Question

The Manning Company has financial statements as shown next, which are representative of the company’s historical average.

The firm is expecting a 35 percent increase in sales next year, and management is concerned about the company’s need for external funds. The increase in sales is expected to be carried out without any expansion of fixed assets, but rather through more efficient asset utilization in the existing store. Among liabilities, only current liabilities vary directly with sales.

Using the percent-of-sales method, determine whether the company has external financing needs, or a surplus of funds. (Hint: A profit margin and payout ratio must be found from the income statement.)

Income statement
Sales	\(250,000
Expenses	192,000
Earnings before interest and taxes	\)58,000
Interest	7,500
Earnings before taxes	\(50,500
Taxes	15,500
Earning after taxes	\)35,000
Dividends	\(7,000

BALANCE SHEET
Assets		Liabilities and Stockholder’s equity
Cash	\)8,500	Accounts payable	\(26,400
Accounts receivable	63,000	Accrued wages	2,350
Inventory	91,000	Accrued taxes	3,750
Current assets	\)162,500	Current liabilities	\(32,500
Fixed assets	85,000	Notes payable	7,500
		Long term debts	17,500
		Common stock	125,000
		Retained earnings	65,000
Total assets	\)247,500	Total liabilities and stockholder’s equity	$247,500

Short answer

The company requires external funding amounting of $37,450.

Step-by-step solution

Profit margin ratio

$\begin{array}{rcl}\mathrm{Profit}\mathrm{margin}& =& \frac{\mathrm{Earning}\mathrm{after}\mathrm{tax}}{\mathrm{Sales}}\\ & =& \frac{\$35,000}{\$250,000}\\ & =& 14\%\end{array}$

Dividend payout ratio

$\begin{array}{rcl}\mathrm{Dividend}\mathrm{payout}\mathrm{ratio}& =& \frac{\mathrm{Dividends}}{\mathrm{Earnings}}\\ & =& \frac{\$7,000}{\$35,000}\\ & =& 20\%\end{array}$

Change in sales

$\begin{array}{rcl}\mathrm{Change}\mathrm{in}\mathrm{sales}& =& \mathrm{Existing}\mathrm{sales}\times \mathrm{Growth}\mathrm{ratio}\\ & =& \$250,000\times 35\%\\ & =& \$87,500\end{array}$

Assets to sales ratio

$\begin{array}{rcl}\mathrm{Assets}\mathrm{to}\mathrm{sales}\mathrm{ratio}& =& \frac{\mathrm{Total}\mathrm{assets}}{\mathrm{Sales}}\\ & =& \frac{\$247,500}{\$250,000}\\ & =& 0.99\end{array}$

Liabilities to sales ratio

$\begin{array}{rcl}\mathrm{Liabilities}\mathrm{to}\mathrm{sales}\mathrm{ratio}& =& \frac{\mathrm{Liabilities}}{\mathrm{Sales}}\\ & =& \frac{\$32,500}{\$250,000}\\ & =& 0.13\end{array}$

New sales level

$\begin{array}{rcl}\mathrm{New}\mathrm{sales}\mathrm{level}& =& \mathrm{Existing}\mathrm{sales}+\mathrm{Increase}\mathrm{in}\mathrm{sales}\\ & =& \$250,000+\$87,500\\ & =& \$337,500\end{array}$

Required new funds

$\begin{array}{rcl}\mathrm{Required}\mathrm{new}\mathrm{funds}& =& \left(\mathrm{Assets}\mathrm{to}\mathrm{sales}\mathrm{ratio}\times \mathrm{Change}\mathrm{in}\mathrm{sales}\right)-\left(\mathrm{Liabilities}\mathrm{to}\mathrm{sales}\mathrm{ratio}\times \mathrm{Change}\mathrm{in}\mathrm{sales}\right)-\left(\mathrm{Profit}\mathrm{margin}\times \mathrm{New}\mathrm{sales}\mathrm{level}\right)\left(1-\mathrm{Dividend}\mathrm{payout}\mathrm{ratio}\right)\\ & =& \left(0.99\times \$87,500\right)-\left(0.13\times \$87,500\right)-\left(0.14\times \$337,500\right)\left(1-0.20\right)\\ & =& \$86,625-\$11,375-\$37,800\\ & =& \$37,450\end{array}$