a. Mike Epstein is very optimistic because sales for his feed store are expected to double from $800,000 to $1,600,000 next year. His net assets (Assets – Liabilities) will remain at 50% of sales. The company will enjoy a 10 percent return on total sales. He will start the year with $120,000 in the bank and is bragging about the nice fishing boat he will soon be able to buy. Does his optimistic outlook for his cash position appear to be correct? Compute his likely cash balance or deficit for the end of the year. Start with beginning cash and subtract the asset buildup (equal to 50% of the sales increase) and add in profit.
b. In the above problem, if there had been no increase in sales and all other facts were the same, what would Mike’s ending cash balance be? What lesson does the solution of the two problems illustrate?
c. Buzz Air’s actual sales and purchases for April and May are shown here along with forecasted sales and purchases for June through September.
Sales Purchases
April (actual) $420,000 $220,000
May (actual) 390,000 210,000
June (forecast) 400,000 200,000
July (forecast) 350,000 250,000
August (forecast) 410,000 300,000
September (forecast) 430,000 220,000
The company makes 10 percent of its sales for cash and 90 percent on credit. Of the credit sales, 20 percent are collected in the month after the sale and 80 percent are collected two months later. Buzz Air pays for 40 percent of its purchases in the month after purchase and 60 percent two months after.
Labor expense equals 10 percent of the current month’s sales. Overhead expense equals $15,000 per month. Interest payments of $40,000 are due in June and September. A cash dividend of $20,000 is scheduled to be paid in June. Tax payments of $35,000 are due in June and September. There is a scheduled capital outlay of $300,000 in September.
Buzz Air’s ending cash balance in May is $20,000. The minimum desired cash balance is $15,000. Prepare a schedule of monthly cash receipts, monthly cash payments, and a complete monthly cash budget with borrowing and repayments for June through September. The maximum desired cash balance is $50,000. Excess cash (above $50,000) is used to buy marketable securities. Marketable securities are sold before borrowing funds in case of a cash shortfall (less than $15,000)
a. To determine Mike Epstein's likely cash balance or deficit for the end of the year, we need to consider the starting cash balance, asset buildup, and profit. Here are the steps to calculate it:
1. Starting Cash Balance: Mike starts the year with $120,000 in the bank.
2. Asset Buildup: Since the sales are expected to double from $800,000 to $1,600,000, the asset buildup (equal to 50% of the sales increase) would be 50% of ($1,600,000 - $800,000) = $400,000.
3. Profit: The company will enjoy a 10 percent return on total sales. Therefore, the profit would be 10% of $1,600,000 = $160,000.
4. Cash Balance/Deficit: To calculate the likely cash balance or deficit at the end of the year, we add the starting cash balance, subtract the asset buildup, and add the profit: $120,000 - $400,000 + $160,000 = -$120,000.
Based on this calculation, Mike's optimistic outlook for his cash position does not appear to be correct. He is likely to end the year with a cash deficit of $120,000.
b. If there had been no increase in sales and all other facts remained the same, we can calculate Mike's ending cash balance using the same steps as above, but without considering the asset buildup:
1. Starting Cash Balance: $120,000.
2. Asset Buildup: $0 (as there is no increase in sales).
3. Profit: 10% of $800,000 (current sales) = $80,000.
4. Cash Balance/Deficit: $120,000 - $0 + $80,000 = $200,000.
The solution to these two problems illustrates the importance of sales growth in impacting the cash position of a business. Without sales growth, the cash balance remains relatively stable or improves due to profits. However, when sales grow significantly, especially when the asset buildup exceeds profit, it can result in a negative cash balance or deficit.
c. To prepare the cash budget for Buzz Air for June through September, let's calculate the monthly cash receipts and payments based on the given information and the provided formulas:
- Monthly Cash Receipts:
1. Sales for cash: 10% of total sales for the month.
2. Credit Sales collected in the month after the sale: 20% of total credit sales for the month.
3. Credit Sales collected two months later: 80% of total credit sales two months prior.
- Monthly Cash Payments:
1. Purchases paid in the month after purchase: 40% of total purchases for the month.
2. Purchases paid two months after purchase: 60% of total purchases two months prior.
3. Labor expense: 10% of current month's sales.
4. Overhead expense: $15,000 per month.
5. Interest payments, tax payments, dividends, and capital outlay (as provided).
- Cash Budget:
1. Starting Cash Balance: $20,000 in May.
2. Minimum Desired Cash Balance: $15,000.
3. Maximum Desired Cash Balance: $50,000.
Using these guidelines, you can calculate the monthly cash receipts and payments to prepare a comprehensive cash budget with borrowing and repayments for June through September.