 We have seen in the previous simple example of financial planning that every element of balance sheet and income statement moved in relations with the sales. But that is not the actual case. We know that there are certain items that are subject to the managerial decisions. Like debt level, dividend cash payout, equity level, short term and long term debt proportion. These are the decisions that have to be taken by the management apart from the sales. Let's take another example. In this example, we have divided the items of income statement and balance sheet into two parts. There is a group that will move with the sales and there is a group that will not move with the sales. The purpose of this classification is to determine the value and amount of external financing needed in order to support the growth in increased sales. There are certain assumptions we will be using in our percentage to sales approach. Like sales would be increased by 25%. Total asset would continue in relation of the sales at 80%. Let's see the current income statement. Sales $1,000 cost $800 and taxable income $200. 34% tax rate and net income after taxes $132. This $132 is 2% of the sales. Dividend payout is ⅓ of this profit after tax and remaining ⅔ has been retained as retained earnings. We have projected income statement and in this projected income statement net income is $165. This is again equal to 13.2% of the net sales. The ⅓ of this net income after tax has been paid as cash dividend which is $55 and the $110 which is ⅓ of the net income after tax has been retained and transferred to retained earnings. On the screen, you can see that in the asset side there has been developed a relation of every item with the sales. For example, cash is equal to 16% of the sales. Accounts are equal to 44% of the receivable sales. Similarly, fixed assets are equal to 180% of the sales. In this way, if we see the total assets, this comes to 300% of the total sales. This 300% is also called as capital intensity ratio. By capital intensity ratio, we mean the amount invested in total assets in order to generate ₹1 sales. For example, capital intensity ratio tells us that to generate ₹1 sales, we will have to keep as many assets as possible. This 300% ratio tells us that to generate ₹1 sales, you need to have 3 assets. On the liabilities side, we see that only accounts are payable which can be developed with sales and it is 30%. We also call accounts payable as spontaneous liabilities in other words. Spontaneous liability is a liability that is generated during business operations. Other liabilities like notes payable, long term debt, common stock and retained earnings. These are the four liabilities that have no relation with the sales. In fact, these are the items that the level of those would be set by the management. Now, we see that with the increment of 25% in the sales, total assets would be required by $750. So $750 would be required in the liability side to make both sides equal. Now, we see that we have increased accounts payable by 25%. But we cannot increase the notes payable, long term debt, honors equity and retained earnings by 25%. Within retained earnings, if we add the retained profit of ₹110, then our retained earnings balance increases and reaches $110. As a result, the total liabilities of our side can be increased by ₹105 with $185. This means that we need a further amount of $565 in order to make both sides of this balance sheet equal. Now, question arises how to get this $565? The management has two options, either to increase debt or to raise equity. Dear students, instead of preparing the performer balance sheet and income statement, there is a simple model which can be used in order to determine the external financing needed. Now, external financing needed in the previous example was $565 that the firm needs in order to make the balance sheet sides equal. In this formula, we see three parts of this formula. Projected increase in sales, spontaneous increase in liabilities and projected retention. Using this formula, we can calculate the value of external financing needed. The $565 we calculated using the performer balance sheet and income statement. Now, the question again arises that how can we complete $565? We have two options. Number one, whether to raise debt and number two, whether to raise equity. Now, raising equity can be very expensive for the firm. One reason. The second reason is that existing shareholders would neither be in the right to raise new equity nor would they want to contribute for equity as their earnings can dilute as a result of this. Which option of these two options would be better for management? There are certain scenarios. We use a scenario in which the debt can be used as a plug. We see that in the previous example, we have the difference of current assets and current liabilities which is called the networking capital, which was $800. If we want to retain the net working capital of $800 after the projection, then we will have to invest in some amount of current assets in this scenario and some amount of long-term debt. This means that we can increase the maximum of $225 in the notes table and we will get the remaining $340 long-term debt which will not change our equity and our total debt will increase from $565. And this increase would equalize the liabilities side of the asset side. Dear friends, note that there is no particular strategy that may be fit for every concern. There are other scenarios like current ratio, total debt ratio and other certain variables that the management should consider in order to be comfortable with the debt level.