In late August 1997, Jean Biglow, treasurer of Biglow Toy Company, was concerned with financing its sales operations during the upcoming Christmas selling season. To cope with the Christmas sales peak, Jean planned to build up Biglows toy inventory throughout the fall. This would generate substantial cash deficits in October, November, and December. Some means of short-term financing had to be found to cover these deficits. On the other hand, Jean anticipated a cash surplus in January and February, when Biglows retailers paid their Christmas invoices. A small cash surplus was also anticipated in September as a result of over-the-summer toy purchases.

Jean tried to maintain a minimum balance in Biglows cash account throughout the year. This was to protect against errors in estimating both the size and timing of future cash flows. The planned minimum balance was normally set as a fixed percentage of each months anticipated dollar sales volume. This procedure had proven adequate in the past against virtually all contingencies.

Except for deciding how to finance the fall buildup in inventory, Jean had already completed a six-month financial plan. This covered the period September 1997 through February 1998. Selected portions of the plan are shown in the table below.

The accounts receivable balances shown in the table refer to the beginning of each month. Thus, Jean anticipates $700,000 in accounts receivable at the beginning of September, $500,000 at the beginning of October, and so forth.

On the average, Biglow receives a 3% discount from its toy suppliers for prompt payment of purchases. Jean normally takes advantage of such discounts, whenever possible, and so, the planned payments shown in the table assume prompt payment and realization of the 3% average discount. If Biglows payments are delayed, the discount will be lost, and actual payments will exceed planned payments, accordingly.

The cash surplus and deficit figures shown in the table are net of all other operations, including anticipated sales receipts, planned payments for purchases, and all other planned receipts and payments. These figures are also net of the standard provision for each months minimum cash balance. Thus, Jean expects a surplus of $200,000 from operations during September, a deficit of $250,000 from operations during October, and so forth. Each of the surplus and deficit figures shown in the table represents the incremental (not cumulative) surplus or deficit anticipated during that month.

As anticipated , Jean has three sources of short-term borrowing to meet

Biglows monthly cash needs.

These are:

1_ Pledging accounts receivable balances, that is, factoring;

2_ Delaying payments of purchases; and

3_ Obtaining a six-month bank loan.

A local bank has agreed to loan Biglow funds at the beginning of any month against a pledge of its accounts receivable balance. The maximum loan that Biglow can obtain from this source is 75% of the accounts receivable balance outstanding at the beginning of that month. Whatever is borrowed, if anything, must be returned to the bank at the beginning of the next month, plus an interest payment of 1.5% of the amount actually borrowed.

Payments to suppliers for purchases may be delayed for a maximum of one month. Thus, up to $1,000,000 in payments currently scheduled for November may be delayed until December. Whatever portion, if any, of these planned payments is delayed would become available to finance the anticipated deficit from operations during November. However, Jeans own policy strictly forbids delaying payments more than one month beyond the month when they are supposed to be paid. Also, the average 3% discount is lost on all payments that are actually delayed. For example, if Jean delays the planned payment of $1,000,000 for November, then the payment in December for this delayed amount will be 1,000,000/.97 = 1,000,000 x 1.031 = $1,031,000 approximately.

The local bank is also willing to make a one-time loan to Biglow of any amount from a minimum of $400,000 to a maximum of $1,000,000 for six months. If such a loan is taken, the entire loan will be received by Biglow at the beginning of September and repaid at the end of February. In addition, Biglow must pay the bank a 1% monthly interest charge at the end of each month. Once taken, it is not possible to increase the loan nor to repay any portion of it during the six-month period. The 1% mothly interest charge therefore applies to the entire amount, if any, actually borrowed.

At the end of every month, Jean inspects the current balance in Biglows cash account. Whatever excess funds remain over and above the minimum balance planned for the next month are invested immediately in 30-day government securities. Securities are purchased at the beginning of the next month and sold at the end of that month. Upon selling the securities, Biglow receives one-half percent interest on the excess funds, if any, actually invested. No excess funds are anticipated for month of August, but Jean plans to continue this investment procedure between September and February.

Jean must decide how to cover the operating deficits indicated in Table 1 by utilizing some combination of the three sources of short-term borrowing. Jean expects to maintain at least the planned minimum balances in Biglows cash account at the end of each month as a reserve for contingencies while minimizing the net dollar cost of whatever six-month financing plan is adopted.

SIX-MONTH FINANCIAL PLAN (ALL FIGURES IN THOUSANDS OF DOLLARS) SEP OCT NOV DEC Accounts Receivable Balance $700 $500 $ 700 $1200 Planned Payments for Purchases $800 $900 $1000 $600 Cash Surplus From Operations $200 --- --- --- Cash Deficit From Operations -- $250 $600 $900 JAN $1000 $400 $300 FEB $500 $500 $1500