Pillai Institute Of Management Studies And Research (pimsr), New Panvel

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. 4

(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, 6

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. 12

(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 15

(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. 16

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 18

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 19

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. 20

(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. 21

(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. 22

(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.

(a) (b) (c) (d) (e)

The modern approach to financial planning relates to the four broad decision areas of financial management. These are as follows : Funds requirement decision, Financing decision, Investment decision, Dividend decision Liquidity decision. 23

(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

Net Sales Cost of goods sold Gross Profit Selling expenses General and administration expenses : Depreciation Operting profit Non-operting surplus / deficit Profit before interest and tax Interest on bank loans Interest on debentures Profit before tax Tax Profit after tax Dividends Retained earnings

31.3.2014 31.3.2015 Average Projected percen- P & L on tage of 31.3.2016 sales (%) 1200 1280 100.00 1400.00 775 837 65.39 910.00 425 443 35.00 490.00 25 27 2.10 29.40

75 272 30

80 282 32

6.30 22.03 2.50

88.20 312.20 35.00

302 60 58 184 82 102 60 42

314 65 60 189 90 99 63 36

24.80 5.00 4.80 15.00 6.90 8.10

347.20 210.00 67.20 210.00 96.60 113.40

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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. 27

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

Net Sales Assets : Fixed Assets (net) Investments Current assets, loans and advances : Cash and bank Receivables Inventories Pre-paid expenses Miscellaneous expenditures and losses

Total Liabilities : Share Capital Equity Preference Reserves and surplus

Secured Loans : Debentures Bank borrowings Unsecured Loans : Bank borrowings Current liabilities and provisions : Trade creditors Provisions External Funds requirement (balancing figures) TOTAL

31.3.2014 31.3.2015 Average percentage of sales

Pprojected P & L on 31.3.2016

1200

1280

100.00

1400.00

800 30

850 30

66.50 No change

931.00 30.00

25 200 375 50 20

28 212 380 55 20

2.10 16.60 30.40 4.20 No change

29.40 232.40 425.60 58.80 20.00

1500

1575

1727.20

250 50 250

250 No change 50 No change 286 Proforma Income statement

250.00 50.00 345.60

400 300

400 No change 305 24.40

400.00 341.60

100

125

9.10

127.40

100 50

112 47

8.50 3.90 Balancing figure

119.00 54.60 39.00

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 Fixed Assets (net) Investments Current Assets, loans and advances : Cash and bank Receivables Inventories Loans and advances Miscellaneous expendisures and losses Total Liabilities : Share Capital : Equity Preference Reserves and surplus Secured Loans: Bank borrowings Unsecured Loans : Public deposits Current liabilities and borrowings : Trade creditors Provisions Total :

Year-1

Year-2 240 10

270 10

5 80 125 25 15

6 90 144 30 10

500

560

100 20 150

100 20 169

60

80

0

1

125 45 500

130 50 560

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 Share Capital Reserves Bank Overdraft Creditors

Amount (Rs) Assets Amount (Rs) 8,00,000 Fixed Assets 4,50,000 11,80,000 Stocks 11,50,000 5,80,000 Debtors 16,00,000 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 To Opening stocks 11,50,000 By Sales To purchases 48,00,000 By Closing Stocks To Gross Profit 13,65,400 73,15,400 To expenses (64,000 x 6) 3,84,000 By Gross Profit b/d To Net Profit 9,81,400 13,65,400 (b) Proforma Balance Sheet as on 30.6.2009 Liabilities Amount (Rs) Assets Share Capital 8,00,000 Fixed Assets Reserves 11,80,000 Stocks Profit & Loss Account 9,81,400 Debtors Creditors 8,00,000 Cash and Bank (balancing figure) 37,61,400

Amount (Rs) 60,50,400 12,65,000

73,15,400 13,65,000 13,65,400

Amount (Rs) 4,50,000 12,65,000 20,16,800 29,600 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 Depreciation = 24,000 x 10 Total cost

4,80,000 2,40,000 25,20,000

4,80,000 2,40,000 31,20,000

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Particulars Cost per unit (i) 1st year (25,20,000 / 15,000) = Cost per unit : 2nd year : Opening stock Add : Cost of production Total No. of units Average cost per unit Value of stocks = 156.57 x 3000 =

Amount (Rs) 168

1,68,000 31,20,000 32,88,000 21,000 156.57 4,69,710

(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 = 15,000 x 80 = Closing stocks

12,00,000 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 consumed = 20,000 x 80 = Add : closing stock ( 3months) Total = Less : Opening stock Average = Creditors for 2 months = 17,00,000 x 2/12 =

16,00,000 4,00,000 20,00,000 3,00,000 17,00,000 2,83,333

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(v) Creditors for expenses : Particulars Labour Variable expenses Mfg. & Admn. Expenses Selling expenses Total Creditors for expenses

1st year (Rs) 2nd yr (Rs) 3,00,000 4,00,000 3,00,000 4,00,000 4,80,000 4,80,000 1,40,000 1,80,000 12,20,000 14,60,000 1,01,667 1,21,667

(a) Projected Statement of Profit / Loss Particulars 1st Yr (Rs) Production (units) 15,000 Sales (units) 14,000 Closing stocks 1,000 Sales at Rs 200 each (14,000 x 28,00,000 200) and 18000 x 200 ) Cost of production : Materials at Rs 80 each 12,00,000 Labour at Rs 20 each 3,00,000 Variable expenses 3,00,000 Mfg & Admn expenses (Fixed 4,80,000 24,000 units at Rs 20) Depreciation at Rs 10 for 24,000 2,40,000 units Cost of Production 25,20,000 Add : Opening Stock of finished 0 goods Total 25,20,000 Less : Closing stocks of F.G. 1,68,000 Cost of goods 23,52,000 Add ; Selling expenses 1,40,000 Cost of Sales 24,92,000 Profit 3,08,000 Sales 28,00,000

2nd Yr (Rs) 20,000 18,000 3,000 36,00,000

16,00,000 4,00,000 4,00,000 4,80,000 2,40,000 31,20,000 16,80,000 32,88,000 4,69,710 28,18,290 1,80,000 29,98,290 6,01,710 36,00,000

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(b) Projected Statement of Working Capital Particulars 1st Yr (Rs) (i) Current Assets : Stock of raw-materials 3,00,000 Stock of Finished Goods 1,68,000 Debtors 2,33,333 Cash balance 20,000 Total Current Assets 7,21,333 (ii) Current Liabilities : Creditors for materials Creditors for expenses Total current liabilities Estimate of Working Capital

2,50,000 1,01,667 3,51,667 3,69,666

2nd Yr (Rs)

4,00,000 4,69,710 3,00,000 20,000 11,89,710

2,83,333 1,46,667 4,05,000 7,84,710

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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)

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(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.

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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

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(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

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

9.00 4.50 13.50 2.00

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

2.80

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 = 2,00,000 Balance

3,20,000 23,86,000

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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

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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

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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.

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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 Less : Existing LTL : Additional LTL required

:

:

Rs 400 lakhs Rs 360 lakhs 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%

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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

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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

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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

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(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.

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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.

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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%) Retained earnings(50%)

1,429 1,429

(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 + 2,498 x 1/3)

4,753 Receivables (2580 x 130%)

Short term bank borrowings (2,490 + 2,498 x 2/3)

4,155 Cash at bank (180 x 130%)

Accounts Payable Provisions (780 x 130%

1,612 1,014 19,643

3,354

234

19,643

Note : Balance Sheet tallies on both sides

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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.

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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

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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

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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.

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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

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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

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Solution - 15 : Note : Assume sales for year-3 as Rs 26,000 Particulars Year-1 Year-2

Net Sales Cost of goods sold Gross Profit Selling expenses General & Admn. Exp Depreciation Operting Profit Non-operaing surplus / (deficit) Earnings before interest and tax Interest Earnings before tax Tax Earnings after tax Dividend (given) Retained earnings

18,230 13,210 5,020 820 1,200 382 2,618 132

Average Proforma P % of & L A/c for sales Year-3 22,460 100.00 26000.00 16,100 72.07 18738.98 6,360 27.93 7261.02 890 4.23 1099.89 1,210 5.98 1556.09 364 1.86 483.09 3,896 15.85 4121.95 82 0.54 141.59

2,750

3,978

16.40

4263.55

682 2,068 780 1,288 320 968

890 3,088 980 2,108 450 1,658

3.85 12.55 4.32 8.23

1001.48 3262.07 1123.46 2138.61 500.00

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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 tax Interest Earnings before tax Tax Earnings after tax Dividends Retained earnings

84

117

30 54 21 33 18 15

33 84 30 54 21 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

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Liabilities (Rs in lakhs) Share capital : Equity Reserves nd surplus Secured loans : Term loans Bank borrowings Current liabilities : Trade creditors Provisions

Year-I

Year-II

450 354

450 387

432 489

525 597

378 120 2,223

501 135 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.

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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 and (195/2670) x 100 (iii) General & Admn. Exp. (180/2400) x 100 and (156/2670) x 100 (iv) Non-operting surplus (24 / 2400) x 100 and (30 /2670) x 100

7.50

7.30

7.50

5.84

1.00

1.23

(v) Interest (30 /2400) x 100 and (33/2670) x 100

1.25

1.23

(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 Selling expenses (7.30% rounded off) General & Admn. Exp Depreciation Operating profit Non-operating surplus (1.23% rounded off)

720 220 178 180 142 38

Earnings before interest taxes Interest Earnings before tax (PBT) Tax (35% of EBT) Earnings after tax (PAT) Dividends Retained earnings

180 36 144 50 94 24 70

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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

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(b) Balance Sheet for the year-III Assets : Fixed Assets (net)

(Rs lakhs) 42.7% of sales

Investments Current Assets, Loans and Advances: Cash and Bank balances Receivables Inventories Prepaid expenses Miscellaneous expenenditures paid and losses Total : Liabilities : Share Capital : Equity Reserves and surplus Secured Loans : (see below) Term Loans : 525 Bank borrowings : 1035 Current Liabilities : Trade creditors (18.76%) Provisions (tax) Total : Note : Secured Loans = Total Assets - Other 2956 - 1396 = Rs 1560 lakhs

1,306 60

1.50% 22.47% 21.57% 5.05%

46 688 660 154 42 2,956

450 322

1,560 574 50 2,956

liabilities

(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)

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THANK YOU

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