Financial Management

I. QUESTIONS
1. What are the basic benefits and purposes of developing pro forma statements and cash
budget?

A pro forma statement and a cash budget are tools used for planning in companies. A pro
forma statement projects future amounts a company expects. Provides a projection on the
anticipation of profits over a subsequent period. A cash budget works alongside the pro forma
statement by planning a budget for the future. The pro forma income statement must be
translated into cash flows needed for the period, GOALS, Forecast cash surpluses and shortfalls,
Minimize the amount of cash needed for operations.

2. Explain how the collections and purchases schedules are related to the borrowing needs
of the corporation.

The collection and purchase schedules measure the speed at which receivable are collected
and purchase are paid. To the extend collection do not cover purchasing cost and other
financial requirements, the firm must look to borrowing to cover the deficit.

3. Rapid corporate growth in sales and profits can cause financing problems. Elaborate on
this statement.

Rapid growth in sales and profit is often associated with rapid growth in asset commitment.
For example, a $100,000 increase in sales may cause $ 50,000 increase in asset, with perhaps
only $ 10,000 of the new financing coming from profits. It is very seldom that incremental
profits from sales expansion can meet new financing needs.

4. What conditions would help make a percent-of-sales forecast almost as accurate as pro
form a financial statements and cash budgets?
To the extent that past relationships accurately depict the future, the percent of sales-method will
gives values that reasonably represent the values derived through the pro-forma statements and
the cash budget.

II. MULTIPLE CHOICE QUESTIONS

1. The percent-of-sales method of financial forecasting. C. assumes that statement of financial
position accounts maintain a constant relationship
a. is more detailed than a cash budget approach
b. requires more time than a cash budget approach
c. assumes that statement of financial position accounts maintain a constant relationship to sales
d. provides a month-to-month breakdown of data

2. In the percent-of-sales method. A. as dividend payout ratio goes up, the required new
funds also rise
a. as dividend payout ratio goes up, the required new funds also rise
b. as the dividends payout rise, required new funds decline
c. the dividends payout ratio does not affect new funds
d. None of the above

3. When using the percent-of-sales method in forecasting funds needed, which of the following is
not true? C. Required new funds increase as accumulated depreciation increases
a. As the dividends payout ratio decreases, the required new funds also decrease
b. Required new funds decrease as profits margins increase
c. Required new funds increase as accumulated depreciation increases
d. As the tax rate increases, the required new funds increase

4. BH Inc. determines that sales will rise from P300,000 to P500,000 next year.
Spontaneous assets are 70% of sales and spontaneous liabilities are 30% of sales.
BH has 10% profit margin and a 40% dividend payout ratio. What is the level of required new
funds? A. 50,000
a. P50, 000
b. P20, 000
c. P 100,000
d. BH is in balance and no new funds are needed

5. A firm has targeted a 40% growth in sales this year. Last year’s cash as a percent of sales was
15%, accounts receivable 30%, and inventory 35%. What percentage growth in current assets is
required to support the growth in sales under the percent of- sales forecasting method? D. Not
enough information to tell
a.32%
b.26%
c.18%
d. Not enough information to tell

6. A rapid rate of growth in sales and profits may require B. Increased borrowing by the firm
to support the sales increase
a. higher dividend payments to shareholders
b. increased borrowing by the firm to support the sales increase
c. the firm to be less lenient with credit customers
d. sales forecasts to be made less frequently

7. Firms that successfully increase their rates of inventory will, among other things.
A. Be able to reduce their borrowing needs
a. be able to reduce their borrowing needs
b. be able to reduce their dividend payments stockholders
c. find it more difficult to be given credit by their resource suppliers
d. have a greater need for high balances in their cash accounts

8. Which of the following statements is true? C.Pro forma income statements follow a sales
forecast and production plan
a. An increase in sales and/or profits means there is also an increase in cash on the statement of
financial position
b. An increase in sales and profits generates the necessary cash required for economic growth
c. Pro forma income statements follow a sales forecast and production plan
d. If inventory turnover is equal to 3, that means that the company keep a three month supply of
inventory on hand

9. Which of the following statements is false? B. The percent-of-sales forecast is likely to be

most accurate when used with cyclical companies
a. The percent-of-sales method for financial forecasting assumes that statement
of financial position accounts maintain a constant relationship to sales
b. The percent-of-sales forecast is likely to be most accurate when used with cyclical companies
c. Level production schedules usually have the advantage of reducing overall production costs
d. The percent-of-sales method would be more accurate under a steady sales assumption than
cyclical sales

10. Which of the following statements is correct? A. It is helpful to break down the income
statement into smaller monthly periods
a. It is helpful to break down the income statement into smaller monthly periods
to enable evaluation of seasonal patterns of cash inflows and outflows
b. When sales volume varies from to month it is not advisable to use level production
c. As the dividend payout ratio declines more external funds are required
d. Lower profit margin resulting from increased competition would mean a lower need for
external funds

11. Which of the following statements is incorrect? D. The generations of sales and profits
ensures that there will be adequate cash on hand to meet financial obligations as they come
due

a. A lower dividend payout ratio will decrease the firm’s need for borrowing
b. A higher growth rate in sales will require more external funds
c. sales projections and the ability to accurately predict the future have a large impact on cash
flow targets
d. The generations of sales and profits ensures that there will be adequate cash on hand to meet
financial obligations as they come due

12. A firm forecasted sales of P3, 000 in April, P4,500 in May and P6,500 in June. All sales are
on credit. 30% is collected the month of sales and the remainder the following month. What will
be the balance in accounts receivable at the end of June? C. P4,550
June P6,500 x.70% of uncollected sales for the month
a. P1,950
b. P6,500
c. P4,550
d. P5,100
13. In general, the larger the portion of a firm’s sales that are on credit, the
B. Higher will be the firm’s need to borrow

a. lower will be the firm’s need to borrow

b. higher will be the firm’s need to borrow
c. more rapidly credit sales will be paid off
d. more the firm can buy raw on credit

14. The need for an increase or decrease in short term borrowing can be predicted by
C. Cash budget
a. ratio analysis
b. trend analysis
c. a cash budget
d. an income statement.

15. The following is the statement of financial position for 2014 for marvellous Inc.
Marvelous Inc
Statement of Financial Position
2014
Assets Liabilities & Equity
Cash P150, 000 Accounts Payable P 900, 000
Accounts receivable 900, 000 Notes payable 300, 000
Inventory 600, 000 Accrued expenses 75, 000
Current assets 1,650,000 Current liabilities 1,275,000
Fixed assets 600,000 Ordinary shares 750,000
Retained earnings 225,000
Total assets P2,250, 000 Total liabilities & equity P2,250,000

Sales for 2014 were P3,000,000. Sales for 2015 have been projected to increase by 20%.
Marvelous Inc. is operating below capacity. The company has an 8% return on sales 70% is paid
out as dividends.

The amount of new funds required is A. 48,600

a. P48,600. c. P50,000
b. P46,800. d. P45,000

16. A company had sales last year of P10 million, with net income equal to 6% of sales.
This year the sales are expected to be P11.2 million. The accounts receivable balance was P1.5
million at the end of last year. Using the percentage-of-sales method, the accounts receivable
balance at the end of this year is forecasted to be D. P2.7M
Computation:
Sales expected to be 11.2 M
Less: Sales last year (10M )
Total sales 1.2M
AccountsReceivable balance 1.5M
AccountsReceivable balance at the of the year 2.7M

a. P1.572 million.
b. P1.68 million
c. P2.172 million
d. P2.7 million

17. A company had P500,000 of sales for the year just ended and is projecting sales of
P600,000 for the coming year. For every P1 increase in sales, 38 centavos of additional financing
is required for the purchase of additional assets. The projected profit margin is
20%, and 60% of profits will be retained for reinvestment in the company. The amount of
additional external financing needed by the company in the coming year is A. 0
a. 0
b. P38, 000
c. P86, 000
d. P110, 000

18. Short-term interest rates are D. Not significantly related to long term rates
a. Usually lower than long-term rates
b. Usually higher than long-term rates
c. Lower than long-term rates during periods of high inflation only
d. Not significantly related to long term rates

19. A downward-sloping yield curve depicting the team structure of interest rates implies that
D. Prevailing short-term interest rates are higher than prevailing long-term interest rates
a. Interest rates have declined over recent years
b. Interest rates have increased over recent years
c. Prevailing short-term interest rates are lower than prevailing long-term interest rates
d. Prevailing short-term interest rates are higher than prevailing long-term interest rates
III. PROBLEMS
Problem 1.
Odette Electronics has 90 operating plants in seven southwestern states. Sales for
last year were P100 million, and the statement of financial position at year-end is similar in
percentage of sales to that of previous years (and this will continue in the future). All assets
(including fixed assets) and current liabilities will vary directly with sales.
_____________________________________________________________________________
Statement of Financial Position
(in P millions)
Assets Liabilities and Equity
Cash…………………………. P2 Accounts payable……………………... P15
Accounts receivable………… 20 Accrued wages………………………… 2
Inventory……………………. 23 Accrued taxes………………………….. 8
Current assets……………. P45 Current liabilities……………………… P25
Fixed assets…………………. 40 Notes payable………………………….. 10
Ordinary shares………………………... 15
Retained earnings……………………… 35
Total assets………………..... P85 Total liabilities and equity……………. P85
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Odette’s has an after-tax profit margin of 7 percent and a dividend payout ratio of 40 percent.
If sales grow by 10 percent next year, determine how much of new funds are needed to finance
the growth.

Owen’s Electronics
At Full Capacity

Spontaneous Assets = Current Assets  Fixed Assets

Spontaneous Liabilities = Acc. Pay. + Accrued Wages & Taxes
 A L
Required New Funds =  S   S  PS2  1  D 
S S
S = (10%)(P100,000,000)

S = P100,000,000

RNF =
85,000,000 25,000,000
( P10,000,000 )− ( P 10,000,000 )−.07 ( P 110,000,000 )(1−.40)
100,000,000 100,000,000

= .85 (P10,000,000) - .25 (P10,000,000) - .07 (P110,000,000) (.60)

= P8,500,000 – P2,500,000 – P4,620,000

RNF = P1,380,000

Problem 2
Tess’ Shop, Inc., a national clothing chain, had sales of P300 millions last year.
The business has a steady net profit margin of 8 percent and a dividend payout ratio of 25 percent. The
statement of last year is shown below.
_______
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Statement of Financial Position

End of Year
(P millions)
Assets Liabilities & Equity
Cash……………………..…. P20 Accounts payable………………… P70
Accounts receivable………... 25 Accrued expenses………………... 20
Inventory………………….... 75 Other payables…………………… 30
Plant and equipment………... 120 Ordinary shares………………….. 40
Retained earnings………………... 80
Total assets…………………P240 Total liabilities and equity………..P240
________________________________________________________________________________
The firm’s marketing staff has told the president that in the coming year there will be a large increase in
demand for overcoats and wool stacks. A sales increase of 15 percent is forecasted for the company.
All statement of financial position items are expected to maintain the same percent-of-sales relationships
as last year, except for ordinary shares and retained earnings. No change is scheduled in the number of
ordinary shares outstanding, and retained earnings will change as dictated by the profits and dividend
policy of the firm. (Remember the net profit margin is
8 percent.)
a. Will external financing be required for the company during the coming year?
b. What would be the need for external financing if the net profit margin went up to 9.5 percent and the
dividend payout ratio was increased to 50 percent? Explain.

Solution:
Tess’ Shops, Inc.
A L
Required New Funds =  S    S   PS2  1  D 
A. S S
∆ S=15 % × P 300,000,000=P 45,000,000

240,000,000 120,000,000
RNF= ( P 45,000,000 ) − (P 45,000,000)−.08 ( P345,000,000 )( 1−.25 )
300,000,000 300,000,000

= .80 (P45,000,000) – .45 (P10,000,000) – .08 (P345,000,000) (.75)

= P36,000,000 – P18,000,000 – P20,700,000

RNF = (P2,700,000)

A negative figure for required new funds indicates that an

excess of funds (P2,700,000) is available for new investment.
No external funds are needed.

B.

RNF=P 36,000,000−P 18,000,000−.095 ( P 345,000,000 ) × ( 1−.5 ) =P 36,000,000−P18,000,000−P16,387,500

¿ P 1,612,500external funds required

The net profit margin increased slightly, from 8% to 9.5%,

which decreases the need for external funding.