13 Financial planning. Pulfer Ltd is a small company that has been operating for five years. It now employs 40 people, and turnover during the last financial year was

£875,000. The board of directors has been asked by the company’s bank to provide company’s financial objectives.
The board has decided that the primary financial objectives should be to achieve a return on capital employed (defined as earnings before interest and tax related to shareholders’ equity) of 20 per cent per year for each of the first two years, rising to 25 per cent per year in year three, and also to increase dividends per share by 10 per cent per year. The current dividend per share is 2.5 pence.
Statistical analysis by one of the company’s managers has produced the following relationships for the last two financial years:
Cost of goods sold 75% of sales Other expenses (excluding interest) £5,000+18% of sales Cash (at year end) minimum 1% of sales Debtors (at year end) £10,000+20% of sales Stock (at year end) £12,000+25% of sales Creditors (at year end) 35% of sales Net fixed assets are currently £410,000, and cash £9,000. Sales, at current prices, are expected to increase by 15 per cent per year for two years and by either 15 per cent or 25 per cent in year three depending upon how quickly the economy recovers from a recession.
Existing machinery can only satisfy a demand of up to £1.1 million per year (current prices), and the purchase of new machinery at a cost of £200,000 (current prices)
would be necessary to satisfy higher levels of demand.
The company’s current capital structure is:
£000 Ordinary shares (50 pence par value) 200 Reserves 149 12% bank loan 180 529 No overdraft finance is currently used, but a £50,000 facility exists for short-term financing. The current overdraft interest rate is 10 per cent per year, and interest on any new longer-term debt would be 11 per cent per year.
Other information:
(i) Corporation tax is at the rate of 25 per cent.
(ii) If external finance is required, debt will be used wherever possible as the existing shareholders, who are mainly directors, do not have the funds to subscribe to further equity capital. Any new equity that was necessary would be sought from venture capital organisations, (iii) Restrictive covenants on the existing bank loan limit the current ratio to a minimum of 1.3 to 1, and gearing (total loans to shareholders’ equity) to a maximum of 80 per cent, (iv) Cash is kept in a non-interest-bearing current account.
Required:
As a consultant to Pulfer you have been asked to use the above information to produce pro forma profit and loss accounts and a schedule of funding requirements for the next three years. This should be incorporated into a report for the board of directors which also

(a) highlights your major findings, and

(b) discusses any concerns that you have about (i) the financial relationships used by the company as the basis for its forecasts, and (ii) the company’s financial objectives.
Inflation may be ignored in your forecasts. Depreciation/capital allowances may be assumed to equal the cash flows required for the replacement of existing fixed assets.
Interest may be assumed to be paid or received at the year end. State clearly any other assumptions that you make.