FNCE371 Applications in Corporate Finance

October 18, 2022   Essayheroes

Cash Management

Ms. Amanda Truly is the new CFO of Mind and Body, Inc., which produces popular yoga and Pilates videos. Ms. Truly is concerned about the company’s cash flow management, and would like to get a better “feel” for the way cash flows are managed at Mind and Body, Inc. The CEO of the company, Mr. Lawrence Jackson, is worried about the company’s cash situation. Although the company has consistently produced positive net income, the level of its short-term borrowing is worrisome. Mr. Jackson would like Ms. Truly to construct a cash budget for next year so that they can devise a short-term financial policy that would effectively suit the company’s cash flows.

To this end, Mr. Jackson has provided Ms. Truly with the company’s most recent Statement of Comprehensive Income, Statement of Financial Position, and Cash Budget, and the following disparate information:

  • Purchases from suppliers = 70% of predicted sales for the next month
  • Accounts payable period = 30 days
  • Wages and other expenses = 20% of predicted sales
  • Capital expenditures (computer system purchase) in June = $500,000
  • Long-term debt interest expense = $50,000
  • Dividends = $30,000 per quarter
  • Minimum cash balance = $200,000
  • Short-term cost of borrowing = 13% APR, compounded monthly
  • Long-term cost of borrowing = 10% APR, compounded monthly
  • Income taxes from last year’s income will be paid monthly in this year
  • Interest expense on accumulated short-term expense must be paid in the following month
  • Customer payments: 50% in the month of sales, 30% pay in the month after sales, and 20% two months after sales
  • Bad debt = ~ 2% if customers have not made payment after 60 days
Table 1: Last Year’s Statement of Comprehensive Income
Sales $10,944,250
Cost of goods sold 7,660,975
Wages and other expenses 2,188,850
Earnings before depreciation, interest, and taxes 1,094,425
Depreciation 100,000
Earnings before interest and taxes 994,425
Interest expense 603,760
Taxable income 390,665
Taxes 140,640
Net income 250,025
     Dividends 120,000
     Additions to retained earnings 130,025

 

 

 

Table 2: Last Year’s Statement of Financial Position
Cash $200,000 Accounts payable 140,000
Inventory 140,000 Notes payable 41,520
Accounts receivable 792,080    Current liabilities 181,520
   Current assets 1,132,080
Long-term debt 6,000,000
Common stock 2,500,000
   Net fixed assets 9,004,814 Retained earnings 1,455,374
   Total owners’ equity 3,955,374
Total assets 10,136,894 Total liabilities & owners’ equity 10,136,894

 

Table 3: Cash Budget

Cash collections:
January February March April May June
Sales 185,000 370,000 740,000 2,035,000 203,500 407,000
Month 0 collections 92,500 185,000 370,000 1,017,500 101,750 203,500
Month -1 collections 540,000 55,500 111,000 222,000 610,500 61,050
Month -2 collections 172,872 352,800 36,260 72,520 145,040 398,860
   Total collections 805,372 593,300 517,260 1,312,020 857,290 663,410
Beginning accounts receivable 1,076,400 452,500 222,000 444,000 1,165,500 508,750
Sales 185,000 370,000 740,000 2,035,000 203,500 407,000
Cash collections 805,372 593,300 517,260 1,312,020 857,290 663,410
Ending accounts receivable 452,500 222,000 444,000 1,165,500 508,750 244,200
Cash disbursements:
January February March April May June
Beginning accounts payable 129,500 259,000 518,000 1,424,500 142,450 284,900
Purchases 259,000 518,000 1,424,500 142,450 284,900 466,200
Payment of accounts Payable 129,500 259,000 518,000 1,424,500 142,450 284,900
Ending accounts payable 259,000 518,000 1,424,500 142,450 284,900 466,200
             
 

 

 

            
             
             
Payment of accounts payable 129,500 259,000 518,000 1,424,500 142,450 284,900
Wages and other expenses 37,000 74,000 148,000 407,000 40,700 81,400
Taxes 20,833 20,833 20,833 20,833 20,833 20,833
Capital expense 0 0 0 0 0 0
ST interest expense 400 0 0 0 897 0
LT interest expense 50,000 50,000 50,000 50,000 50,000 50,000
Dividends 0 0 30,000 0 0 30,000
Cash disbursements 237,733 403,833 766,833 1,902,333 254,880 467,133
Cash collections 805,372 593,300 517,260 1,312,020 857,290 663,410
Cash disbursements 237,733 403,833 766,833 1,902,333 254,880 467,133
Net cash inflow 567,639 189,467 –249,573 –590,313 602,410 196,277
Cash Budget:
January February March April May June
Beginning cash balance 200,000 767,639 957,105 707,532 200,000 719,629
Net cash inflow 567,639 189,467 –249,573 –590,313 602,410 196,277
Ending cash balance 767,639 957,105 707,532 117,219 802,410 915,905
Minimum cash balance 200,000 200,000 200,000 200,000 200,000 200,000
Surplus/deficit 567,639 757,105 507,532 –82,781 602,410 715,905
Short-term borrowing 0 0 0 82,781 0 0
Repayment of ST debt 0 0 0 0 82,781 0
Cumulative ST debt 0 0 0 82,781 0 0
ST interest expense 0 0 0 897 0 0

 

 

Table 3: Cash Budget (Cont.)

 

Cash collections:
July August September October November December
Sales 666,000 2,442,000 305,250 610,500 980,000 2,000,000
Month 0 collections 333,000 1,221,000 152,625 305,250 490,000 1,000,000
Month -1 collections 122,100 199,800 732,600 91,575 183,150 294,000
Month -2 collections 39,886 79,772 130,536 478,632 59,829 119,658
   Total collections 494,986 1,500,572 1,015,761 875,457 732,979 1,413,658
Beginning accounts receivable 244,200 414,400 1,354,200 641,025 366,300 612,100
Sales 666,000 2,442,000 305,250 610,500 980,000 2,000,000
Cash collections 494,986 1,500,572 1,015,761 875,457 732,979 1,413,658
Ending accounts receivable 414,400 1,354,200 641,025 366,300 612,100 1,196,000
Cash disbursements:
July August September October November December
Beginning accounts payable 466,200 1,709,400 213,675 427,350 686,000 1,400,000
Purchases 1,709,400 213,675 427,350 686,000 1,400,000 140,000
Payment of accounts payable 466,200 1,709,400 213,675 427,350 686,000 1,400,000
Ending accounts payable 1,709,400 213,675 427,350 686,000 1,400,000 140,000
Payment of accounts payable 466,200 1,709,400 213,675 427,350 686,000 1,400,000
Wages and other expenses 133,200 488,400 61,050 122,100 196,000 400,000
Taxes 20,833 20,833 20,833 20,833 20,833 20,833
Capital expense 0 0 0 0 0 0
ST interest expense 0 0 2,464 0 0 0
LT interest expense 50,000 50,000 50,000 50,000 50,000 50,000
Dividends 0 0 30,000 0 0 30,000
Cash disbursements 670,233 2,268,633 378,022 620,283 952,833 1,900,833
Cash collections 494,986 1,500,572 1,015,761 875,457 732,979 1,413,658
Cash disbursements 670,233 2,268,633 378,022 620,283 952,833 1,900,833
Net cash inflow –175,247 –768,061 637,739 255,174 –219,854 –487,175
Cash budget:
January February March April May June  
Beginning cash balance 915,905 740,658 200,000 610,336 865,509 645,655
Net cash inflow –175,247 –768,061 637,739 255,174 –219,854 –487,175
Ending cash balance 740,658 –27,403 837,739 865,509 645,655 158,480
Minimum cash balance 200,000 200,000 200,000 200,000 200,000 200,000
Surplus/deficit 540,658 –227,403 637,739 665,509 445,655 –41,520
Short-term borrowing 0 227,403 0 0 0 41,520
Repayment of ST debt 0 0 227,403 0 0 0
Cumulative ST debt 0 227,403 0 0 0 41,520
ST interest expense 0 2,464 0 0 0 450

 

 

 

 

Table 4: Sales Forecasts for next 13 months

January 200,000
February 400,000
March 800,000
April 2,200,000
May 220,000
June 440,000
July 720,000
August 2,640,000
September 330,000
October 660,000
November 1,080,000
December 3,960,000
January 220,000

 

Mr. Jackson asks Ms. Truly to produce a report on the current state of the company’s cash flows and short-term financing needs for a meeting next week. Ms. Truly wrote down the following tasks that must be completed prior to writing her report:

  • Construct the monthly cash collections table.
  • Construct the monthly cash disbursements table.
  • Calculate the monthly net cash inflow.
  • Construct the monthly cash budget.

In the report, Ms. Truly plans to include the cash budget as well as answers to the following questions (just sent in by Mr. Jackson):

  1. What will be the predicted monthly cash deficits and surpluses, and how much short-term financing will the company need in the coming year? What can be inferred from the pattern of cash deficits and surpluses, and the pattern of requirements for short-term financing?
  2. Why is depreciation expense (a large amount) not included in the cash budget?
  3. Evaluate the company’s minimum cash reserve policy. What would happen to the cash budget if we changed the minimum cash reserve to $0? To $5,000? To $50,000? To $500,000? Should the company stick with its $200,000 minimum cash balance?
  4. The Bank of Scotia is offering to invest the company’s surplus cash at 6% APR compounded semi-annually for a fee of $2,000 per year, payable at the end of the year. Earnings on the investment will be calculated and deposited at the end of each month. Should the company invest with the bank?
  5. The sales estimates were provided by the sales department. Can we trust these figures? What can be done to overcome the forecasting risk?

 

 

Notes

  1. Jackson has told Ms. Truly that he does not like looking at Excel spreadsheets (he actually said, “these gobbledygooks give me a headache”), and he requested that Ms. Truly not show him any. He would prefer a word-processed document containing the cash budget and analyses.
  2. To make things easier and more efficient, Ms. Truly asked the office intern (Mr. John Jones, a third-year student in the Princess University undergraduate business program) to build a spreadsheet program that will allow them to simply enter the sales figures and quickly produce the cash budget. Mr. Jones did that, but unfortunately, he returned to his studies before he could check the accuracy of the spreadsheet program. There appears to be some errors in the program, as the numbers did not add up when Ms. Truly input the sales figures from last year. Ms. Truly can either look through the spreadsheet program (Cash Budget Builder.xlsx) and find and fix the errors, or build her own cash budget manually.
  3. Note to students: Since setting up and building a budget spreadsheet is a big undertaking, you may choose to use the incorrect spreadsheet program (Cash Budget Builder.xlsx). If you do, make sure that you find and fix the errors before you do your case study analysis. One way to know that the errors have been fixed is when your cash budget reveals the same numbers as the one provided in the case.

Marking Rubric

Item Available marks
Cash Budget 40
1 10
2 5
3 25
4 15
5 5
   Total 100

 

 

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