Finance for Non Financial Managers. 2 Page Report Please

MODULE 2 STATEMENT OF CASH FLOWS DECISION-MAKING IN ACTION: CASE, ANALYSIS AND DECISION CASE The CEO of Lennon Electronics Inc. is contemplating investing $1.0 million in non- current assets in 2014. Before presenting the capital budget plan to the board of directors, he wants to know how much money would be generated internally, before deciding on the amount of cash that would have to be raised from investors (e.g., long-term lenders and shareholders). In order to do this, the controller had to go through the following seven steps: 1. All operating managers had to prepare their respective operating budgets (e.g. manufacturing, marketing, human resources, engineering): 2. The controller then consolidated these operating budgets and prepares: - The company's master budget; and - A projected statement of income for the year 2014 (see Table 3.1). 3. The controller prepared a detailed listing of all capital projects estimated at SLO million (e.g., acquisitions, purchase of equipment or machinery, plant expansion and/or modernization) that would be acquired or undertaken during the budget year (capital budget). 4. The treasurer identified the additional external sources of financing in addition to internal sources) that would be required to finance: - The $1.0 million capital budget; - The working capital accounts (e.g., trade receivables, inventories), and - The amount of money that will be paid in dividends (an amount of $155,674 shown in Table 3.2) during 2014. Table 3.1: Lennon's Projected Statement of Income Lennon Electronics Inc. For the Year Ended 2014 In $ Revenue Cost of sales Gross profit 5,100,000 (3,800,000) 1,300,000 Other income Distribution costs Administrative expenses Depreciation Finance costs Total 22.000 (270,000) (270.000) (60,000) (50.000) (628,000) Profit before taxes Income tax expense Profit for the year 672,000 (260,000) 412,000 5. The controller then prepared the company's monthly cash budget and the projected statement of financial position for the year 2014. 6. The controller compared individual accounts shown on the company's projected statement of financial position for 2014 to the 2013 accounts. (This information is shown on the right side of Table 3.3.) YOU will need to identify the amount of the cash inflow or cash outflow for each account for your analysis. 7. The final step was the preparation of the projected statement of cash flows (Table 3.4). The cash flow changes between the two accounting periods generated from each activity are as follows: - operating activities: $367,000 - financing activities: $ 644,326 - investing activities: ($ 1,000,000) - change in the cash account: ($ 11,326) Table 3.2: Lennon's Projected Statement of Changes in Equity Lennon Electronics Inc. For The Year Ended 2014 (in $) Retained earnings (beginning of year) Profit for the year 412.000 Dividends (155.674) Retained earnings (end of year) 1,310,000 256,326 1.566,326 Table 3.3: Lennon's Comparative Statements of Financial Position Cash Outflows Lennon Electronics Inc. Statement of Sources and Uses of Funds In $ Assets Projected Year-end Cash 2014 2013 Inflows Non-current assets Property, plant, and 3.450,000 2.450,000 equipment (at cost) Accumulated (710,000) (650,000) depreciation Property, plant, and 2,740,000 1,800,000 equipment (net) Intangible assets 65,000 65,000 Total non-current assets 2,805,000 1.865.000 Current assets Inventories Trade receivables Prepaid expenses Marketable securities Cash and cash equivalents Total current assets Total assets 850,000 550,000 25,000 50,000 46,326 750,000 450.000 30.000 50.000 35.000 1.521,326 4.326,326 1,315.000 3.180,000 Equity Share capital Retained earnings Total equity 500,000 1,566,326 2,066,326 400,000 1,310.000 1.710,000 1,600,000 900,000 170,000 Liabilities Long-term borrowings Current liabilities Trade and other payables Accrued expenses Current portion of long-term debt 130,000 50,000 40,000 50,000 40,000 Short-term borrowings Total current liabilities Total liabilities 400.000 660,000 2.260,000 350,000 570,000 1.470,000 Total equity and liabilities 4.326.326 3.180.000 Table 3.4 Lennon's Projected Statement of Cash Flows Lennon Electronics Inc. For the Year Ended 2014 In $ 412,000 Operating activities Profit for the year Adjustments Depreciation Adjustments in non-cash working capital accounts Net cash from operating activities 60.000 (105.000) 367,000 Financing activities Payment of dividends Long-term borrowings Share capital Cash flow from financing activities (155.674) 700,000 100.000 644,326 Investing activities Purchase of property, plant, and equipment Cash flow from investing activities (1,000,000) (1.000.000) (11,326) Increase in cash Cash at beginning of year Cash at end of year 35,000 46,000 Adjustments in non-cash working capital accounts Cash inflows Trade and other payables 40,000 Prepaid expenses 5.000 Short-term borrowings 50,000 95.000 Cash outflows Inventories Trade receivables Adjustments in non-cash working capital accounts (100,000) (100.000) (200,000) (105,000) Required: In your role as CEO, using the information in Table 3.4. you need to inform the board of directors of how much cash inflow will be generated from the business itself (from operating activities) versus investors (financing activities) to finance the $1.0 million purchase of the property, plant, and equipment. Therefore as CEO prepare a report, maximum 2 pages, answering the following questions: Should operating managers redo their operating budgets in order to squeeze more cash from the business (more than the $412,000 profit)? Should operating managers examine whether more cash could be squeezed from working capital (e.g., trade receivables, inventories)? What is the net cash inflow / outflow from these items? Hint: This information is available on the cash flow statement under operating activities. Should Lennon pay less than the $155,674 amount in dividends? What impact would this have on the shareholders' views about Lennon? Will Lennon be able to raise the $700,000 from the long-term lenders? What's the WACC (cost of capital) based on the 2014 projections? Will Lennon be able to raise the $100,000 from the shareholders? Should the company ask for more or less? If Lennon is unable to obtain more cash from internal or external sources, should the company then cut back the $1.0 million amount in the capital budget? Where should the cuts take place? What impact will these cuts have on the business