CASE 6B - CHESTER & WAYNE

Chester & Wayne is a regional food distribution company. Mr. Chester, CEO, has asked your assistance in preparing cash-flow information for the last three months of this year. Selected accounts from an interim balance sheet dated September 30, have the following balances:

Cash

$142,100

Accounts payable

$354,155

Marketable securities

200,000

Other payables

53,200

Accounts receivable

$1,012,500

Inventories

150,388

Mr. Wayne, CFO, provides you with the following information based on experience and management policy. All sales are credit sales and are billed the last day of the month of sale. Customers paying within 10 days of the billing date may take a 2 percent cash discount. Forty percent of the sales is paid within the discount period in the month following billing. An additional 25 percent pays in the same month but does not receive the cash discount. Thirty percent is collected in the second month after billing; the remainder is uncollectible. Additional cash of $24,000 is expected in October from renting unused warehouse space.

Sixty percent of all purchases, selling and administrative expenses, and advertising expenses is paid in the month incurred. The remainder is paid in the following month. Ending inventory is set at 25 percent of the next month's budgeted cost of goods sold. The company's gross profit averages 30 percent of sales for the month. Selling and administrative expenses follow the formula of 5 percent of the current month's sales plus $75,000, which includes depreciation of $5,000. Advertising expenses are budgeted at 3 percent of sales.

Actual and budgeted sales information is as follows:

Actual:

Budgeted:

August

$750,000

October

$826,800

September

787,500

November

868,200

December

911,600

January

930,000

The company will acquire equipment costing $250,000 cash in November. Dividends of $45,000 will be paid in December.

The company would like to maintain a minimum cash balance at the end of each month of

$120,000. Any excess amounts go first to repayment of short-term borrowings and then to

investment in marketable securities. When cash is needed to reach the minimum balance, the

company policy is to sell marketable securities before borrowing.

The company will acquire equipment costing $250,000 cash in November. Dividends of $45,000

will be paid in December.

The company would like to maintain a minimum cash balance at the end of each month of

$120,000. Any excess amounts go first to repayment of short-term borrowings and then to

investment in marketable securities. When cash is needed to reach the minimum balance, the

company policy is to sell marketable securities before borrowing.

Questions (use of spreadsheet software is recommended):

1. repare a cash budget for each month of the fourth quarter and for the quarter in total.

Prepare supporting schedules as needed. (Round all budget schedule amounts to the

nearest dollar.)

2. You meet with Mr. Chester and Mr. Wayne to present your findings and happen to bring

along your PC with the budget model software. They are worried about your findings in

Part 1. They have obviously been arguing over certain assumptions you were given.

a. Mr. Wayne thinks that the gross margin may shrink to 27.5 percent because of

higher purchase prices. He is concerned about what impact this will have on

borrowings. Comment.

b. Mr. Chester thinks that "stock outs" occur too frequently and wants to see the

impact of increasing inventory levels to 30 and 40 percent of next quarter's sales

on their total investment. Comment on these changes.

c. Mr. Wayne wants to discontinue the cash discount for prompt payment. He thinks

that maybe collections of an additional 20 percent of sales will be delayed from

the month of billing to the next month. Mr. Chester says "That's ridiculous! We

should increase the discount to 3 percent. Twenty percent more would be

collected in the current month to get the higher discount." Comment on the cashflow

impacts.

Solutions: October November December FourthQu

1. Cash Budget

Beginning balance $142,100

Receipts:

Receivables collection (See A. below for calculation) 0 0 0 0

Rent income 0

Total receipts 0 0 0 0

Total cash available 0 0 0 142,100

Disbursements:

Accounts payable (See B. below for calculation) 0 0 0 0

Other payables (See C. below for calculation) 0 0 0 0

Equipment purchases 0

Dividends 0

Total disbursements 0 0 0 0

Balance before loans and investments 0 0 0 142,100

Sale (purchase) of investments 0

Loans needed (repaid) 0

Ending balance $0 $0 $0 $142,100

Investments at month end

Loans payable at month end

A. Cash receipts:

From prior month with discount

(98% (net of discount) x 40% x prior month sales)

From prior month without discount

(25% x prior month sales)

From second prior month

(30% x second prior month sales)

Total collections $0 $0 $0

B. Accounts Payable

Beginning account payable balance

Plus Purchases (see below D. to calculate this) 0 0 0

Total Paybles 0 0 0

Minus payments:

Current Month Purchases (60%)

Prior Month Purchases (40%)

Accounts Payable Disbursements $0 $0 $0

Ending balance, Accounts Payable $0 $0 $0

C. Other Payables:

Beginning other payables balance

Plus:

Selling & administrative expenses

Advertising expenses

Total payables 0 0 0

Minus payments:

Current month selling & admin (60%)

Prior month selling & admin (40%)

Current month advertising (60%)

Prior month advertising (40%)

Total Other Payables Disbursements $0 $0 $0

Ending balance, Other Payables $0 $0 $0

D. Purchases budget January

Sales $0

Cost of goods sold (70% x sales) $0 $0 $0 $0

Plus ending inventory (25% of next month's ending cost of goods sold) 0

Total Available 0 0 0 0

Minus beginning inventory 0

Purchases $0 $0 $0 $0

2. a. What If gross margin becomes 27.5% October November December FourthQu

Cash Budget

Beginning balance $142,100

Receipts:

Receivables collection (See A. below for calculation) 0 0 0 0

Rent income 0

Total receipts 0 0 0 0

Total cash available 0 0 0 142,100

Disbursements:

Accounts payable (See B. below for calculation) 0 0 0 0

Other payables (See C. below for calculation) 0 0 0 0

Equipment purchases 0

Dividends 0

Total disbursements 0 0 0 0

Balance before loans and investments 0 0 0 142,100

Sale (purchase) of investments 0

Loans needed (repaid) 0

Ending balance $0 $0 $0 $142,100

Investments at month end

Loans payable at month end

A. Cash receipts:

From prior month with discount

(98% (net of discount) x 40% x prior month sales)

From prior month without discount

(25% x prior month sales)

From second prior month

(30% x second prior month sales)

Total collections $0 $0 $0

B. Accounts Payable

Beginning account payable balance

Plus Purchases (see below D. to calculate this) 0 0 0

Total Paybles 0 0 0

Minus payments:

Current Month Purchases (60%)

Prior Month Purchases (40%)

Accounts Payable Disbursements $0 $0 $0

Ending balance, Accounts Payable $0 $0 $0

C. Other Payables:

Beginning other payables balance

Plus:

Selling & administrative expenses

Advertising expenses

Total payables 0 0 0

Minus payments:

Current month selling & admin (60%)

Prior month selling & admin (40%)

Current month advertising (60%)

Prior month advertising (40%)

Total Other Payables Disbursements $0 $0 $0

Ending balance, Other Payables $0 $0 $0

D. Purchases budget

Sales $0

Cost of goods sold (72.5% x sales) $0 $0 $0 $0

Plus ending inventory (25% of next month's ending cost of goods sold) 0

Total Available 0 0 0 0

Minus beginning inventory 0

Purchases $0 $0 $0 $0

2. b. 1. Assume that Inventory Level is changed to 30% October November December FourthQu

Cash Budget

Beginning balance $142,100

Receipts:

Receivables collection (See A. below for calculation) 0 0 0 0

Rent income 0

Total receipts 0 0 0 0

Total cash available 0 0 0 142,100

Disbursements:

Accounts payable (See B. below for calculation) 0 0 0 0

Other payables (See C. below for calculation) 0 0 0 0

Equipment purchases 0

Dividends 0

Total disbursements 0 0 0 0

Balance before loans and investments 0 0 0 142,100

Sale (purchase) of investments 0

Loans needed (repaid) 0

Ending balance $0 $0 $0 $142,100

Investments at month end

Loans payable at month end

A. Cash receipts:

From prior month with discount

(98% (net of discount) x 40% x prior month sales)

From prior month without discount

(25% x prior month sales)

From second prior month

(30% x second prior month sales)

Total collections $0 $0 $0

B. Accounts Payable

Beginning account payable balance

Plus Purchases (see below D. to calculate this) 0 0 0

Total Paybles 0 0 0

Minus payments:

Current Month Purchases (60%)

Prior Month Purchases (40%)

Accounts Payable Disbursements $0 $0 $0

Ending balance, Accounts Payable $0 $0 $0

C. Other Payables:

Beginning other payables balance

Plus:

Selling & administrative expenses

Advertising expenses

Total payables 0 0 0

Minus payments:

Current month selling & admin (60%)

Prior month selling & admin (40%)

Current month advertising (60%)

Prior month advertising (40%)

Total Other Payables Disbursements $0 $0 $0

Ending balance, Other Payables $0 $0 $0

D. Purchases budget

Sales $0

Cost of goods sold (70% x sales) $0 $0 $0 $0

Plus ending inventory (30% of next month's ending cost of goods sold) 0

Total Available 0 0 0 0

Minus beginning inventory 0

Purchases $0 $0 $0 $0

2. b. 2. Assume that Inventory Level is changed to 40% October November December FourthQu

Cash Budget

Beginning balance $142,100

Receipts:

Receivables collection (See A. below for calculation) 0 0 0 0

Rent income 0

Total receipts 0 0 0 0

Total cash available 0 0 0 142,100

Disbursements:

Accounts payable (See B. below for calculation) 0 0 0 0

Other payables (See C. below for calculation) 0 0 0 0

Equipment purchases 0

Dividends 0

Total disbursements 0 0 0 0

Balance before loans and investments 0 0 0 142,100

Sale (purchase) of investments 0

Loans needed (repaid) 0

Ending balance $0 $0 $0 $142,100

Investments at month end

Loans payable at month end

A. Cash receipts:

From prior month with discount

(98% (net of discount) x 40% x prior month sales)

From prior month without discount

(25% x prior month sales)

From second prior month

(30% x second prior month sales)

Total collections $0 $0 $0

B. Accounts Payable

Beginning account payable balance

Plus Purchases (see below D. to calculate this) 0 0 0

Total Paybles 0 0 0

Minus payments:

Current Month Purchases (60%)

Prior Month Purchases (40%)

Accounts Payable Disbursements $0 $0 $0

Ending balance, Accounts Payable $0 $0 $0

C. Other Payables:

Beginning other payables balance

Plus:

Selling & administrative expenses

Advertising expenses

Total payables 0 0 0

Minus payments:

Current month selling & admin (60%)

Prior month selling & admin (40%)

Current month advertising (60%)

Prior month advertising (40%)

Total Other Payables Disbursements $0 $0 $0

Ending balance, Other Payables $0 $0 $0

D. Purchases budget

Sales $0

Cost of goods sold (70% x sales) $0 $0 $0 $0

Plus ending inventory (40% of next month's ending cost of goods sold) 0

Total Available 0 0 0 0

Minus beginning inventory 0

Purchases $0 $0 $0 $0

2. c. 1. Mr. Wayne's What if NO DISCOUNT October November December FourthQu

Cash Budget

Beginning balance $142,100

Receipts:

Receivables collection (See A. below for calculation) 0 0 0 0

Rent income 0

Total receipts 0 0 0 0

Total cash available 0 0 0 142,100

Disbursements:

Accounts payable (See B. below for calculation) 0 0 0 0

Other payables (See C. below for calculation) 0 0 0 0

Equipment purchases 0

Dividends 0

Total disbursements 0 0 0 0

Balance before loans and investments 0 0 0 142,100

Sale (purchase) of investments 0

Loans needed (repaid) 0

Ending balance $0 $0 $0 $142,100

Investments at month end

Loans payable at month end

A. Accounts Receivalbe, Cash receipts:

From prior month without discount

(45% x prior months sales)

From second prior month

(50% x second prior month sales)

Total collections $0 $0 $0

B. Accounts Payable

Beginning account payable balance

Plus Purchases (see below D. to calculate this) 0 0 0

Total Paybles 0 0 0

Minus payments:

Current Month Purchases (60%)

Prior Month Purchases (40%)

Accounts Payable Disbursements $0 $0 $0

Ending balance, Accounts Payable $0 $0 $0

C. Other Payables

Beginning other payables balance

Plus:

Selling & administrative expenses

Advertising expenses

Total payables 0 0 0

Minus payments:

Current month selling & admin (60%)

Prior month selling & admin (40%)

Current month advertising (60%)

Prior month advertising (40%)

Total Other Payables Disbursements $0 $0 $0

Ending balance, Other Payables $0 $0 $0

D. Purchases budget

Sales $0

Cost of goods sold (70% x sales) $0 $0 $0 $0

Plus ending inventory (25% of next month's ending cost of goods sold) 0

Total Available 0 0 0 0

Minus beginning inventory 0

Purchases $0 $0 $0 $0

a

0 24,000

2,327,055

$1,996,417

414,557

250,000

45,000

$840,011 $2,705,974

200,000

156,819

$919,170

254,925

$624,948 $653,472

168,563

0 24,000

Total receipts $754,575 $767,056 $805,424 $2,327,055

Total cash available $896,675 $887,056 $925,424 $2,469,155

Disbursements:

Accounts payable7 $720,571 $614,390 $631,932 $1,966,893

Other payables3 134,886 138,132 141,539 414,557

Equipment purchases 0 250,000 0 250,000

Dividends 0 0 45,000 45,000

Total disbursements $855,457 $1,002,522 $818,471 $2,676,450

Balance before loans and investments $41,218 ($115,466) $106,953 ($207,295)

Sale (purchase) of investments 78,782 121,218 0 200,000

Loans needed (repaid) 0 114,248 13,047 $127,295

Ending balance $120,000 $120,000 $120,000 $120,000

Balance of investments at month end $121,218 $0 $0 $0

Balance of loans at month end $0 $114,248 $127,295 $127,295

7 Payments on accounts payable: October November December

Beginning balance $354,155 $244,278 $246,742

Plus purchases8 610,694 616,854 641,984

Total payables $964,849 $861,132 $888,726

Minus payments:

For current month purchases (60%) $366,416 $370,112 $385,190

For prior month purchases (40%) 354,155a 244,278 246,742

Total payments $720,571 $614,390 $631,932

Ending balance $244,278 $246,742 $256,794

8 Purchases budget: October November December January

Sales $826,800 $868,200 $911,600 $930,000

Cost of goods sold (70% x sales) $578,760 $607,740 $638,120 $651,000

Plus ending inventory (30% of next

month's cost of goods sold) 182,322 191,436 195,300

Total available $761,082 $799,176 $833,420

Minus beginning inventory 150,388 182,322 191,436

Purchases $610,694 $616,854 $641,984

The increase in inventory levels will require increased purchase costs and disbursements.The net effect will be an increase in the total loan balance in December of $32,292 ($127,365 - $95,073).

Second, assume that inventory level is changed to 40 percent:

Cash budget: October November December Fourth Q

Beginning balance $142,100 $120,000 $120,000 $142,100

Receipts:Receivables collection1 $730,575 $767,056 $805,424 $2,303,055

Rent income 24,000 0 0 24,000

Total receipts $754,575 $767,056 $805,424 $2,327,055

Total cash available $896,675 $887,056 $925,424 $2,469,155

Disbursements:

Accounts payable9 $757,036 $640,522 $633,920$ 2,031,478

Other payables3 134,886 138,132 141,539 414,557

Equipment purchases 0 250,000 0 250,000

Dividends 0 0 45,000 45,000

Total disbursements $891,922 $1,028,724 $820,459 $2,741,105

Balance before loans and investments $4,753 ($141,668) $104,965 ($271,950)

Sale (purchase) of investments 115,247 84,753 0 200,000

Loans needed (repaid) 0 176,915 15,035 191,950

Ending balance $120,000 $120,000 $120,000 $120,000

Balance of investments at month end $84,753 $0 $0 $0

Balance of loans at month end $0 $76,915 $191,950 $191,950

9 Payment on accounts payable: October November December

Beginning accounts payable balance $354,155 $268,587 $247,957

Plus purchases10 671,468 619,892 643,272

Total payables $1,025,623 $888,479 $891,229

Minus payments:

For current month purchases (60%) $402,881 $371,935 $385,963

For prior month purchases (40%) 354,155a 268,587 247,957

Total payments $757,036 $640,522 $633,920

Ending balance $268,587 $247,957 $257,309

10 Purchases budget: October November December January

Sales $826,800 $868,200 $911,600 $930,000

Cost of goods sold (70% x sales) $578,760 $607,740 $638,120 $651,000

Plus ending inventory (40% of

next month's cost of goods sold) 243,096 255,248 260,400

Total available $821,856 $862,988 $898,520

Minus beginning inventory 150,388 243,096 255,248

Purchases $671,468 $619,892 $643,272

The increase in inventory levels to 40 percent will require increased purchase costs and disbursements.The net effect will be an increase in the total loan balance in December of $96,877 ($191,950 - $95,073).

(2) c.First, Mr. Wayne's "what if":

Cash budget: October November December Fourth Q

Beginning balance $142,100 $120,000 $120,000 $142,100

Receipts:Receivables collection11 729,375 765,810 804,090 2,299,275

Rent income 24,000 0 0 24,000

Total receipts $753,375 $765,810 $804,090 $2,323,275

Total cash available $895,475 $885,810 $924,090 $2,465,375

Disbursements:

Purchases $702,339 $601,324 $630,938 $1,934,601

Other payables3 134,886 138,132 141,539 414,557

Equipment purchases 0 250,000 0 250,000

Dividends 0 0 45,000 45,000

Total disbursements $837,225 $989,456 $817,477 $2,644,158

Balance before loans and investments $58,250 ($103,646) $106,613 ($178,783)

Sale (purchase) of investments 61,750 138,250 0 200,000

Loans needed (repaid) 0 85,396 13,387 98,783

Ending balance $120,000 $120,000 $120,000 $120,000

Balance of investments at month end $138,250 $0 $0 $0

Balance of loans at month end $0 $85,396 $98,783 $98,783

11 Budgeted collections of accounts rec: October November December

Beginning accounts receivable balance $807,750 $905,175 $1,007,565

Plus sales 826,800 868,200 911,600

Total receivables $1,634,550 $1,773,375 $1,919,165

Minus cash receipts:

From prior month without discount

(45% x prior month sales) $354,375 $372,060 $390,690

From second prior month

(50% x second prior month sales) 375,000b 393,750 413,400

Total collections $729,375 $765,810 $804,090

Ending balance $905,175 $1,007,565 $1,115,075

b Note that if the balance sheet given in the problem is real life, the accounts receivables from August will only be $225,000 because of existing credit policies and current account balances.If this is the case, the sudden change in October would cause receipts to drop and loans to increase by $150,000

Mr. Wayne's idea would result in a $3,780 increase in loans required.Therefore, the reduction in discount expense due to eliminating the discount does not compensate for the slow down it will have on customer collections.However, in Part (1), we saw that discounts for the fourth quarter totaled $19,856.This will pay the interest on a large amount of money.The savings on discounts significantly outweigh the extra interest costs.This assumes that Mr. Wayne is correct in his analysis of the change in cash flows.This analysis assumes that the fourth quarter is part of a financial plan for the entire year.

Mr. Chester's "what if":

Cash budget: October November December Fourth Q

Beginning balance $142,100 $120,000 $120,000 $142,100

Receipts:Receivables collection12 $730,200 $766,648 $805,022 $2,301,870

Rent income 24,000 0 0 24,000

Total receipts $754,200 $766,648 $805,022 $2,325,870

Total cash available $896,300 $886,648 $925,022 $2,467,970

Disbursements:

Purchases $702,339 $601,324 $630,938 $1,934,601

Other payables3 134,886 138,132 141,539 414,557

Equipment purchases 0 250,000 0 250,000

Dividends 0 0 45,000 45,000

Total disbursements $837,225 $989,456 $817,477 $2,644,158

Balance before loans and investments $59,075 ($102,808) $107,545 ($176,188)

Sale (purchase) of investments 60,925 139,075 0 200,000

Loans needed (repaid) 0 83,733 12,455 96,188

Ending balance $120,000 $120,000 $120,000 $120,000

Balance of investments at month end $139,075 $0 $0 $0

Balance of loans at month end $0 $83,733 $96,188 $96,188

12 Budgeted collections of accounts rec: October November December

Beginning accounts receivable balance $807,750 $904,350 $1,005,902

Plus sales 826,800 868,200 911,600

Total receivables $1,634,550 $1,772,550 $1,917,502

Minus cash receipts:

From prior month with discount

(97% x 60% x prior month sales) $458,325 $481,198 $505,292

From prior month without discount

(25% x prior month sales) 196,875 206,700 217,050

From second prior month

(10% x second prior month sales) 75,000 78,750 82,680

Total collections $730,200 $766,648 $805,022

Ending balance $904,350 $1,005,902 $1,112,480

Total discounts (3% x sales x 60%) $14,175 $14,882 $15,628

Mr. Chester's idea would not have a positive benefit.The total loans required by December would be $1,185 higher ($96,258 - $95,073).Therefore, the loss of revenue due to the greater discount is bigger than any increase in customer collections.In fact, $44,685 in discounts were given in the fourth quarter.This caused more cash to be collected but not enough to cover the cash lost to discounts.This is a much more costly proposal than Mr. Wayne's suggestion.

2. c. 2. Mr. Chester's What if 3% DISCOUNT October November December FourthQu

1. Cash Budget

Beginning balance $142,100

Receipts:

Receivables collection (See A. below for calculation) 0 0 0 0

Rent income 0

Total receipts 0 0 0 0

Total cash available 0 0 0 142,100

Disbursements:

Accounts payable (See B. below for calculation) 0 0 0 0

Other payables (See C. below for calculation) 0 0 0 0

Equipment purchases 0

Dividends 0

Total disbursements 0 0 0 0

Balance before loans and investments 0 0 0 142,100

Sale (purchase) of investments 0

Loans needed (repaid) 0

Ending balance $0 $0 $0 $142,100

Investments at month end

Loans payable at month end

A. Cash receipts:

From prior month with discount

(97% (net of discount) x 40% x prior month sales)

From prior month without discount

(25% x prior month sales)

From second prior month

(10% x second prior month sales)

Total collections $0 $0 $0

B. Accounts Payable

Beginning account payable balance

Plus Purchases (see below D. to calculate this) 0 0 0

Total Paybles 0 0 0

Minus payments:

Current Month Purchases (60%)

Prior Month Purchases (40%)

Accounts Payable Disbursements $0 $0 $0

Ending balance, Accounts Payable $0 $0 $0

C. Other Payables:

Beginning other payables balance

Plus:

Selling & administrative expenses

Advertising expenses

Total payables 0 0 0

Minus payments:

Current month selling & admin (60%)

Prior month selling & admin (40%)

Current month advertising (60%)

Prior month advertising (40%)

Total Other Payables Disbursements $0 $0 $0

Ending balance, Other Payables $0 $0 $0

D. 2

Sales $0

Cost of goods sold (70% x sales) $0 $0 $0 $0

Plus ending inventory (25% of next month's ending cost of goods sold) 0

Total Available 0 0 0 0

Minus beginning inventory 0

Purchases $0 $0 $0 $0