In order to better serve their rural patients, Drs. Hao and Jun Zhang (brothers) began giving safety seminars. Especially popular were their “emergency-preparedness” talks given to farmers. Many people asked whether the “kit” of materials the doctors recommended for common farm emergencies was commercially available.

After checking with several suppliers, the doctors realized that no other company offered the supplies they recommended in their seminars, packaged in the way they described. Their wives, Tian and
Qing, agreed to make a test package by ordering supplies from various medical supply companies and assembling them into a “kit” that could be sold at the seminars. When these kits proved a runaway success, the sisters-in-law decided to market them. At the advice of their accountant, they organized this venture as a separate company, called Life Protection Products (LPP), with Tian Zhang as CEO and Qing Zhang as Secretary-Treasurer.

LPP soon started receiving requests for the kits from all over the country, as word spread about their availability. Even without advertising, LPP was able to sell its full inventory every month. However, the company was becoming financially strained. Tian and Qing had about HK$1,000,000 in savings, and they invested about half that amount initially. They believed that this venture would allow them to make money. However, at the present time, only about HK$300,000 of the cash remains, and the company is constantly short of cash.

Tian has come to you for advice. She does not understand why the company is having cash flow problems. She and Qing have not even been withdrawing salaries. However, they have rented a local building and have hired two more full-time workers to help them cope with the increasing demand. They do not think they could handle the demand without this additional help.

Tian is also worried that the cash problems mean that the company may not be able to support itself. She has prepared the cash budget that follows. All seminar customers pay for their products in full at the time of purchase. In addition, several large companies have ordered the kits for use by employees who work in remote sites. They have requested credit terms and have been allowed to pay in the month following the sale. These large purchasers amount to about 25% of the sales at the present time. LPP purchases the materials for the kits about 2 months ahead of time. Tian and Qing are considering slowing the growth of the company by simply purchasing less materials, which will mean selling fewer kits.

The workers are paid weekly. Tian and Qing need about HK$150,000 cash on hand at the beginning of the month to pay for purchases of raw materials. Right now they have been using cash from their savings, but as noted, only HK$300,000 is left.

Instructions

Write a response to Tian Zhang. Explain why LPP is short of cash. Will this company be able to support itself? Explain your answer. Make any recommendations you deem appropriate.

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Life Protection Products Cash Budget For the Quarter Ending June 30, 2020 April May June Cash balance, beginning HK$150,000 HK$150,000 HK$150,000 Cash received From prior month sales From current sales 50,000 150,000 75,000 225,000 125,000 375,000 350,000 Total available cash 450,000 650,000 Cash payments To employees For products Miscellaneous expenses Postage 30,000 30,000 350,000 60,000 30,000 250,000 50,000 10,000 450,000 70,000 10,000 10,000 Total cash payments 340,000 450,000 560,000 HK$ 10,000 HK$ HK$ 90,000 Cash balance Borrow from savings HK$ 10,000 HK$140,000 HK$150,000 HK$ Borrow from bank? HK$ HK$ 50,000