the retention ratio from net income (equal to 1 minus the dividend payout ratio; disregard if
dividends are not declared)
Additional Funds Needed
ΔS ΔS
= A0 × − L0 × − S1 × PM × b
S0 S0
Where,
Ao = current level of assets
Lo = current level of liabilities
ΔS/So = percentage increase in sales i.e. change in sales divided by current sales
S1 = new level of sales
PM = profit margin
b = retention rate = 1 – payout rate
EXAMPLE 2:
Laughing Pieces Incorporation expects a 10% jump in sales in 2022. At the end of
2021, its assets were $25 million, while its liabilities were $17 million. The sales for
the year 2021 were $30 million, while its profit margin is 4%. The current retention
ratio of Laughing Pieces is about 40%.
Increase in Assets = 2021 assets * sales growth rate = $25 million × 10% = $2.5 million.
Increase in Liabilities = 2021 liabilities * sales growth rate = $17 million × 10% = $1.7
million.
Increase in Retained Earnings = 2022 sales * profit margin * retention rate

2021 (1 + sales growth rate) × profit margin × retention rate)
$30 billion × (1 + 10%) ×4%×40% = $0.528 billion
Additional Funds Needed (AFN) = $2.5 million less $1.7 million less $0.528 million = $0.272
million.

Financial Forecasting Using Afn Handouts

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Financial Forecasting Using Afn Handouts

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FINANCIAL FORECASTING USING AFN

Benefits of Financial Forecasting

 Financial forecasts are an essential part of business planning, budgeting, operations,

Increase in Retained Earnings = 2022 sales * profit margin * retention rate

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