Rusty Spears, CEO of Rustys Renovations, a custom building and repair company, is preparing documentation for a line of credit request from his commercial banker. Among the required documents is a detailed sales forecast for parts of 2014 and 2015.
Estimates obtained from the credit and collection department are as follows: collections within the month of sale, 15%; collections during the month following the sale, 65%; collections the second month following the sale, 20%. Payments for labor and raw materials are typically made during the month following the one in which these costs were incurred. Total costs for labor and raw materials are estimated for each month as shown in the table.
General and administrative salaries will amount to approximately $15,000 a month; lease payments under long-term lease contracts will be $5,000 a month; depreciation charges will be $7,500 a month; miscellaneous expenses will be $2,000 a month; income tax payments of $25,000 will be due in both September and December; and a progress payment of $80,000 on a new office suite must be paid in October. Cash on hand on July 1 will amount to $60,000, and a minimum cash balance of $40,000 will be maintained throughout the cash budget period.
Input Data
Collections during month of sale				15%
Collections during month after sale				65%
Collections during second month after sale				20%
Lease payments				$5,000
Target cash balance				$40,000
General and administrative salaries				$15,000
Depreciation charges				$7,500
Income tax payments (Sep & Dec)				$25,000
Miscellaneous expenses				$2,000
New office suite payment (Oct)				$80,000
Cash on hand July 1				$60,000
Sales, labor, and RM adjustment factor				0%
a. Prepare a monthly cash budget for the last six months of the year.
			May	June	July	August	September	October	November	December	January
Original sales estimates			$60,000	$100,000	$130,000	$120,000	$100,000	$80,000	$60,000	$40,000	$30,000
Original labor and raw mat. estimates			$75,000	$90,000	$95,000	$70,000	$60,000	$50,000	$20,000	$20,000
Forecasted Sales
Sales (gross)			$60,000	$100,000	$130,000	$120,000	$100,000	$80,000	$60,000	$40,000	$30,000
Collections
During month of sale					$19,500	$18,000	$15,000	$12,000	$9,000	$6,000
During 1st month after sale					$65,000	$84,500	$78,000	$65,000	$52,000	$39,000
During 2nd month after sale					$12,000	$20,000	$26,000	$24,000	$20,000	$16,000
Total collections					$96,500	$122,500	$119,000	$101,000	$81,000	$61,000
Purchases
Labor and raw materials			$75,000	$90,000	$95,000	$70,000	$60,000	$50,000	$20,000	$20,000
Payments for labor and raw materials					$90,000	$95,000	$70,000	$60,000	$50,000	$20,000
Payments
Payments for labor and raw materials					90,000	95,000	70,000	60,000	50,000	20,000
General and administrative salaries					15,000	15,000	15,000	15,000	15,000	15,000
Lease payments					5,000	5,000	5,000	5,000	5,000	5,000
Miscellaneous expenses					2,000	2,000	2,000	2,000	2,000	2,000
Income tax payments							25,000			25,000
Design studio payment								80,000
Total payments					$112,000	$117,000	$117,000	$162,000	$72,000	$67,000
Net Cash Flows
Cash on hand at start of forecast period					$60,000	$44,500	$50,000	$52,000	($9,000)	($0)
Net cash flow (NCF): Total collections Total payments					($15,500)	$5,500	$2,000	($61,000)	$9,000	($6,000)
Cumulative NCF: Prior month cumulative + this month's NCF					$44,500	$50,000	$52,000	($9,000)	($0)	($6,000)
Cash Surplus (or Loan Requirement)
Target cash balance					$40,000	$40,000	$40,000	$40,000	$40,000	$40,000
Surplus cash or loan needed: Cumulative NCF Target cash					$4,500	$10,000	$12,000	($49,000)	($40,000)	($46,000)
		Max. Loan		$49,000
b. How much must Spears borrow each month to maintain the target cash balance?
Answer. Look at the "Surplus cash or loan needed" line at the bottom of the cash budget.
c. Would the cash budget be accurate if inflows came in all during the month but outflows were bunched
early in the month?
No, in these circumstances, the company may experience cash shortfalls because outflows occur before inflows. For example, the company may have many expenses due at the beginning of the month, but will not receive inflows later - thus the company may not be able to cover its exepenses when the occur - it would need to wait for its inflows to have enough cash for expenses
d. If the company operates on a seasonal basis, how would this affect the current ratio and the debt ratio?
When there was a change to a high-volume season, materials and labor payments would increase but collections on sales would not yet catch up. This would increase the debt ratio. Over time, when collections had time to come in, this would stabilize the debt ratio. The debt ratio would then lower after the high-volume season as late collections would be finishing up. The current ratio would be affected by inventory levels. When demand is high, the company would require larger inventories, so the current ratio would increase as inventory is an asset. During slow seasons, the company would not have to maintain a safety stock of inventory, so the current ratio would decrease.
e. If its customers began to pay late, this would slow down collections and thus increase the required loan amount. Also, if sales dropped off, this would have an effect on the required loan. Do a sensitivity analysis that shows the effects of these two factors on the max loan requirement. Assume the purchases of labor and raw material also vary by the sales adjustment factor.
	Change	Maximum Loan Required
	in Sales	% Collections in 2nd month
	$49,000	0%	15%	30%	45%	60%	85%	100%
	-100%
	-75%
	-50%
	-25%
	0%
	25%
	50%
	75%
	100%