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Gadgets, Inc. is incorporated and will begin operations on January 1, 2019. Its primary business is the manufacture and sale of gadgets. Because cash resources are limited, the company anticipates the need to have access to capital during the first year of operations and seeks to establish a line of credit with a local bank. The bank requires a complete operating and cash budget and pro-forma financial statements for 2019 as part of the loan application. The following information and data are to be used in preparing the budget.

1) Gadgets, Inc. is a closely-held corporation. The original owners have invested an initial $150,000 (assume the initial cash funding occurs on January 1, 2019) to establish the corporation and are the only shareholders of the company.

2) Production equipment totaling $36,000 will be purchased on January 2, 2019 and put into immediate use. The equipment has an expected useful life of five years, with no salvage value. It will be depreciated using straight-line depreciation method.

3) The sole product is the Standard Gadget. Each unit requires four pounds of raw material. The cost of the raw material is $0.50 per pound. It takes six minutes of direct labor to produce one gadget. Direct labor employees are paid $15.00 per hour.

4) Monthly fixed and variable overhead and selling & administrative (S&A) expenses are estimated below. Fixed manufacturing overhead is allocated on the basis of direct labor hours. VARIABLE FIXED Manufacturing overhead (including depreciation) 30% of direct labor costs $20,000 Selling & Administrative Expenses $0.30 per unit sold $ 6,000

5) Gadgets will sell for $8.00 each. January sales are expected to be 8,000 units. Demand is expected to increase by 400 units per month until a level of 12,000 units per month is reached.

6) Gadgets, Inc.s inventory policy establishes the following required monthly ending inventory levels: Finished Goods: Maintain an ending inventory equal to one-half of the following month's expected sales. Raw Materials: Maintain an ending inventory quantity equal to three-fourths of the materials needed for the next month's production. Work-in-Process: Assume the month-end inventory is zero.

7) All sales are made to established credit customers with credit terms of net 90 days. No 3 sales discounts are offered for early payment. Twenty percent (20%) of payments for credit sales are expected to be received in the first month subsequent to the month of sale. Another sixty percent (60%) of payments are expected to be received in the second month after the sale. The remaining twenty percent (20%) of payments are expected to be received in the third month subsequent to the sale. (As an example, if January sales are $10,000, the company expects to receive payments of $2,000, $6,000 and $2,000 in February, March and April, respectively.)

8) Gadgets, Inc. has a credit arrangement with its raw materials vendor and purchases all materials on account with a basic invoice term of net 60 days. The company receives NO cash discounts for early payment of invoices. One-half of raw material purchases will be paid in the month of purchase. The remaining one-half will be paid in the first month subsequent to the purchase.

9) All other operating expenses will be paid in the month incurred.

10) The income tax rate is 24%. Estimated tax payments are made to the US Treasury on the last day of each quarter. Each quarterly payment is $5,000. Any balance due at year-end is recorded as a liability on the balance sheet. If taxes have been overpaid, the estimated refund is recorded as a receivable on the balance sheet.

11) The company requires a minimum ending monthly cash balance of $2,000 which must be reflected in the cash budget.

12) The proposed funding agreement with the bank is a line of credit of up to $100,000, effective January 1, 2019. The annual interest rate on the line of credit is 4%, payable on the last day of each month on the outstanding loan balance.

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In any month that the cash budget indicates ending monthly cash balance less than the required minimum cash balance; the company will borrow against the line of credit an amount sufficient to bring the ending cash balance up to the required $2,000 minimum. If the ending monthly cash balance is greater than the $2,000 required minimum, the excess cash will be used to repay the outstanding balance. Borrowings and repayments throughout the year will be budgeted in increments of $100. However, the company will budget for a final December payment that will reduce the line of credit balance to zero. Borrowing and repayments will occur on the last day of the month (not affecting the month end calculation of interest payment due that day.

Conditions: In calculating the month-end amount to borrow, it must be an amount sufficient to cover any cash deficit plus any amount due as interest for that month. Every month must end with a cash balance above the $2,000 minimum.

b) Repayments: Loan repayments are budgeted to be paid only if (1) there is a cash surplus at the end of the month, (2) the amount of the cash surplus exceeds any interest due that month, and (3) there is any balance due on the loan. The cash surplus must first be used to pay interest due, and then any remaining surplus can be used for repayment of the loan principal.

c) Loan Balance: Include a line in the cash budget to calculate the running principal balance of the line of credit. The loan balance at the end of any month is equal to the loan balance at the end of the previous month, plus any new borrowing in the current month, or minus any repayment in the current month.

d) Interest Payments: All borrowing and repayments take place on the last day of the month. Therefore, any interest to be paid in the current month is based on the loan balance at the end of the previous month.

e) Ending Cash Balance: The ending cash balance for each month is total cash receipts, minus total cash expenditures, plus the amount of net financing.

Financial budget Capital expenditures budget Cash budget Pro-forma balance sheet at December 31, 2019 Pro-forma statement of cash flows for the year ended December 31, 2019