ESTIMATING THE ADDITIONAL FUNDS NEEDED (AFN) FOR CORPORATE GROWTH: A CONTINGENCY PLANNING APPROACH

Abstract

ABSTRACT Planning for growth is, perhaps, the most important responsibility of all Corporate Chief Executives. The growth of any company is closely tied to the growth in its sales revenue. Obviously, the higher the planned growth rate in sales, the larger is the amount of investment needed in the fixed and current assets of the company. To achieve the target growth rate in sales, the company executives need to undertake the task of estimating the additional funds needed and devising a strategy for meeting those funding needs. Most commonly, the equation used in the estimation of the additional or external funds needed is based on the “percentage of sales approach.” Under this approach, the main assumption is that the increases in the relevant balance sheet items will be in direct proportion to the planned growth rate in sales. While the additional investment in the buildings and equipment or inventories is under the control of the company management, it is not necessarily so with regard to the “spontaneous” increases in accounts receivable or accounts payable. In fact, their final values might be significantly different from the values forecasted from the simple equation based on the percentage of sales approach. In this paper we describe a contingency planning approach and develop different estimates for current assets such as accounts receivable, and for current liabilities such as accounts payable, using probability distributions under different scenarios. We use these estimates in the calculation of the external funds needed. This approach will provide the company management with different options and help them plan for the contingencies that may arise in achieving the growth targets of the company. Keywords Sales Growth, Percentage of Sales Approach, Additional Funds Needed (AFN)