Determine a credit recommendation for Kent Bank, to lend or not. Justify your credit decision.

2. Explain why the cash budget is more important to a bank than the accounting net income when determining a credit decision.

Cash is King Case study

MANUFACTURING AND SG&A COSTS

The flags are made in one plant, which has a capacity of 6,200 units per month.

LAF budgets have 20% of next month's 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% of next month's fabric needs on hand at the end of

the month. Fabric is purchased on credit with 40% paid in the month of purchase and

60% paid 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 property, plant, and equipment

(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 depreciation of the administrative office building and equipment.

FINANCIAL STATEMENT DETAILS AND CASH PLANNING

LAF uses first in, first out (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 longterm

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.

LAF 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 co

me on line until after the quarter, thus not affecting the manufacturing overhead costs.

LOAN DETAILS

LAF 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 the interest repaid at

the end of the quarter. The interest rate on this loan is 16% per year.