CASE 5-1

You are the Chief Financial Officer (CFO) for Zen Distributors, Inc., a media broker that secures shelf space in independent bookstores for small publishing companies. As a member of the companys executive team, you are preparing the operating budget for the fourth quarter of 2015. Your intent is to summarize the budget for team members and provide them with detailed schedules that support your overview.

Zens general ledger provides you with current account data on September 30, 2015 (the end of the third quarter) of operations:

Accounts (account amounts in thousands of dollars)

Debit

Credit

Cash

$ 8,000

Accounts receivable

20,000

Inventory

36,000

Buildings and equipment, net of depreciation

120,000

Accounts payable

$ 21,750

Common stock

150,000

Retained earnings

12,250

Totals

$184,000

$184,000

Jack Closer, Vice President of Sales, estimated that sales should increase slightly from their fourth quarter levels of the previous year. Per your request, he forwarded his monthly fourth quarter sales estimates to you, along with the current months actual sales and his forecast for January 2016.

Month

Sales

September (actual)

$ 50,000

October

60,000

November

72,000

December

90,000

January 2016

48,000

You next met with Mary Balance, Zens Controller. Ms. Balance informed you that the company prices its products in order to ensure a 25% gross profit margin on sales. Zen has met that margin throughout the first three quarters of 2006, and she was confident that the firm would meet this target margin in the near term. Mary also told you that, on average, 60% of Zens customer pay in cash. Those customers receive a one percent discount on the invoice price. The remaining 40% of the customers pay on account.

Credit sales terms are n/2EOM. This means credit customers must pay the full invoice price by the end of the month following the month in which they purchased merchandise. Mary explained, Our customers are pretty sophisticated, and they constantly manage their cash flows--just as we do. Consequently, if we make a credit sale in October, they will pay us by the end of November.

Mary also stated that Zen typically writes off 1% of credit customer accounts as uncollectible. She added that despite this policy, no writes offs were currently pending as of September 30 and none were expected to originate from third quarter activity. She stated, In other words, we have a clean slate for the fourth quarter budget. We will collect all of the $20,000 accounts receivable balance at September 30 by the end of October. Therefore, bad debt expense and the allowance for doubtful accounts have zero balances at September 30, and we need to reestablish them for fourth quarter bad debts. We will write off 2015 fourth quarter bad debts sometime during 2016.

Mary also provided you with third quarter monthly expense data to assist in constructing your budget. The next table presents that information:

Monthly Expense Item

Amount

Administration

$2,500

General

6% of sales

Commissions

12% of sales

Depreciation

$850

She concluded that, As you know, we pay our operating expenses in the month we accrue them.

Procurement officer Jim Washburn managed inventory so that its ending balance equaled 80% of the next months cost of goods sold. He also stated that the accounts payable clerk pays one-half of each months inventory cost in the month of acquisition, and the remaining 50% in the following month.

Ashleigh McNamara, head of capital expenditures, informed you that Zen will make a cash purchase of $1,500 worth of hand-held scanning devices in early October. Per corporate policy, the firm will depreciate this equipment over thirty months on a straight-line basis. Ashleigh added, Theyll be useless at the end of that time, so we will scrap them.

In your role as CFO, you insist that Zen maintain an ending monthly cash balance of $4,000 in order to remain financially flexible. The company has an open line of credit with its banking partner to ensure that it can meet its cash balance goal. This agreement mandates a 12% annual interest rate for all short-term borrowings. Financing must take place at the beginning of the month in thousand dollar multiples. Repayments of borrowing must also occur in thousand dollar increments, and the bank only accepts interest payments when Zen repays principal.

Required:

Compose a memorandum to Zens management team that highlights the key aspects of the 2015 fourth quarter operating budget. Supplement your summary with budgetary schedules and attach them to the executive summary. The budgetary flow that you select is as follows:

Cash collections Inventory purchases Cash disbursements for purchases Cash disbursements for operating expenses Overall cash budget (collections, disbursements, and financing)

You construct each of the above budgets on a monthly and quarterly basis. You may find it beneficial to construct your budgetary schedules in the manner presented in this chapter.

Finally, you conclude your budgets with a projected (pro-forma) income statement for the fourth quarter and a pro-forma balance sheet as of December 31. The company has a zero percent income tax rate, due to previous tax losses.