BUS601: Financial Management

LEARNING OBJECTIVE Calculate the additional funds needed equation KEY POINTS 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. The simplified formula is: AFN = Projected increase in assets – spontaneous increase in liabilities – any increase in retained earnings. If this value is negative, this means the action or project which is being undertaken will generate extra income for the company, which can be invested elsewhere. The mathematical formulas used to determine AFN are based on showing how liabilities will grow relative to new assets and sales when a project is undertaken and can be used as tools to determine whether a project or operational expansion is worthwhile. TERMS liabilities An amount of money in a company that is owed to someone and has to be paid in the future, such as tax, debt, interest, and mortgage payments. asset Something or someone of any value; any portion of one's property or effects so considered. sales Revenues

AFN stands for "additional funds 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 . To phrase it another way, the business must have some plan to actually finance the new assets that will be needed to increase sales.

Assets – Economic Resources

AFN determines the extra assets and financing that will be needed for a firm to undertake a new project or expand its operations and sales.

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. Determining the amount of external funding needed is a key part of calculating AFN. This can be determined by mathematical formulas which use inputs that can be found in a company's financial statements.

The simplified formula is:

AFN = Projected increase in assets – spontaneous increase in liabilities – any increase in retained earnings.

If this value is negative, this means the action or project which is being undertaken will generate extra income for the company, which can be invested elsewhere.

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).

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Source: Boundless.
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