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Case 4 Growing Pain
Case 4 Growing Pain
1. Since this is the first time Jim and Manson will be conducting a financial forecast for
Oats R Us, how do you think they should proceed? Which approaches or models can they
use? What are the assumptions necessary for utilizing each model?
As this is the first time Jim and Manson will be conducting a financial forecast for Oats R Us,
they should first do the sales forecasting planning. While preparing the sales forecasting report,
Jim and Mason should takes note on the future economic conditions. Then, they should proceed
to preparing the pro-forma financial statement. In the pro-forma financial statement, they can
assume that the items in it vary proportionately with their sales or remain the same. Based on
their utilization rate, they would be able to determine the asset requirements for growth. Fund
needed in financing growth can be raised from accounts payables and accruals, future retained
earnings, external sources (debt and stock offering). While for the approaches, Jim and Mason
can consider of using one of the methods stated below:
1) Pro-forma approach This approach is where most of the items in income statement and
balance sheet are assumed to remained constant proportion to sales, but individual items can be
forecasted using statistical techniques and feedback effects involving changes in interest costs
can be added
2) External financing needed (EFN) It is where they need to identify the funds needed to be
raised in order to support their forecasted sales level. EFN is easy to use but it does not allow the
inclusion of feedback effects
2. If Oats R Us is operating its fixed assets at full capacity, what growth rate can it
support without the need for any additional external financing?
First, calculate % of sales for income statement. Table shown below:
Table 1
Table 1 refer to calculation where each items divided by sales times 100%
Example: % of cost of goods sold in 2004
= (3877500 / 4700000) * 100%
= 82.5%
Then, calculate % of sales for balance sheet items as well with the same formula. Table 2 is
shown on the next page.
Table 2
Net profit margin = net income / sales
= 219900 / 4700000 = 4.678%
Retention rate = 60%
Current sales = $4700000
Asset to sales ratio (Ao/So) -used to compare how much in assets a company has relative to the
amount of revenues that the company can generate using their assets
= total asset / sales
= 25.68% (refer table 2)
Account payable to sales (Lo/So) = 2.87% (refer table 2)
For example we calculate the additional financing needed to support revenue growth rate of 25%
and so,
= (25.68%*1175000) (2.87%*1175000) [4.678%*60 %*(4700000+1175000)]
= 103118
5. After conducting an interview with the production manager, Jim realizes that Oats R Us is
operating its plant at 90% capacity, how much additional financing will it need to support growth
rates ranging from 25% to 40%?
6. What are some actions that Mason can take in order to alleviate some of the need for
external financing? Analyze the feasibility and implications of each suggested action.
Below are actions that Mason can take in order to alleviate some of the need for external
financing:
(i) Increase profit margin it is achievable but difficult as there is competition
(ii) Increase sales can be achievable but need a strong marketing and promotional strategy
(iii) Increase account payables by using more trade credit this can be done but until certain
point only as it can be very risky and expensive especially if the firm could avail itself of
discounts for paying cash
7. How critical is the financial condition of Oats R Us? Is Vicky justified in being concerned
about the need for financial planning? Explain why.
8. Given that Mason prefers not to deviate from the firms 2004 debt-equity ratio, what will the
firms pro-forma income statement and balance sheet look like under the scenario of 40% growth
in revenue for 2005 (ignore feedback effects).