Hello,

Can you show me how to calculate net income? The answer is $243,125, but I need to be able to understand the steps to calculate this amount. Thank you!

Little Annin Flagmakers

Budgeted Income Statement(US$)

Quarter Ending June 30

Net sales

Less: Cost of goods sold

Gross margin

Less: S&A expenses

Net operating income

Less: Interest expense

Net income $243,125

INTRODUCTION 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 p.m. today for the 4 p.m. 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 more than 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. Buford 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 (Certified Management Accountant) examination. Buford reports directly to Anton, the senior commercial credit analyst who has been with Kent Bank for 10 years. As Buford began the work, he recalled his last 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 of a sales reduction of 2%, 5%, and 10% on the applicant's cash needs. He wanted to be prepared for these types of questions. LITTLE ANNIN FLAGMAKERS BACKGROUND LAF manufactures one product, a large durable 8' 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 online 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, but some variation in demand does occur, and the retailers expect to be able to adjust orders as needed. LAF allows retailers to adjust each month's purchases to 80% to 120% of the estimated sales levels. Flags are shipped to retail customers using JIT distribution so that the online retailers do not have to store inventory. Typical sales for the flag are 1,800 units per month with seasonal increases in April through August. Sales estimates are 2,500 units in April, 6,000 units in May, 3,000 units in June, 2,500 units in July, and 2,000 units in August. Customers historically have paid 40% of their purchases in the month of the sale, 55% in the following month, and the remaining 5% is uncollectible. IMA EDUCATIONAL CASE JOURNAL 1 VOL. 11, NO. 4, ART. 4, DECEMBER 2018 ISSN 1940-204X Cash Is King: Master Budgets to Inform a Credit Decision Anne M.A. Sergeant, CMA, PhD Seidman College of Business Grand Valley State University Grand Rapids, MI Neal VandenBerg, CPA, PhD Seidman College of Business Grand Valley State University Grand Rapids, MI 2018 IMA 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 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. 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 come 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. REQUIRED 1. Using the data input provided (Exhibit 1), prepare LAF's master budgets in Excel. Do not hard-code numbers into the spreadsheet, except in the financing section of the cash budget. 2. Conduct a sensitivity analysis, decreasing sales 2%, 5%, and 10% for April through August. New sales levels are provided in Exhibit 2. Adjust the financing and cash needs at these new sales levels. 3. Determine a credit recommendation for Kent Bank, to lend or not. Be prepared to justify your credit decision. 4. Explain why the cash budget is more important to a bank than the accounting net income when determining a credit decision. 5. Explain why decreases in sales is examined in a sensitivity analysis for a credit decision. IMA EDUCATIONAL CASE JOURNAL 2 VOL. 11, NO. 4, ART. 4, DECEMBER 2018 ABOUT IMA (INSTITUTE OF MANAGEMENT ACCOUNTANTS) IMA, the association of accountants and financial professionals in business, is one of the largest and most respected associations focused exclusively on advancing the management accounting profession. Globally, IMA supports the profession through research, the CMA (Certified Management Accountant) program, continuing education, networking and advocacy of the highest ethical business practices. IMA has a global network of more than 100,000 members in 140 countries and 300 professional and student chapters. Headquartered in Montvale, N.J., USA, IMA provides localized services through its four global regions: The Americas, Asia/Pacific, Europe, and Middle East/India. For more information about IMA, please visit www.imanet.org. IMA EDUCATIONAL CASE JOURNAL 3 VOL. 11, NO. 4, ART. 4, DECEMBER 2018 A B 1 Input Data (US$) 2 3 Budgeted Sales Expected 4 April (units) 2,500 5 May (units) 6,000 6 June (units) 3,000 7 July (units) 2,500 8 August (units) 2,000 9 10 Selling price/unit US$120.00 11 12 Cash Collection Pattern 13 Month of sale 40% 14 Following month 55% 15 Uncollectible 5% 16 17 Cash Payments for Materials 18 Month of purchase 40% 19 Following month 60% 20 21 Production Requirements 22 Raw material per unit (lb.) 5 23 Raw material cost per lb. US$7.00 24 Direct labor hours per unit 0.5 25 Direct labor rate per hour US$40.00 26 Variable manufacturing overhead rate per direct labor hour US$10 27 Fixed manufacturing overhead cost per month US$57,950 28 Depreciation in Fixed manufacturing overhead US$20,000 29 A B 30 Selling & Administrative (S&A) Costs 31 Variable S&A cost per unit sold US$1.25 32 Fixed S&A cost per month US$63,000 33 Depreciation in fixed S&A cost US$10,000 34 35 Other Cash Outflows 36 Cash dividends paid each month US$15,000 37 Equipment purchases May US$47,820 38 Equipment purchases June US$154,600 39 40 Desired Ending Inventory 41 Finished goods 20% 42 Raw materials 40% 43 Cash US$30,000 44 45 Beginning Account Balances on March 31 46 Cash US$37,745 47 Accounts receivable US$132,000 48 Finished goods inventory (at US$75/unit) US$30,750 49 Finished goods cost per unit US$75.00 50 Finished goods inventory (units) 410 51 Raw materials (at US$7.00/lb.) US$32,200 52 Raw materials (lb.) 4,600 53 Accounts payable US$55,000 54 55 Land US$520,000 56 Buildings and equipment US$1,800,000 57 Accumulated depreciation (US$750,000) 58 Common stock US$500,000 59 Retained earnings US$1,247,695 Exhibit 1. Excel Data Input Section Exhibit 2. Sales at Different Levels Decreased by Budgeted Sales Expected 2% 5% 10% April (units) 2,500 2,450 2,375 2,250 May (units) 6,000 5,880 5,700 5,400 June (units) 3,000 2,940 2,850 2,700 July (units) 2,500 2,450 2,375 2,250 August (units) 2,000 1,960 1,900 1,800