Final answer:
The equation in question refers to the Additional Funds Needed (AFN), which is used by businesses to calculate the amount of additional financing needed to support an increase in sales. It takes into account the need for more assets, impacts of liabilities, and the portion of profits retained after dividends.
Step-by-step explanation:
The equation provided is related to the concept of Additional Funds Needed (AFN), which is a financial formula used by companies to estimate the additional financing required to support a higher level of sales. The equation AFN = (A/S) (ΔS) – (L/S) (ΔS) – m (1 – payout ratio) S1 involves several variables: A is the assets required per dollar of sales, S is the sales, L is the liabilities per dollar of sales, ΔS is the change in sales, m represents the net profit margin, and the payout ratio is the proportion of earnings paid out as dividends.
When calculating AFN, the company anticipates the additional assets required to support new sales while accounting for the spontaneous increase in liabilities and the retained earnings that will not be available for reinvestment due to dividend payouts. The main components of the equation represent the new assets required, the liabilities that will finance part of the new assets naturally (spontaneously), and the profit (after dividends) that can further contribute to financing the new assets.