Cash is King: Master Budgets to Inform a Credit Decision Early one morning in March, Jordan Buford was preparing his daily work when his boss, Olivia Anton, approached him and announced, Little Annin Flagmakers (LAF) has submitted an application for a line of credit (LOC) for April through June. I want you to prepare budgeted financial statements similar to the ones you prepared for our last LOC applicant. I need this by 3 PM today for the 4 PM credit committee meeting. Be prepared to make a loan recommendation and to address questions from the credit committee. I have cleared your schedule. Let me know if you need anything. Kent Bank is a state bank with multiple branches that offers a variety of services for personal and commercial needs. The bank has been serving the local community for over 110 years and prides itself on its personalized approach to provide financial services, local management, long-term stability and a full range of deposit and lending products and services. Commercial credit decisions at Kent Bank are made by the Commercial Credit Committee, which consists of the senior commercial credit analyst and two vice presidents. Jordan was recently hired by Kent Bank as a commercial credit analyst, to provide analysis for commercial loan applications. During his undergraduate studies, he studied accounting and finance and shortly after graduation passed the CMA exam. Jordan reports directly to Olivia Anton, the senior commercial credit analyst who has been with Kent Bank for ten years. As Jordan began the work, he recalled his last line of credit (LOC) analysis and how well received it was. He had taken the information provided by the company and developed master budgets in Excel that used an input section with numbers that could be changed for assessing different scenarios. The committee had specifically asked about the effect on the applicants cash needs would be if sales were reduced by 2%, 5%, and 10%. He wanted to be prepared for these types of questions. LITTLE ANNIN FLAGMAKERS BACKGROUND Little Annin Flagmakers (LAF) manufactures one product, a large durable 8 x 12 American flag, which it sells for US$120. Because of the large size of the flag, this product is not sold in stores; rather, it is sold through a relatively small number of on-line retailers. Each quarter, retailers estimate sales for the upcoming five months, revising proximate sales as necessary. In general, the retailers are reasonably good at estimating their sales needs; however, some variation in demand does occur and the retailers expect to be able to adjust orders as needed. LAF allows retailers to adjust each months purchases to 80-120 percent of the estimated sales levels. Flags are shipped to retail customers using JIT distribution so that the on-line retailers do not have to store inventory. Typical sales for the flag are 1,800 units per month with seasonal increases April through August. Sales estimates are April 2,500 units, May 6,000 units, June 3,000 units, July 2,500 units, and August 2,000 units. Customers historically have paid 40 percent of their purchases in the month of the sale, 55 percent in the following month, and the remaining five percent is uncollectible. MANUFACTURING AND SG&A COSTS The flags are made in one plant which has a capacity of 6,200 units per month. LAF budgets to have 20 percent of next months sales in finished goods inventory at the end of each month. There is plenty of storage space for finished goods. Fabric is the only direct material and each flag requires five pounds of fabric at US$7 per pound. LAF plans to have 40 percent of next months fabric needs on hand at the end of the month. Fabric is purchased on credit with 40 percent paid in the month of purchase and 60 percent the next month. The standard direct labor hours to manufacture one flag is 0.50 hours at US$40 per hour. For simplicity, direct labor costs are budgeted as if they were paid when incurred. Manufacturing overhead rates are computed quarterly and applied based on direct labor hours. Fixed manufacturing overhead costs are estimated to be US$57,950 per month, of which US$20,000 is PPE depreciation. Variable manufacturing overhead, including indirect materials, indirect labor, and other costs, is estimated at US$10 per direct labor hour. The selling and administrative expenses include variable selling costs (primarily shipping) of US$1.25 per unit, and fixed costs of US$63,000 per month of which US$10,000 is deprecation of the administrative office building and equipment. FINANCIAL STATEMENT DETAILS AND CASH PLANNING Little Annin Flagmakers uses FIFO inventory valuation. As of March 31, the expected finished goods inventory is 410 units, valued at US$75 per unit. The company expects to have 4,600 pounds of fabric on hand, valued at US$7 per pound. Other expected account balances include: accounts payable at US$55,000, accounts receivable at 132,000, cash at US$37,745, land at US$520,000, and building and equipment at US$1,800,000 with accumulated depreciation of US$750,000. LAF has no long-term debt; common stock is valued at US$500,000 and is not expected to change during the quarter; expected retained earnings as of March 31 are US$1,247,695. Little Annin Flagmakers budgets for US$30,000 ending cash balance each month and is requesting a line of credit that will allow it to adjust for its cash needs. The dividends of US$15,000 are paid each month. During the quarter, LAF planned to purchase equipment in May and June for US$47,820 and US$154,600 respectively. This equipment is being purchased to increase capacity and is not expected to come on-line until after the quarter, thus not affecting the manufacturing overhead costs. LOAN DETAILS Little Annin Flagmakers has requested a line of credit of US$60,000 to cover production costs during the seasonal increase in business. Kent Bank uses the following terms on its lines of credit. All borrowing is done at the beginning of the month, in whole dollar increments. All repayments are made at the end of the month, in whole dollar increments. The full line of credit is expected to be paid off by the end of the quarter with all of the interest repaid at the end of the quarter. The interest rate on this loan is 16 percent per year. CASE REQUIREMENTS Part I (2.5 Points): Watch the following video https://www.youtube.com/watch?v=GPC1ZMOeAr8 then complete the cost classification sheet and answer the questions below: Part II (10 Points): Using the data input provided in Exhibit 1 and the attached Excel sheet template, prepare LAFs master budgets in Excel. Do not hard-code numbers into the spreadsheet, except in the financing section of the cash budget. Part III (2.5 Points): Prepare a one-page business report that includes a synopsis of the case and your credit decision for LAF. Include in your report your justification for the credit decision (hint: the importance of the cash budget when determining a credit decision and the financial position and performance from Pro forma financial statements). Yellow-use only cell references Little Annin Flagmakers Blue-may type numbers here Sales Budget (USD) April May June Quarter Budgeted Sales (units): 2,500 6,000 3,000 11,500 Selling Price per unit: $120 $120 $120 $360 Total Sales: $300,000 $720,000 $360,000 $1,380,000 Little Annin Flagmakers Schedule of Expected Cash Collections (USD) April May June Quarter Accounts Receivable Beginning Balance $132,000 $132,000 April Sales $120,000 $165,000 $285,000 May Sales $288,000 $396,000 $684,000 June Sales $144,000 $144,000 Total Cash Collections: $252,000 $453,000 $540,000 $1,245,000 Accounts Receivable, June 30: $198,000 Little Annin Flagmakers Production Budget April May June Quarter July Budgeted Sales 2,500 6,000 3,000 11,500 2,500 Add: Desired ending inventory 500 1,200 600 2,300 500 Total Needs 3,000 7,200 3,600 13,800 3,000 Less: Beginning inventory -410 -500 -1,200 -2,110 0 Required Production 2,590 6,700 2,400 11,690 3,000 Little Annin Flagmakers Direct Materials Budget (USD) April May June Quarter Required Production in units 2,590 6,700 2,400 11,690 Raw Materials per unit (lbs.) 5 5 5 15 Production Needs (lbs) 12,950 33,500 12,000 58,450 Add: Desired ending inventory 5,180 13,400 4,800 23,380 Total Needs 18,130 46,900 16,800 81,830 Less: Beginning inventory -4,600 -5,180 -13,400 -23,180 Raw Materials to be purchased 13,530 41,720 3,400 58,650 Cost of Raw Materials: $7.00 $7.00 $7.00 $7.00 Total Cost of Raw Materials $94,710 $292,040 $23,800 $410,550 Little Annin Flagmakers Schedule of Expected Cash Disbursements for Material (USD) April May June Quarter Accounts Payable Beginning Balance $55,000 $55,000 April Purchases $37,884 $56,826 $94,710 May Purchases $116,816 $175,224 $292,040 June Purchases $9,520 $9,520 Total Cash Disbursements $92,884 $173,642 $184,744 $451,270 For Materials Accounts Payable, June 30: $14,280 Little Annin Flagmakers Direct Labor Budget (USD) April May June Quarter Units to be produced 2,590 6,700 2,400 11,690 DL hours per unit 0.5 0.5 0.5 0.5 Total DL hours needed 1,295 3,350 1,200 5,845 DL cost per hour $40.00 $40.00 $40.00 $40.00 Total direct labor cost $51,800 $134,000 $48,000 $233,800 Little Annin Flagmakers Manufacturing Overhead Budget (USD) April May June Quarter Budgeted DL hours 1,295 3,350 1,200 5,845 Variable MOHD rate $10 $10 $10 $10 Total Variable MOHD $12,950 $33,500 $12,000 $58,450 Fixed MOHD Expense $57,950 $57,950 $57,950 $57,950 Total MOHD Expense $70,900 $91,450 $69,950 $116,400 Less: Depreciation -$20,000 -$20,000 -$20,000 -$60,000 Cash disbursements for MOHD $90,900 $111,450 $89,950 $292,300 M-OHD rate $19.91 /DLH Little Annin Flagmakers Unit Product Cost (USD) Absorption cost per unit Quantity Cost Cost/unit Direct Materials 5 $7.00 $1.40 Direct Labor 0.5 $40.00 $80.00 Manufacturing Overhead 19.91 Unit Product Cost $101.31 Little Annin Flagmakers Cost of Goods Sold Budget (USD) Cost of Goods Sold (FIFO) Units Cost/unit Total Cost Beg. FG inventory 410 $75.00 $30,750 Add: Cost of Goods Mfg'd 11,500 $81.45 $936,650 Good Available for Sale 11,910 156 967,400 Less: Ending FG inventory 2,382 31 193,480 Cost of Good Sold $773,920 Little Annin Flagmakers Selling and Administrative Expense Budget (USD) April May June Quarter Budgeted sales in units 2,500 6,000 3,000 11,500 Variable S&A per unit $1.25 $1.25 $1.25 $1.25 Total Variable S&A $3,125 $7,500 $3,750 $14,375 Total Fixed S&A $63,000 $63,000 $63,000 $189,000 Total S&A Expense $66,125 $70,500 $66,750 $203,375 Less: Depreciation -$10,000 -$10,000 -$10,000 -$30,000 Cash Disbursements for S&A $56,125 $60,500 $56,750 $173,375 Little Annin Flagmakers Cash Budget (USD) April May June Quarter Cash Balance, Beginning: $37,745 $76,964 -$35,372 -$179,784 Add: Receipts Cash Collections $252,000 $453,000 $540,000 $1,245,000 Total Cash Available $289,745 $529,964 $504,628 $1,065,216 Less Disbursements: Direct Materials $92,884 $173,642 $184,744 $451,270 Direct Labor $51,800 $134,000 $48,000 $233,800 Manufacturing Overhead $90,900 $111,450 $89,950 $292,300 Selling and Administrative 56,125 60,500 56,750 173,375 Dividends 15,000 15,000 15,000 45,000 Equipment Purchases 47,820 154,600 202,420 Total Disbursements $306,709 $494,592 $394,444 $1,195,745 Excess (deficiency) of cash available: $16,964 -$35,372 -$110,184 $130,529 Financing: Borrowing $60,000 $ - $60,000 Repayments -$60,000 -$60,000 Interest 16% 16% Total Financing $60,000 $ - -$69,600 -$9,600 Cash Balance, ending: $76,964 -$35,372 -$179,784 -$138,192 Little Annin Flagmakers Budgeted Income Statement (USD) Quarter Ending: June 30 Net Sales $1,380,000 Less: Cost of Goods Sold $773,920 Gross Margin $606,080 Less: S&A Expenses $173,375 Net Operating Income $432,705 Less: Interest Expense -$9,600 Net Income $423,105 Computation of Net Sales: Sales: $1,380,000 Less uncollectible amounts: $69,000 Net Sales: $1,311,000 Little Annin Flagmakers Budgeted Balance Sheet (USD) Ending March 31st Ending June 30th Current Assets: Cash $37,745 -$138,192 Accounts Receivable $132,000 $198,000 Raw Materials Inventory $32,200 $410,550 Finished Goods Inventory $30,750 $232,695 $30,750 $639,300 Plant and Equipment: Land $520,000 $520,000 Buildings and Equipment $1,800,000 $1,800,000 Accumulated Depreciation -$750,000 $1,570,000 -$90,000 $2,230,000 Total Assets: $1,802,695 $2,869,300 Liabilities: Accounts Payable $55,000 $55,000 $451,270 $451,270 Stockholder's Equity: Common Stock $500,000 $500,000 Retained Earnings $1,247,695 $1,747,695 $423,105 $923,105 Total Liabilities and stockholder's equity: $1,802,695 $1,374,375

Only need one page report ): Prepare a one-page business report that includes a synopsis of the case and your credit decision for LAF. Include in your report your justification for the credit decision (hint: the importance of the cash budget when determining a credit decision and the financial position and performance from Pro forma financial statements).