Question

"When EFN (External Financing Needed, aka AFN) is negative, it indicates that the company is holding excessive money than that is needed. When company is merely holding the surplus of money is often as bad as holding the surplus of debt. It is because money laying unused creates opportunity costs, so the firm should use it to clear high interest debt, to repurchase shares, or to increase dividends."

The statement above is basically wrong for two reasons:

1) Why is the AFN not about "holding"?

2) Why is the AFN not about "money"?

Answer 1

1:A negative AFN means that there is surplus capital . This means that the retained earnings and spontaneous liabilities exceed the additional assets needed. So, it implies that the company can either distribute greater dividends or it can pay off its liabilities and need to take the additional finance in the form of liabilities. Hence it is not about holding money.

2: AFN is not about money. It does not represent cash. Rather AFN represnts financing in the form of retained earnings or additional liabilities. The retained earnings do not always come in the form of cash and it can be just an accounting figure. Also the liabilities are not always followed by money. It can be in the form of additional credit period.