Jones Company sales last year were $25 million and its total assets were $8 million. Accounts payable were $2 million and common stock and retained earnings were $5 million. Jones sales are forecasted to be $30 million this year, earnings after tax are expected to be 3% of sales, and dividends of $250,000 are expected to be paid. Assuming that the ratio of assets to sales and current liabilities to sales remain the same this year as last year, determine the amount of additional financing required.
First, we assume that the reason we need additional financing is that the Jones Company will require additional assets in order to meet the demands of its increasing sales. That requirement can be met in one of three ways: By increasing the company's short-term debt load (i.e., increasing its current liabilities), funding the requirement from its earnings next year, or obtaining additional non-current liability financing. The formula is thus:
This solution illustrates how to compute the additional financing required.