Question

What is the Additional Funds Needed (AFN)? How to understand the AFN Equation?

How to forecast sales growth g?

What is payout ratio? How does the ratio affect AFN?

Answer 1

AFN = ((current level of assets - current level of spontaneous liabilities) * % increase in sales) - (next year sales * net profit margin * retention ratio)

When calculating assets, the total assets are taken. However, when calculating liabilites, only the spontaneous liabilities are considered, i.e. only accounts payable (notes payable are not considered).

next year sales = current year sales * (1 + growth rate)

net profit margin = net income / sales

retention ratio = 1 - dividend payout ratio

dividend payout ratio = dividend per share / EPS, or total dividends paid / net income

growth rate = ROE * retenton ratio , where ROE = net income / total equity

If the payout ratio is higher, the AFN is higher, since there are less internal funds available for funding the company's growth