2/1/2012

Chapter 21. Student Ch21 P18 Build a Model

Rusty Spears, CEO of Rustys Renovations, a custom building and repair company, is preparing documentation for a line of credit request from his commercial banker. Among the required documents is a detailed sales forecast for parts of 2013 and 2014.

Estimates obtained from the credit and collection department are as follows: collections within the month of sale, 15%; collections during the month following the sale, 65%; collections the second month following the sale, 20%. Payments for labor and raw materials are typically made during the month following the one in which these costs were incurred. Total costs for labor and raw materials are estimated for each month as shown in the table.

General and administrative salaries will amount to approximately $15,000 a month; lease payments under long-term lease contracts will be $5,000 a month; depreciation charges will be $7,500 a month; miscellaneous expenses will be $2,000 a month; income tax payments of $25,000 will be due in both September and December; and a progress payment of $80,000 on a new office suite must be paid in October. Cash on hand on July 1 will amount to $60,000, and a minimum cash balance of $40,000 will be maintained throughout the cash budget period.

Input Data

Collections during month of sale

15%

Collections during month after sale

65%

Collections during second month after sale

20%

Lease payments

$5,000

Target cash balance

$40,000

General and administrative salaries

$15,000

Depreciation charges

$7,500

Income tax payments (Sep & Dec)

$25,000

Miscellaneous expenses

$2,000

New office suite payment (Oct)

$80,000

Cash on hand July 1

$60,000

Sales, labor, and RM adjustment factor

0%

a. Prepare a monthly cash budget for the last six months of the year.

May

June

July

August

September

October

November

December

January

Original sales estimates

$60,000

$100,000

$130,000

$120,000

$100,000

$80,000

$60,000

$40,000

$30,000

Original labor and raw mat. estimates

$75,000

$90,000

$95,000

$70,000

$60,000

$50,000

$20,000

$20,000

Forecasted Sales

Sales (gross)

Collections

During month of sale

During 1st month after sale

During 2nd month after sale

Total collections

Purchases

Labor and raw materials

Payments for labor and raw materials

Payments

Payments for labor and raw materials

General and administrative salaries

Lease payments

Miscellaneous expenses

Income tax payments

Design studio payment

Total payments

Net Cash Flows

Cash on hand at start of forecast period

Net cash flow (NCF): Total collections Total payments

Cumulative NCF: Prior month cumulative + this month's NCF

Cash Surplus (or Loan Requirement)

Target cash balance

Surplus cash or loan needed: Cum NCF Target cash

Max. Loan

b. How much must Spears borrow each month to maintain the target cash balance?

Answer. Look at the "Surplus cash or loan needed" line at the bottom of the cash budget.

c. Would the cash budget be accurate if inflows came in all during the month but outflows were bunched

early in the month?

d. If the company operates on a seasonal basis, how would this affect the current ratio and the debt ratio?

e. If its customers began to pay late, this would slow down collections and thus increase the required loan amount. Also, if sales dropped off, this would have an effect on the required loan. Do a sensitivity analysis that shows the effects of these two factors on the max loan requirement. Assume the purchases of labor and raw material also vary by the sales adjustment factor.