Solution 12/8/2012
Chapter: 16
Problem: 18
Input Data
Collections during month of sale 15%
Collections during month after sale 65%
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
Rusty Spears, CEO of Rusty’s 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.
Note: When the percent collected
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
Net Cash Flows
Cash on hand at start of forecast period $60,000
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)
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?
Answer: No. In the first month, only a little of the cash would have come in by the 5th, but all of the payments
d. If the company operates on a seasonal basis, how would this affect the current ratio and the debt ratio?
Answer: Just before the busy season, the company would have some current assets, but not very much, and it
Answer: The “Sales adjustment factor” can be used to cause sales to vary from the base levels. Similarly, we
can change the percentage of late paying customers. Here is the relevant data table:
Change
in Sales
$49,000 0% 20% 30% 45% 60% 75% 90%
Maximum Loan Required
% Collections in 2nd month
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.
Total payments $112,000 $117,000 $117,000 $162,000 $72,000 $67,000