Percent of sales notes

Percent of sales notes - Percent of Sales Method (Chapter...

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The percent of sales method is used to forecast a company’s balance sheet. Then it is possible to determine whether or not the company needs extra financing to meet its sales goals. This amount is known as the Additional Funds Needed or AFN. This method works best for small to mid-sized companies. Larger companies have sophisticated accounting systems that can perform the same functions. To give you an overview of the method, the company forecasts the income statement first and then uses that information to forecast the balance sheet. As strange as this seems, the balance sheet will most likely not balance. If assets are greater than liabilities, that means the company needs outside financing in the form of debt or equity. If liabilities are greater than assets, then the company does not need outside financing. As you study this method, it will look more complicated than it really is. The notes below will help you understand the method and also show you a shortcut to forecasting the balance sheet. The shortcut makes the method much easier to use, but you should understand the method in order to apply it. Forecasting the Income Statement The process starts with a forecast of the income statement which is shown on page 484. Once again, the company is MicroDrive which manufactures hard disk drives. Current sales amount to \$3 billion and are expected to increase by 10 percent to \$3.3 billion next year. The increase of 10 percent is the key to using the method. Before forecasting the balance sheet, let’s look at the income statement forecast and analyze the components. The sales forecast is the responsibility of the Marketing and Sales Department. Marketing people are generally optimistic so it is important to ask a few questions to establish the feasibility of the increase. Sales are composed of price times units. Is this increase due to an increase in price, an increase in units sold, or a combination of both? If the answer is both, this goes against the fundamental law of demand which states that when the price increases, the quantity sold decreases. The explanation for an increase in both units sold and the price should be that the demand curve has shifted out so there is an increase in demand for MicroDrive’s products. The Operations Department is responsible for forecasting expenses. The example in the text is unrealistic because all costs are summarized in one line. In a real situation, each cost category would be listed separately and the assumptions for each line item would be documented. The assumption of an 87.2 percent cost of sales comes from table 14-1 on the previous page. The cost of sales is expected to be the same in the future as it is now. This is unrealistic because it does not take into account any economies of scale and the increase in purchasing power for MicroDrive. The Accounting Department is responsible for the depreciation forecast.

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This note was uploaded on 02/27/2012 for the course BUS 510 taught by Professor Mehdi during the Spring '11 term at University of La Verne.

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Percent of sales notes - Percent of Sales Method (Chapter...

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