Additional Funds Needed

Additional funds needed (AFN) is the amount of money a company must raise from external sources to finance the increase in assets required to support increased level of sales. Additional funds needed (AFN) is also called external financing needed.

Additional funds needed method of financial planning assumes that the company's financial ratios do not change. In response to an increase in sales, a company must increase its assets, such as property, plant and equipment, inventories, accounts receivable, etc. Part of this increase in offset by spontaneous increase in liabilities such as accounts payable, taxes, etc., and part is offset by increase in retained earnings.

Formula and Calculation

Additional funds needed (AFN) is calculated as the excess of required increase in assets over the increase in liabilities and increase in retained earnings.

Additional Funds Needed = Ao × ΔS − Lo × ΔS × S1 × PM × b
So So

Where,
Ao = current level of assets
ΔS/So = percentage increase in sales i.e. change in sales divided by current sales
Lo = current level of liabilities
S1 = new level of sales
PM = profit margin
b = retention rate = 1 – payout rate

A negative figure for additional funds needed means that there is a surplus of capital.

Example

TransWorld Inc. runs a shipping business and has forecasted a 10% increase in sales over 20Y3. Its assets and liabilities at the end of 20Y2 amounted to $25 billion and $17 billion respectively. Sales for the period were $30 billion and it earned a 4% profit margin. It reinvests 40% of its net income and pays out the rest to its shareholders. Calculate additional funds needed.

Solution

Additional funds needed = increase in assets − increase in liabilities – increase in retained earnings

Increase in assets = 20Y2 assets × sales growth rate = $25 billion × 10% = $2.5 billion

Spontaneous increase in liabilities = 20Y2 liabilities × sales growth rate = $17 billion × 10% = $1.7 billion

Increase in retained earnings = 20Y3 sales × profit margin × retention rate = 20Y2 sales × (1 + sales growth rate) × profit margin × retention rate = $30 billion × (1 + 10%)×4%×40% = $0.528 billion

Plugging all the figures gives us a figure of $0.272 billion.

Additional funds needed = $2.5 billion – $1.7 billion − $0.528 billion = $0.272 billion

TransWorld must raise $272 million to finance the increased level of sales.

Written by Obaidullah Jan