Recognize how growth can put a firm’s balance sheet out of order.
Identify the factors that would determine how much external financing is needed.
Introduction
This section develops a simple forecasting model that permits the analyst to determine how fast a growth pattern a company can sustain. This approach can be a valuable planning tool.
Definitions
SA
Spontaneous assets – These are assets that generally need to increase as sales increase. They include most of the current assets, but not short term investments.
ΔFA
Change in net fixed assets – This includes new, fixed asset acquisitions, less depreciation expenses.
PO
Payout ratio – This is the proportion of earnings paid out as a dividend. The retention ratio is (1 – PO).
PM
Profit margin – This is often called the net profit margin and is net income divided by net sales revenue.
EFN
External financing needed – This is the amount of additional long-term financing needed from external debt and equity sources.
ss
Derivation of the sustainable growth model
The model comes from the equation used in the sales method forecasting model.
An expression for new debt and new assets can be set up that equals our target debt to asset ratio for the increased business.
By substituting the value of EFN from (1) into (2) and solving for ΔS, we can obtain the ...
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