practice questions Chapter 14-16
Identify the letter of the choice that best completes the statement or answers the question.
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.
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.
As a firm's sales grow its current asset accounts tend to increase. For instance, as sales increase the firm's in-
ventories increase and its level of accounts payable will increase. Thus, spontaneously generated funds will
arise from transaction accounts that increase as sales increase.
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.
An increase in the firm's inventory balance will normally require additional financing unless the increase is
matched by an equally large decrease in some other asset account.
One of the key steps in the development of pro forma financial statements is to identify those assets and liab-
ilities which increase spontaneously with net income.
Pro forma financial statements, as discussed in the text, are used primarily to assess a firm's historical per-
The first, and most critical, step in constructing a set of pro forma financial statements is the sales forecast.
Any firm with a positive growth rate in sales will require some amount of external funding, assuming all ex-
isting ratios are to be maintained.
To determine the amount of additional funds needed, you may subtract the expected increase in liabilities (a
source of funds) from the sum of the expected increases in retained earnings and assets (both uses of funds).
The fact that long-term debt and equity funds are raised infrequently and in large amounts lessens the need for
the firm to forecast them on a continual basis.
The percentage of sales method assumes that all financial ratios are constant, which means, for example, that
if you plotted a graph of inventories versus sales, the regression line would be linear and would have a posit-
The percentage of sales method would be appropriate if, in a regression of sales on each asset and spontan-
eous liability, the regression line was linear and passed through the origin.
If any firm with a positive net worth is operating its fixed assets at full capacity, if its dividend payout ratio is
100 percent, and if it wants to hold all financial ratios constant, then for any positive growth rate in sales, the
firm will require external financing.