Question 1

Errors in the sales forecast can be offset by similar errors in costs and income forecasts. Thus, as long as the errors are not large, sales forecast accuracy is not critical to the firm.

Accepted Answer

Errors in sales forecasts can have significant impact on a firm's financial performance as they can result in lost opportunities or overproduction leading to excess inventory. While errors in cost and income forecasts can also occur, relying on similar errors to offset each other is not a reliable strategy for sustainable profitability. Therefore, sales forecast accuracy is critical to the firm's success.

Question 2

If a firm's capital intensity ratio (A*/S0) DECREASES as sales increase, use of the AFN formula is likely to UNDERSTATE the amount of additional funds required, other things held constant.

Accepted Answer

False

Question 3

As a firm's sales grow, its current assets also tend to increase. For instance, as sales increase, the firm's inventories generally increase, and purchases of inventories result in more accounts payable. Thus, spontaneously generated funds arise from transactions brought on by sales increases.

Accepted Answer

This statement is true as an increase in sales would require an increase in inventory and consequently an increase in accounts payable to suppliers. This increase in current assets would result in more spontaneously generated funds for the firm.

Question 4

The first, and most critical, step in constructing a set of pro forma financial statements is the sales forecast.

Accepted Answer

The sales forecast is the foundation of the pro forma financial statements, as it drives all other projections and estimates. Without an accurate sales forecast, the rest of the pro forma financial statements will be inaccurate as well.

Question 5

By developing a financial plan, a firm benefits by being forced to think about and forecast the future, set goals and establish priorities, and make sure that goals are internally consistent.

Accepted Answer

Developing a financial plan requires a firm to think ahead and set clear objectives for the future. This helps prioritize goals and ensures that they align with the overall vision and mission of the organization. Ultimately, a well-developed financial plan is a useful tool for managing resources and making informed decisions.

Question 6

Which of the following is NOT a key element in strategic planning as it is described in the text?

Accepted Answer

The statement of cash flows is not a key element in strategic planning. While it is important for financial planning and management, it does not directly relate to the formulation of strategy and corporate objectives. The mission statement, statement of the corporation's scope, and statement of corporate objectives are all essential components to identify a company's purpose, assess its competitive landscape, and set specific goals for long-term success.

Question 7

The AFN formula would be appropriate if, in a regression of each asset and spontaneous liability on sales, the regression line was linear and passed through the origin.

Accepted Answer

The AFN (Additional Funds Needed) formula is based on the assumption that certain balance sheet items vary directly with sales. If the regression of assets and spontaneous liabilities on sales is linear and passes through the origin, it implies a direct proportionality, which aligns with the assumptions underlying the AFN formula.

Question 8

One of the key steps in the development of pro forma financial statements is to identify those assets and liabilities that increase spontaneously with sales.

Accepted Answer

This statement is true as identifying the assets and liabilities that increase spontaneously with sales is essential for accurately forecasting pro forma financial statements based on projected sales levels.

Question 9

Suppose that a firm's profit margin is 5%, its debt/assets ratio is 56%, and its dividend payout ratio is
40%. If the firm is operating at less than full capacity, then sales could increase to some extent without the need for external funds; however, but if it is operating at full capacity with respect to all assets, including fixed assets, then any positive growth in sales will require some external financing.

Accepted Answer

The answer of Suppose that a firm's profit margin is...

Question 10

The term "spontaneously generated funds" generally refers to increases in the cash account that result from growth in sales, assuming the firm is operating with a positive profit margin.

Accepted Answer

The answer of The term "spontaneously generated funds" generally refers...

Question 11

Pro forma financial statements are used primarily to assess a firm's historical performance.

Accepted Answer

Pro forma financial statements are not used to assess a firm's historical performance. They are used to project future financial performance based on certain assumptions and adjustments to the historical financial statements.

Question 12

Two firms with identical capital intensity ratios are generating the same amount of sales. However, Firm A is operating at full capacity, while Firm B is operating below capacity. If the two firms expect the same growth in sales during the next period, then Firm A is likely to need more additional funds than Firm B, other things held constant.

Accepted Answer

Since Firm A is already operating at full capacity, any increase in sales will require additional funds for expansion, whereas Firm B has some spare capacity and may not need additional funds for expansion.

Question 13

A rapid build-up of inventories normally requires additional financing, unless the increase is matched by an equally large decrease in some other asset.

Accepted Answer

When a company builds up inventories quickly, it typically requires additional financing to purchase the additional inventory. If the increase in inventory is not offset by a decrease in some other asset, such as accounts receivable or cash, the company will need to find other sources of financing to fund the inventory build-up. This can include borrowing money from banks or investors, or using trade credit from suppliers.

Question 14

When we use the AFN formula to forecast the additional funds needed, we are implicitly assuming that all financial ratios are constant. This means, for example, that if you plotted a graph of inventories versus sales, the regression line would be linear and would have a positive (non zero) Y-intercept.

Accepted Answer

The AFN formula assumes that financial ratios are constant, but it does not make any assumptions about the shape or slope of a regression line for inventory versus sales.

Question 15

A typical sales forecast, though concerned with future events, will usually be based on recent historical trends and events as well as on forecasts of economic prospects.

Accepted Answer

A sales forecast typically takes into account recent historical trends and events, as well as forecasts of economic prospects, in order to predict future sales.

Question 16

Which of the following assumptions is embodied in the AFN formula forecasting method?

Accepted Answer

The AFN (Additional Funds Needed) formula assumes that accounts payable and accruals vary directly with sales, as they are part of the spontaneous liabilities that change with sales levels.

Question 17

To determine the amount of additional funds needed (AFN), you may subtract the expected increase in liabilities, which represents a source of funds, from the sum of the expected increases in retained earnings and assets, both of which are uses of funds.

Accepted Answer

To determine the amount of additional funds needed (AFN), you should subtract the sum of the expected increases in liabilities and retained earnings from the expected increase in assets. This is because assets and retained earnings represent uses of funds, while liabilities represent a source of funds.

Question 18

Suppose a firm with a positive net worth is operating its fixed assets at full capacity, its dividend payout ratio is 100%, and it wants to hold all financial ratios constant. Then, for any positive growth rate in sales, it will require external financing.

Accepted Answer

If the firm wants to hold all financial ratios constant, and its dividend payout ratio is already 100%, then it cannot use its internal funds to finance any growth in sales. Therefore, it will require external financing to fund its growth.

Question 19

The fact that long-term debt and common stock are raised infrequently and in large amounts lessens the need for the firm to forecast those accounts on a continual basis.

Accepted Answer

The answer of The fact that long-term debt and common...

Question 20

When a firm wants to maintain its ratios at their existing levels, if it has a positive sales growth rate of any amount, it will require some amount of external funding.

Accepted Answer

The answer of When a firm wants to maintain its...

Quiz 5: Financial Planning and Forecasting Financial Statements