Free «The Additional Funds Needed (AFN) Method» Essay Paper
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- A* Stands for assets with direct association to sales
- L* Spontaneous liabilities likely to be affected by sales increase
- S0 Total last year sales
- S1 Next year sales projections
- M Profit margin
- MS1 Net Income forecasts
- RR Net Income retention ratio
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Additional funds needed (AFN) is a famous financial instrument or method used mostly by corporate companies to determine their expansion strategy. The underlying concept behind this method is that in order to have a strategic sales expansion, then an overwhelming consideration has to be given to asset expansion provisions that will be responsible for meeting the increased sales output. In short, for any strategy to increase sales for a company, then financing plan must be put in order to purchase new assets that will produce the new increased quantity (Boyd, 1988).
It should be noted that AFN is a way of calculating the additional funding required so that the firm can realistically produce the new increased sales levels. In pursuit of this concept, AFN takes as center stage, the determination of external funding since many businesses do not readily have the amount necessary to finance business expansions. A simple AFN equation normally used can be summarized as follows:
AFN= Increase in Assets Projections – Spontaneous Liability Increase – Any increase in retained earnings.
One fundamental consideration business consultants always take into account before using AFN is that they first of all determine whether the business is operating at full capacity. Suppose the business is operating below its capacity, then it is possible to increase sales without increasing the existing asset base. Again, suppose a negative value for AFN is found as the solution, then it means that the intended action has got a capacity to generate more revenue that the company could invest in other lines. The reverse holds when the AFN value is positive. The general AFN equation always used is as shown below:
AFN = (A*/S0) ΔS – (L*/S0) ΔS – MS1 (RR)
The abbreviations stand for the following:
A* Stands for assets with direct association to sales
L* Spontaneous liabilities likely to be affected by sales increase
S0 Total last year sales
S1 Next year sales projections
ΔS Change in sales between S0 and S1
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M Profit margin
MS1 Net Income forecasts
RR Net Income retention ratio
In terms of practical application of the method, this is outlaid clearly after the 2007 economic down turn that affected many business ventures in the world. This method was particularly used by many agribusinesses to get back on their feet and continue with their operations by helping these businesses source for the necessary funds to keep them moving. More so, it should be remembered that since it is used to provide fund projections for the following year, many businesses then use it to set goals for assets required, liabilities and even on retained earnings on company revenue (Boyd, 1988).
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