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Table of Contents
Brief Background of the Case……………………………………………………. 1
Point of View…….…………………………………………………………………. 1
Statement of the Problem.……………………………………………………...… 1
Areas for Consideration.………………………………………...….…………….. 1
Alternative Courses of Actions.…………………………………………………... 5
Conclusion and Recommendation.………………………………………………..9
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I. Summary of the Case
Vicky and Mason established Oats "R" Us, an oatmeal snack company, in 1998. Due to
the assistance of local retailers and a sponsorship from a major bread company, the company
reached $ 4 million in 2004. Mason was confident that, given the industry's growth forecast, they
would be able to meet or exceed the 30 percent sales growth target.
With the company’s steadfast growth, Vicky became concerned about the company’s
growth as it continued to operate and decided to plan for the future and discussed it together with
Mason. Soon then, Mason called their treasurer to inquire about how much additional funding
would the company require for their operations for the upcoming year. Both Mason and Vicky
anticipate a growth rate of revenues ranging from 25 to 40 percent.
II. Point of View
Jim Moroney, the treasurer of Oats "R" Us, will be the point of view in this case study.
III. Statement of the Problem
In general, the goal of this case is to provide financial data to Oats "R" Us in addition to
helping the company's future and growth. The following issues are raised by this case in particular:
1. How would the company be able to reach or exceed the industry's 30 percent
growth rate?
2. How much additional funding would the company be needing for the next operating
year to meet the expected growth rate ranging from 25-40%? Will the company
require additional external financing?
IV. Areas for consideration
A. Forecasting model to be utilized in the financial forecast.
As the firm will be conducting a financial forecast for the first time, Jim, as the
treasurer of the firm, has limited experience in various models in financial forecasting,
which might cause him to overlook some necessary information. Jim and the business
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owners should address this factor and be extra careful in selecting distinct approaches,
calculating and predicting their sales, formulating Pro-forma financial statements, and
concluding the External Fund Needed (EFN). Sales are used to measure the company's
performance. In preparing the pro forma financial statement, the company will be able to
know its asset requirement growth by computing the capital intensity ratio. The amount
needed for its growth will be financed by internal funding, and the remaining funds
required can be obtained from external financing. They must consider using the following
approaches:
1. Percentage of Sales Method.
It is commonly utilized in forecasting to anticipate the sales growth of the business
in its annual operation. The information of growth sales will be used to prepare an accurate
output of pro forma and forecasted financial statements, which are also required to
accomplish the goal, which is to generate an accurate forecast.
2. Pro Forma Approach.
Pro Forma Approach is a method of calculating financial results using projections
or presumptions. Firms are utilizing pro forma statements in the process of business
planning and control. By arranging the data for the operating and financial statements side-
by-side, management analyzes the projected results of competing plans to decide which
best serves the interests of the business. It is usually prepared in advance of the planned
transactions, including new capital investment or changes in the capital structure, such as
the incurrence of new debt or the issuance of stock. It summarizes the projected future
standing of the firm based on its recent financial statements.
3. External Fund Needed (EFN) Formula Method
The EFN formula method would allow Jim to project how much financing will be
needed from external sources. Moreover, this method will help him have a prompt process,
in identifying how much funds are required to support the forecasted sales.
B. Oat’s ‘R’ Us Current Financial Condition
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According to the firm’s financial statements, the debt ratio of the company had
been constantly falling from 74.79% in 2002, 67.73% in 2003, and 60.4% in 2004. These
ratios indicate that the company had been steadfastly operating with fewer debts used to
imply that the company’s risk is low and the company is less likely to face bankruptcy. As
the company’s debt ratio indicates a low risk, it is not relatively costly for the company to
borrow additional funds without raising more equity, hence, the company would not have
any problem raising funds from external sources.
Debt Ratio
2002 74.79%
2003 67.73% 2004 60.4%
C. Internal growth of the company
If the company is operating at full capacity, the company’s internal growth is
12.27%; this means that the company can grow at a rate of 12.27% without the need for
any additional external financing and only using its retained earnings.
D. Additional External Financing Needed at Full Capacity and in 90% capacity.
If the company utilizes its assets at full capacity, the right amount of external funds
to be secured, allocated and used to support predicted revenue growth rates ranging from
25% to 40% would be assessed and identified.
If the Fixed assets were operating at full capacity
Growth Rate
Additional Funds needed (Full Capacity)
25%
103,054.00
30%
150,052.80
35%
197,051.60
40%
244,050.40
When operating at full capacity, the amount of external financing required to
support expected growth rates of 25% to 40% would be between 103,054 and 244,
050.40.
If the firm operates at 90% capacity:
Growth Rate
Additional Funds Needed (90% Capacity)
25%
54,929.00
30%
100,002.80
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35%
145,076.60
40%
190,150.40
Capacity Utilization
90%
Current Sales
4,700,000
Fixed Assets
385,000
Fixed Assets / Sales
8.19%
Full Capacity Sales (4,700,000 / 90%)
5,222,222.22
Full Capacity fixed Assets / Sales (385,000 / 5,222,222.22)
7.37%
Current Assets / Sales Ratio
17.49%
E. Economic trends
In managing a business it is rooted not only in its internal operations but as well in
the external environment of the business that is why it is essential for a company to
consider and look after the external factors that can greatly affect the company operations
along the way. It gives an outlook on the current condition of the economy when it comes
to demand and supply, stock prices, employment, market structures, and many more that
can give insights, ideas, draw conclusions from gathered data, and contribute to the
decision-making process in the management of the business.
V. Alternative courses of action
A. Using the Proforma Approach to present its financial projection
This is the Pro Forma Income statement of Oat ‘R’ Us that allows the company to create a hypothetical
projection of their sales, expenses and income in the succeeding year. The projections will help the
company to analyze the current and succeeding operations of the firm. Also, decision-making in financial
planning and control especially about the funds that they can generate to provide for the business and a
potential need of funds from external sources.
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OATS 'R' US
PRO-FORMA INCOME STATEMENT
AT 90% CAPACITY SALES
SALES
COST OF GOOD SOLD
GROSS PROFIT
SELLING AND GENERAL
EXPENSES
FIXED EXPENSES
DEPRECIATION EXPENSE
EARNINGS BEFORE INTEREST
AND TAXES
INTEREST EXPENSE
EARNINGS BEFORE TAXES
TAXES 40%
NET INCOME
RETAINED EARNINGS
2004
25%
30%
2005
35%
40%
$4,700,000
$5,875,000
$6,110,000
$6,345,000
$6,580,00
0
100%
3,877,500
4,846,000
5,040,750
5,234,625
5,428,500
82.50%
822,500
1,028,125
1,069,250
1,110,375
1,151,500
17.50%
275,000
343,688
357,435
371,183
384,930
5.85%
90,000
112,213
116,701
121,190
125,678
1.91%
25,000
31,138
32,383
33,629
34,874
0.53%
432,500
541,086
562,731
584,373
606,018
66,000
82,485
85,784
89,084
92,383
366,500
458,601
476,947
495,289
513,635
146,600
183,440
190,779
198,116
205,454
219,900
275,161
286,168
297,173
308,181
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$131,940
$165,096
$171,701
$178,304
$184,909
60%
OATS 'R' US
PRO-FORMA BALANCE SHEET
AT 90% CAPACITY OF SALES
ASSETS
CASH AND CASH EQUIVALENTS
ACCOUNTS RECEIVABLE
INVENTORIES
TOTAL CURRENT ASSETS
PLANT AND EQUIPMENT
ACCUMULATED DEPRECIATION
NET PLANT AND EQUIPMENT
TOTAL ASSETS
TOTAL LIABILITIES AND OWNERS' EQUITY
ACCOUNTS PAYABLE
NOTES PAYABLE
OTHER CURRENT LIABILITIES
TOTAL CURRENT LIABILITIES
LONG TERM DEBT
TOTAL LIABILITIES
OWNERS' CAPITAL
RETAINED EARNINGS
2004
25%
30%
2005 35%
40%
$60,000
$75,200
$78,208
$81,216
$84,224
1.28%
250,416
313,138
325,663
338,189
350,714
5.33%
511,500
639,200
664,768
690,336
715,904
10.88%
821,916
1,027,538
1,068,639
1,109,741
1,150,842
17.49%
560,000
699,713
727,701
755,690
783,678
11.91%
175,000
218,550
227,292
236,034
244,776
3.72%
385,000
481,163
500,409
519,656
538,902
8.19%
1,206,916
1,508,700
1,569,048
1,629,396
1,689,744
25.68%
135,000
168,613
175,357
182,102
188,846
2.87%
275,000
343,688
357,435
371,183
384,930
5.85%
43,952
55,225
57,434
59,643
61,852
0.94%
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453,952
567,525
590,226
612,927
635,628
9.66%
275,000
343,688
357,435
371,183
384,930
5.85%
728,952
911,213
947,661
984,110
1,020,558
15.51%
155,560
109,987
127,282
144,578
161,873
322,404
487,500
494,105
500,708
507,313
TOTAL LIABILITIES AND OWNER'S EQUITY
$1,206,916
$1,508,700
$1,569,048
$1,629,396
$1,689,744
25.68%
In a pro forma balance sheet, this summarizes all the In 2005 balance sheet assumption, only owner’s
capital and retained earnings do not vary with sales. The 40% dividend pay-out ratio and the 60% of net
income will be added to retained earnings and all potential changes will be added or deductions on
owners’ capital.
B. Using the AFN approach to present its financial projection.
Additional Funds Needed (AFN) approach helps the company's current situation to determine
the amount of funds that will be needed from external sources in order for them to finance the increase
in assets required to support increased levels of sales without putting the current operations under
distress.
Formula:
AFN = [(Assets/Sales) x Sales Increase] [(Accounts Payable/Sales) x Sales Increase] (Profit
Margin x Expected Sales x Retained Ratio)
Growth Rate
Additional Funds Needed
25%
= [($1,206,916/$4,700,000) x $1,175,000] [($135,000/$4,700,000) x $1,175,000] (4.6787% x
$5,875,000 x 60%)
= $ 301,729 - $ 33,750 - $164,924
= $ 103,054
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30%
= [($1,206,916/$4,700,000) x $1,410,000] [($135,000/$4,700,000) x $1,410,000] (4.6787% x
$6,110,000 x 60%)
= $ 362,074.8 - $ 40,500 - $171,521
= $ 150,052.8
35%
= [($1,206,916/$4,700,000) x $1,645,000] [($135,000/$4,700,000) x $1,645,000] (4.6787% x
$6,345,000 x 60%)
= $ 422,420.6 - $ 47,250 - $ 178,118
= $ 197,051.6
40%
[($1,206,916/$4,700,000) x $1,880,000] [($135,000/$4,700,000) x $1,880,000] (4.6787% x
$6,580,000 x 60%)
= $ 482,766.4 - $ 54,000 - $ 184,715
= $ 244,050.4
C. Make use of the Company’s Resources (Internal Funding)
Internal funding can be used up to the percentage that the company can afford.
Internal finance, on the other hand, is good for the firm since it gives them control over the
capital, eliminates legal responsibilities, and allows them to solely keep the interest without
increasing their liabilities. The company can achieve up to a 12.27% growth rate using the
company's resources. Then, if they still require additional finances, they can dip into
external financing to cover the shortfall.
Internal Growth Rate = (ROA x Retention Ratio) / (1-ROA x Retention Ratio)
= (18.22% x 60%) / (1 - 18.22% x 60%)
= 10.93% / 89.07%
= 12.27%
It's important to note that their sales flow should be strong and consistent in order for them
to have extra cash.
D. Obtain external sources of finances
Because the company's debt ratio shows a minimal risk, raising financing from
outside sources should not be an issue. Although a debt ratio of 60% in some companies
may be deemed large, it is generally steady in terms of the company. Furthermore, the
company's interest coverage shows that it can cover its interest charges by around 6.6x,
which is a solid ratio. The company's Return on Assets and Return on Equity are both
healthy. Moreover, the company’s liquidity ratios are not too bad to keep creditors away.
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Financial Ratios
Operating margin
9.20%
Profit Margin
4.68%
Return on Assets
18.22%
Return on Equity
35.84%
Basic Earning Power
46.00%
Current Ratio
1.81
Quick Ratio
0.68
Times-interest-earned ratio
6.6x
Debt Ratio
60%
Inventory Turnover 7.58x
Receivable Turnover 19.45x Fixed Asset
Turnover 12.21x
Total Assets Turnover 3.90x
Inventory Conversion Period 48.15 days
Oats 'R' Us can look into the possibility of obtaining external money to satisfy its
predicted growth rate based on the previous calculations. Rather than depleting their
savings and cash, external funding will supply them with a wide selection of business
finance solutions.
VI. Conclusion and Recommendation
According to the previous calculations, the company's internal growth rate is only 12.27 percent,
implying that the company can only grow at a rate of 12.27 percent without outside funding. However, if
the company expects a revenue growth rate of 25-40%, it will almost certainly require external financing
to achieve the expected growth rates. Based on the preceding calculations, if the company intends to grow
at a rate of 25%, 30%, 35%, and 40%, the additional expenditures required if the fixed assets are running
at full capacity would be 54 929, 100 022.80, 145 076.60, and 190 150.40.
Here are the recommended ways for the company to meet its expected growth rate and what
would determine if whether the business can meet or exceed the industrial growth rate of 30%:
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