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CS Executive · Corporate Accounting and Financial Management · Forecasting Financial Statements

In the percentage-of-sales method of forecasting, which of the following correctly describes how the External Funds Requirement (EFR) is arrived at?

EFR equals the increase in assets required for projected sales, less the spontaneous rise in liabilities and less the profit retained for the year. Spontaneous liabilities and retained earnings are internal sources, so they reduce the funds to be raised externally.

  1. AIncrease in required assets minus spontaneous increase in liabilities minus retained earnings on projected salesCorrect
  2. BIncrease in required assets plus spontaneous increase in liabilities plus retained earnings
  3. CIncrease in sales minus retained earnings plus increase in net worth
  4. DOpening cash balance plus receipts minus payments

Explanation

EFR is the financing gap: additional assets needed for higher sales, less the liabilities that rise automatically (such as creditors) and less profit retained during the year. Adding liabilities and retained earnings, as in the second option, reverses their financing effect. The last option is a cash budget, not EFR.

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