External financing is another source of capital for your business obtained from outside firms. Determining how much external financing a company needs will depend on the operating budget for your business and the current capital resources. Calculating the amount for the required external financing is one of the biggest hurdles a corporate manager faces and it will be much easier if the company develops a stable operating budget.
- Forecasting sales. In computing for the projected sales of your company for next year, you need to get the annual growth sales for the five most recent years. Let us say that your annual growth rate is at 15% for the last five years with the current sale for the year is at $1000. By $100 x (1 + 10%) = $110 will be the forecast sale for the following year.
- Cost of goods sold and operating expense. You would now need to compute for the cost of products sold and the operating expenses by utilizing the percentage sales method. Let us say that the cost of products sold as percentage sale averaged at 25% for the last five years, allocating the cost of products sold will be equivalent to $110 x 25% = $27.5 for the following year. For the operating expenses using the percentage sale averaged 20% for the last five years, allocation for the operating expenses will be equivalent to $110 x 20%= $22 for the following year.
- Pre-Tax income. To determine the pre-tax income, you need to subtract the cost of products sold and the operating cost from the sales. Using the figures above, the pre-tax income will be $110 - $27.5 - $22 = $ 30.5 for the following year.
- Net income. To compute for the net income, you need to compute for the taxes for next year and subtract the taxes from the pre-tax income. Let us say that the tax figures averaged at 30% for the last five years, your net income will be equivalent to $ 30.5 - (35% x $30.5) = $19.84 for the following year.
- Forecast next year's current asset. Using the sales percentage method, you need to project the next year's current asset. Let's peg the current assets at an average of 20%, you can allocate the present assets at 20% x 110 = $22 for the following year.
- Forecast next year's present liabilities. Utilizing the percentage of rate of products sold, you can project the next year's current liabilities. Let us say that the current liabilities at the percentage of rate of products sold had an average of 40% for the last five years, allocate the present liabilities to 40% x $27.5 = 11 for next year.
- Working capital. The working capital would be the daily operational expense. To compute for the working capital needs of your company, you need to subtract the current liabilities from the current assets. Using the same figures above, the working capital requirements would be $22 - $11 - $11.
- Capital Expenditure. Utilizing percentage sales method, with your capital expenditure of sales pegged an average of 30%, you can allocate the capital expenditure requirements at $110 x 30% = $33 for the following year.
- External financing needs. To get the figures, you need to subtract the forecast working capital requirements with the capital expenditures to the net income. The computation using the same example would be $19.84 - $11 - $33 = (24.16), this will translate to $24.16 of external financing requirements since the numbers posted a negative figure. If you posted a positive figure then there is no need for an external financing.
Pursuing the external financing capital option has its advantage and disadvantage. It is important that you consider how much ownership you are willing to give up and actually feel comfortable with the decision.
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