08/12/2012       Chapter: 16                     Problem: 18                                             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.                                                                   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)                                               Collections                       During month of sale                     During 1st month after sale                   During 2nd month after sale                   Total collections                                             Purchases                       Labor and raw materials                   Payments for labor and raw materials                                         Payments                       Payments for labor and raw materials                 General and administrative salaries                   Lease payments                     Miscellaneous expenses                     Income tax payments                     Design studio payment                     Total payments                                             Net Cash Flows                     Cash on hand at start of forecast period                 Net cash flow (NCF):  Total collections – Total payments               Cumulative NCF:  Prior month cumulative + this month’s NCF                                       Cash Surplus (or Loan Requirement)                 Target cash balance                     Surplus cash or loan needed:  Cum NCF – Target cash                                           Max. Loan                                           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?                                                                                                                                             d.  If the company operates on a seasonal basis, how would this affect the current ratio and the debt ratio?                                                                                                                                                                                                                             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