Sweats Galore case study

After graduating from Eastern University in Campus Town, USA with a degree in business, Michael Woods realized that he wanted to remain in Campus Town. After a number of unsuccessful attempts at getting a job in his discipline, Michael decided to go into business for himself. In thinking about his business venture, Michael determined that he had four criteria for the new business.

First, he wanted to do something that he would enjoy.

Second, he wanted a business that would give back to the community.

Third, he wanted a business that would grow and be more successful every year.

Fourth, realizing that he was going to have to work very hard, Michael wanted a business that would generate a minimum net income of $25,000 annually.

While reflecting on the criteria he had outlined, Michael, who had been president of his fraternity and served as an officer in several other student organizations, realized that there was no place in Campus Town to have custom sweatshirts made using a silk-screen process. When student organizations wanted sweatshirts for their members or to market on campus, the officers had to make a trip to a city 100 miles away to visit Shirts and More. Michael had worked as a part-time employee at Shirts and More while he was in high school and had envisioned owning such a shop. He realized that a sweatshirt shop in Campus Town had the potential to meet all four criteria he had set. Michael set up an appointment with Jayne Stoll, the owner of Shirts and More, to obtain information useful in getting his shop started. Because Jayne liked Michael and was intrigued by his entrepreneurial spirit, she answered many of Michaels questions.

In addition, Jayne provided information concerning the type of equipment Michael would need for his business and the average useful life. Jayne knows a competitor who is retiring and would like to sell his equipment. Michael can purchase the equipment at the beginning of 2006 and the owner is willing to give him terms of 50 percent due upon purchase and 50 percent due the quarter following the purchase. Michael will purchase the following equipment January 1, 2006:

	Cost	Useful Life
Hand operated press that applies ink to the shirt	$7,500	5 yrs
Light exposure table	1,350	10 yrs
Dryer conveyer belt that makes ink dry on the shirts	2,500	10 yrs
Computer with graphics software and color printer	3,500	4 yrs
Display furniture	2,000	10 yrs
Used cash register	500	5 yrs

Michael has decided to use the sweatshirt supplier recommended by Jayne. He learned the cost of a gross of good quality sweatshirts to be silk-screened would be $1,440.

Jayne has encouraged Michael to ask the sweatshirt supplier for terms of 40 percent of a quarters purchases to be paid in the quarter of purchase with the remaining 60 percent of the quarters purchases to be paid in the quarter following the purchase.

Michael also learned from talking with Jayne that the ink used in the silk-screen process costs approximately $.75 per shirt.

Knowing that the silk-screen process is somewhat labor intensive, Michael plans to hire six college students to help with the silk-screen process with each one working an average of 20 hours per week for 50 weeks during the year. Total annual wages for the workers is estimated to be $72,000.

In addition, Michael will need one person to take orders, bill customers, and operate the cash register. Cary Sue Smith, who is currently Director of Student Development at Eastern University, has approached Michael about a job in sales. Cary Sue knows the officers of all of the student organizations on campus. In addition, she is very active in the community. Michael thinks Cary Sue can bring in a lot of business. In addition she also has the clerical skills needed for the position. Because of her contacts, Michael is willing to pay Cary Sue $1,200 per month plus a commission of 10 percent of sales. Michael estimates Cary Sue will spend 50 percent of the workday focusing sales, while the remaining 50 percent will be spent on clerical and administrative duties.

Michael realizes that he will have difficulty in finding a person skilled in computer graphics to generate the designs to be printed on the shirts. Jayne recently hired a graphics designer in that position for Shirts and More at a rate of $500 per month plus $.10 for each shirt printed. Michael believes he can find a university graphics design student to work for the same rate Jayne is paying her designer.

Michael was fortunate in finding a commercial building for rent near the University and the downtown area. The landlord requires a one-year lease. Although the monthly rent of $1,000 is more than Michael had anticipated paying, the building is nice, has adequate parking, and there is room for expansion. Michael anticipates that 75 percent of the building will be used in the silk-screen process while 25 percent will be used for sales.

Michaels fraternity brothers have encouraged him to advertise weekly in the Eastern University student newspaper. Upon inquiring Michael found that a 3 x 3 ad would cost $25 per week. Michael also plans to run a weekly ad in the local newspaper that will cost him $75 per week.

Michael wants to sell a large number of quality shirts at a reasonable cost. He estimates the selling price of each customized shirt to be $16. Jayne has suggested that he should ask customers to pay for 70 percent of their purchases in the quarter purchased and pay the additional 30 percent in the quarter following the purchases.

After talking to the insurance agent and the property valuation administrator in his municipality, Michael estimates that the property taxes and insurance on the machinery will cost $2,240 annually, while property tax and insurance on display furniture and cash register will total $380 annually.

Jayne reminded Michael that maintenance of the machines is required for the silk-screen process. In addition, Michael realizes that he must consider the cost of utilities. The building Michael wants to rent is roughly the same size as the building occupied by Shirts and More. In addition, Shirts and More sells approximately the same number of shirts Michael plans to sell in his store. Therefore, Michael is confident that the maintenance and utility costs for his shop will be comparable to the maintenance and utility costs for Shirts and More, which have been observed as follows within the relevant range of zero to 8,000 shirts.

	Shirts Sold	Maintenance Cost	Utility Cost
January	2,000	$1,716	$1,100
February	2,110	1,720	1,158
March	2,630	1,740	1,171
April	3,150	1,740	1,198
May	5,000	1,758	1,268
June	5,300	1,818	1,274
July	3,920	1,825	1,205
August	2,080	1,780	1,117
September	8,000	1,914	1,400
October	6,810	1,860	1,362
November	6,000	1,855	1,347
December	3,000	1,749	1,193

Michael estimates the number of shirts to be sold in the first five quarters, beginning January 2006, to be:

First quarter year 1	8,000
Second quarter year 1	10,000
Third quarter year 1	20,000
Fourth quarter year 1	12,000
First quarter year 2	18,000

Seeing how determined his son was to become an entrepreneur, Michaels father offered to co-sign a note for an amount up to $20,000 to help Michael open his sweatshirt shop, Sweats Galore. However, when Michael and his father approached the loan officer at First Guarantee Bank, the loan officer asked Michael to produce the following budgets for 2006:

Sales budget

Schedule of expected collections from customers

Shirt purchases budget

Schedule of expected payments for purchases

Silk-screen labor budget

Selling & administrative expense budget

Silk-screen overhead budget

Budgeted income statement

Cash budget

Budgeted balance sheet

The loan officer advised Michael that the interest rate on a 12-month loan would be 8 percent. Michael expects the loan to be taken out January 1, 2006.

Michael has estimated that his income tax rate will be 20 percent. He expects to pay the total tax due when his returns are filed in 2007.

Answer each of the following questions.

1) Do you think it was important for Michael to stipulate that he wanted a business that he would enjoy, that would give back to the community, that would grow and be more successful every year, and that would generate a net income of $25,000 annually? Why or why not?

2) If Michael has sales of $12,000 during January of his first year of business, determine the amount of variable and fixed costs associated with utilities and maintenance using the high-low method for each.

3) Using the format below, prepare a Sales Budget for the year ending 2006.

Sweats Galore Sales Budget For the Year Ending December 31, 2006
	Quarter
	1	2	3	4	Year
Expected unit sales
Unit selling price	X
Budgeted sales revenue	$

4) Prepare a Schedule of Expected Collections from Customers

Sweats Galore Schedule of Expected Collections from Customers For the Year Ending December 31, 2006
	Quarter
	1	2	3	4
Accounts Receivable 1/1/06	- 0 -
First quarter
Second quarter
Third quarter
Fourth quarter
Total collections

5) Michael learned from talking with Jayne that the supplier is so focused on making quality sweatshirts that many times the shirts are not available for several days. She encouraged Michael to maintain an ending inventory of shirts equal to 25 percent of the next quarters sales.

Prepare a Purchases Budget for shirts using the format provided.

Sweats Galore Shirt Purchases Budget For the Year Ending December 31, 2006
	Quarter
	1	2	3	4	Year
Shirts to be silk-screened
Plus desired ending inventory
Total shirts required
Less beginning inventory
Total shirts needed
Cost per shirt
Total cost of shirt purchases

6) Prepare a Schedule of Expected Payments for Purchases.

Sweats Galore Schedule of Expected Payments for Purchases For the Year Ending December 31, 2006
	Quarter
	1	2	3	4
Accounts Payable 1/1/06	- 0 -
First quarter
Second quarter
Third quarter
Fourth quarter
Total payments

7) Prepare a Silk-screen Labor Budget.

Sweats Galore Silk-screen Labor Budget For the Year Ending December 31, 2006
	Quarter
	1	2	3	4	Year
Units to be produced
Silk-screen labor hours per unit
Total required silk-screen labor hours
Silk-screen labor cost per hour
Total silk-screen labor cost

8) Prepare a Selling and Administrative Expense Budget for Sweats Galore for the year ending December 31, 2006.

Sweats Galore Selling and Administrative Expense Budget For the Year Ending December 31, 2006
	Quarter
	1	2	3	4	Year
Variable expenses
Sales commissions
Total variable
Fixed expenses
Advertising
Rent
Sales salaries
Office salaries
Depreciation
Property taxes and insurance
Total fixed
Total selling and administrative expenses

9) Prepare a Silk-screen Overhead Budget for Sweats Galore for the year ending December 31, 2006.

Sweats Galore Silk-screen Overhead Expense Budget For the Year Ending December 31, 2006
	Quarter
	1	2	3	4	Year
Variable costs
Ink
Maintenance
Utilities
Graphics design
Total variable
Fixed costs
Rent
Maintenance
Utilities
Graphics design
Property taxes and insurance
Depreciation
Total fixed
Total silk-screen overhead
Direct silk-screen hours
Overhead rate per silk-screen hour

10) Using the information found in the case and the previous budgets, prepare a Budgeted Income Statement for Sweats Galore for the year ended December 31, 2006.

Sweats Galore Budgeted Income Statement For the Year Ending December 31, 2006
Sales
Cost of goods sold
Gross profit
Selling and administrative expenses
Income from operations
Interest expense
Income before income taxes
Income tax expense
Net income

11) Using the information found in the case and the previous budgets, prepare a Cash Budget for Sweats Galore for the year ended December 31, 2006.

Sweats Galore Cash Budget For the Year Ending December 31, 2006
	Quarter
	1	2	3	4	Year
Beginning cash balance
Add: Receipts
Collections from customers
Total available cash
Less: Disbursements
Payments for shirt purchases
Silk-screen labor
Silk-screen overhead
Selling and administrative expenses
Payment for equipment purchase
Total disbursements
Excess (deficiency) of available cash over disbursements
Financing
Borrowings
Ending cash balance

12) Using the information contained in the case and the previous budgets, prepare a Budgeted Balance Sheet for Sweats Galore for the year ended December 31, 2006.

Sweats Galore Budgeted Balance Sheet December 31, 2006
Assets
Cash
Accounts receivable
Sweatshirt Inventory
Equipment
Less: Accumulated depreciation
Total assets
Liabilities and Owners Equity
Accounts payable
Note payable
Interest payable
Taxes payable
Total liabilities
Michael Woods, Capital
Total liabilities and owners equity

13) a) Using the information contained in the case and the previous budgets, calculate the estimated contribution margin per unit for 2006.

b) Calculate the total estimated fixed costs for 2006 (including interest and taxes).

c) Compute the break-even point in units and dollars for 2006.

14) a) Michael is very disappointed that he did not have an income of $25,000 for his first year of budgeted operations as he had wanted. How many shirts would Michael have to sell in order to have a profit of $25,000?

b) Why does Michaels net income differ from his ending cash balance?

15) Do you think it was a good idea to offer Cary Sue a salary plus 10 percent of sales? Why or why not?