Conceptualize the percentage of sales method of forecasting with examples.Financial forecasting is a process by which the firm is able to predict its future assets and liabilities through different methods which helps in identifying asset requirements and the corresponding need for external financing. There are several ways of financial forecasting; amongst which percentage of sales method is one of them.Percentage of sales method is the process of forecasting the financial statements namely, income statement and the balance sheet using sales as a reference point. By forecasting sales in near future, the various accounts under balance sheet and income statement are assumed to increase (or decrease) in proportionate to the sales thereby, enabling us to determine required additional financing to meet the forecasted sales if necessary.In this way, percentage of sales method helps us determine the requirement of additional financing.However, a few assumptions are made while forecasting the financial statements. They are: The firm is operating at full capacity, so all the assets grow in proportionate to sales. Payables and accruals also grow in proportionate to sales. Financial accounts like notes payable, bonds, stock, etc do not grow. Dividend payout ratio and net profit margin are constant.For eg. Consider the following balance sheet and income statement of ABC Co. for the year 2010.Balance Sheet (Amount in Million)Income Statement (Amount in Million)

AssetsAmount%Liabilities and EquityAmount%ParticularsAmount%

Current AssetsCurrent LiabilitiesSales1200

Cash20016.67Accounts Payable40033.33Cost of Goods Sold90075

Accounts Receivables40033.33Notes Payable400NATaxable Income30025

Inventory60050.00Taxes9030

Total CA1200Total CL800Net Income21017.5

Fixed Assets80066.67Long Term Liabilities500NADividends7033.33

Owners EquityAddition to Retained Earnings14066.67

Common stock300NA

Retained Earnings400

Total Equity700

Total2000Total2000

Here the ratios of various accounts to under balance sheet are calculated in relation to sales. Sales are predicted to increase by 25% in the year 2011. Thus, the predicted balance sheet and income statement are:

Balance Sheet (Amount in Rs. Millions)Income Statement (Amount in Rs. Millions)

Assets20102011Liabilities and Equity20102011Particulars20102011

Current AssetsCurrent LiabilitiesSales12001500

Cash200250Accounts Payable400500Cost of Goods Sold9001125

Accounts Receivables400500Notes Payable400400Taxable Income300375

Inventory600750Taxes90112.5

Total CA12001500Total CL800900Net Income210262.5

Fixed Assets8001000Long Term Liabilities500500Dividends7087.5

Owners EquityAddition to Retained Earnings140175

Common stock300300

Retained Earnings400575

Total Equity700875

Total20002500Total20002275*

*Here the balance of 2011 in the assets side and liabilities side arent equal which shows the need for external financing. The additional financing required is hence calculated as follows:AFN = Rs. 2500 Rs. 2275 million = Rs. 225 million

If excess capacity exists, how will that affect the AFN?Excess capacity refers to the capacity in a firm to increase output without having to invest further in its assets thereby reducing the average cost of production to a minimum. When excess capacity exists, sales in a firm can grow upto a certain level with no increase in the fixed assets of the firm. Sales beyond that level only would require additional financing. Hence, in comparison to the firm with no excess capacity, the additional fund needed (AFN) for a firm with excess capacity is lower; given the sales are at the same level in both the firms.What is the implication of regression analysis and percentage of sales method in corporate world?