The Elusive Cash Balance

What do you mean weve used up all our cash and lines of credit? I dont get it! I thought we had a healthy financial position as per last years fi- nancial statements. How could this have happened, Patrick? said Donald Hunt to his chief accountant. If our suppliers find out, we could be in a compromising position. I cant let that happen. Prepare a detailed report including a cash budget for the next year and give it to me by 10 AM to- morrow. Build in a minimum cash balance that is at least 25% higher than our last years ending cash balance, but make sure that its not more than 50% higher than our last years ending cash balance in any period.

Donald Hunt, the owner of Hunt Distributing, Inc., had inherited the family business five years ago, when his father, Nelson, suddenly passed away. Under Nelsons leadership, the firm had grown slowly but steadily. Nelson had always maintained strong ties with local businesses, suppli- ers, and customers. As Patrick began examining the financial statements (Tables 1 and 2), he couldnt help recalling how Nelson had managed to always keep the firms liquidity position strong by being conservative and planning for the future. He did not take undue risk and only accepted prod- ucts of the highest quality for distribution. Bills were always paid on time, and credit terms were only extended to those customers and retailers who were well known to Nelson (as most were).

Donald, on the other hand, had always criticized his fathers conserv- ative business policies. As soon as he took over, he unleashed a host of liberal terms and policies. He significantly expanded the list of products offered for distribution to retailers, extended much longer credit periods to clients, and took on additional bank loans to finance his expansions. The list of product offerings grew from 300 to 650, and the number of suppli- ers more than tripled. Although revenues increased during the five-year period, the volatility increased as well. More importantly, the cash balance had been very unstable and had significantly decreased over time, indicat- ing a problem in cash management.

As Patrick crunched the numbers, he realized that in order to prepare a detailed cash budget and financial report he needed to figure out the average receivables period, the average payables period, and a periodic sales forecast. He made the assumption that sales would increase at the last years rate of 25%. After consulting the sales manager, Patrick devel- oped a breakdown of monthly sales for the last quarter of 2015 and for the forthcoming year (Table 3). Table 4 presents the collection schedule that Patrick assumed the firm would follow in the coming year. All other expenses and charges would be assumed to vary proportionately with sales or held constant. Patrick was aware that the firm would be acquiring a new delivery truck for $40,000 in May of the coming year and figured that he better include it in the cash budget. All operating expenses were uniformly distributed over the year. Debt payments were made monthly, while taxes were paid in March, June, September, and December of each year. The firm had a policy of ordering goods one month in advance of forecasted sales and would pay for them within about 90 days.

As he glanced at his watch, Patrick realized that he better get some assistance or hed face an irate boss in the morning. He picked up the telephone and called for Kelly, his recently hired assistant, to come to his rescue in solving this problem of the elusive cash balance.

Tables attached:

1. Based on your calculations, which months seem to be the most vulnerable to cash deficits and which ones have the greatest surplus funds?

2. Assuming borrowed funds cost 10% per year and excess funds can be invested at 6% per year, prepare an annual financial plan for Hunt Distributing, Inc.

Case 21 The Elusive Cash Balance 101 Table 1 Hunt Distributing, Inc. Income Statement 2015 $6,100,000 4,880,000 1,220,000 610,000 16,000 61,000 15,000 518,000 73,455 444,545 155,591 288,954 2014 $4,880,000 3,904,000 2013 4,000,000 3,200,000 800,000 400,000 12,000 40,000 15,000 333,000 46,000 287,000 100,450 186,550 Sales Cost of Goods Sold Gross Profit 976,00 Salaries Utilities Other Expenses Depreciation 488,000 4,000 48,800 5,000 410,200 61,000 349,200 122,220 226,980 Earnings Before Interest and Taxes Interest Paid Earnings Before Taxes Taxes Net Income 102 Case 21 The Elusive Cash Balance Table 2 Hunt Distributing, Inc. Balance Sheets 2015 2014 2013 Assets $57,154 Cash and Cash Equivalents Accounts Receivable Inventory 700,000 $1,000,000 1,757,154 750,000 145,000 605,000 2,362,154 $48,800 600,000 $619,847 1,268,647 750,000 130,000 620,000 1,888,647 160,000 450,000 300,000 910,000 750,000 115,000 635,000 ,545,000 Total Current Assets Gross Fixed Assets Accumulated Depreciation Net Plant&Equipment Total Assets Liabilities and Owner's Equity $350,000 74,553 79,749 $1,004,553 200,000 1,204,553 $355,117 802,484 Accounts Payable Bank Loan @ 10% per Year Other Current Liabilities $300,000 50,000 69,733 $820,000 200,000 1,020,000 $355,117 513,530 $200,000 300,000 50,000 $550,000 200,000 750,000 $508,450 286,550 Total Current Liabilities Long-Term Debt Total Liabilities Owner's Capital Retained Earnings Total Liabilities and Owner's Equity 2,362,154 1,888,647 1,545,000 Table 3 Actual Sales 400,000 450,000 600,000 Expected Sales 6 Table 4 Collection Schedule