16-10 CASH BUDGETING Helen Bowers, owner of Helen’s Fashion Designs, is

planning to request a line of credit from her bank. She has estimated the following sales
forecasts for the firm for parts of 2015 and 2016:

Estimates regarding payments obtained from the credit department are as follows: collected
within the month of sale, 10%; collected the month following the sale, 75%; collected the
second month following the sale, 15%. Payments for labor and raw materials are made the
month after these services were provided. Here are the estimated costs of labor plus raw
materials:

General and administrative salaries are approximately $27,000 a month. Lease payments
under long-term leases are $9,000 a month. Depreciation charges are $36,000 a month.
Miscellaneous expenses are $2,700 a month. Income tax payments of $63,000 are due in
September and December. A progress payment of $180,000 on a new design studio must be
paid in October. Cash on hand on July 1 will be $132,000, and a minimum cash balance of
$90,000 should be maintained throughout the cash budget period.
a. Prepare a monthly cash budget for the last 6 months of 2015.
Cash Budget from July to December 2016

Month July August September October November December

Opening Cash 132000 201300 387600 90000 222300 363600

Add: Collections from

Debtors 198000 351000 531000 657000 414000 333000

Less: Labor and Raw

Material Payment 90000 126000 882000 306000 234000 162000

Less: General and

Admin Salaries 27000 27000 27000 27000 27000 27000

Less: Lease Payments 9000 9000 9000 9000 9000 9000

Less: Misc. Expenses 2700 2700 2700 2700 2700 2700

Less: Income Tax 63000 63000

Less: Progress
Payment 180000

Add: Financing
Required 155100

Closing Cash Balance 201300 387600 90000 222300 363600 432900

Collection from Debtors

Septembe Novem Decem

Month May June July August r October ber ber

Sale 180000 180000 360000 540000 720000 360000 360000 90000

Received in
Month 10% 18000 18000 36000 54000 72000 36000 36000 9000

Received in
Next one
Month 75% 135000 135000 270000 405000 540000 270000 270000

Received in
second Month
15% 27000 27000 54000 81000 108000 54000
Total Cash
Received in
Month 18000 153000 198000 351000 531000 657000 414000 333000

b. Prepare monthly estimates of the required financing or excess funds—that is, the
amount of money Bowers will need to borrow or will have available to invest.

Month July August September October November December

Opening Cash 132000 90000 90000 90000 90000 90000

Add: Collections from

Debtor’s 198000 351000 531000 657000 414000 333000

Less: Labor and Raw

Material Payment 90000 126000 882000 306000 234000 162000

Less: General and

Admin Salaries 27000 27000 27000 27000 27000 27000

Less: Lease Payments 9000 9000 9000 9000 9000 9000

Less: Misc Expenses 2700 2700 2700 2700 2700 2700

Less: Income Tax 63000 63000

Less: Progress
Payment 180000

Closing Cash Balance

before adjustment 201300 276300 -362700 222300 231300 159300

Add/ Less Adjustment

for Balance 111300 186300 -452700 132300 141300 69300

Closing Balance after

Adjustment 90000 90000 90000 90000 90000 90000

Investment 111300 186300 0 132300 141300 69300

Financing 0 0 452700 0 0 0

c. Now suppose receipts from sales come in uniformly during the month
(that is, cash receipts come in at the rate of 1/30 each day), but all outflows must be
paid on the 5th. Will this affect the cash budget? That is, will the cash budget you
prepared be valid under these assumptions? If not, what could be done to make a valid
 estimate of the peak financing requirements? No calculations are required, although if
you prefer, you can use calculations to illustrate the effects.

The assumption made with regard to the above prepared budget is that all inflow
& outflows are occurring uniformly throughout the month. However, in this case, there
will be a cash flow mismatch since payments need to be paid on 5th of the month while
inflows will come uniformly during the month. For this reason, there is need for the
company to take the short- term finance facility from the bank. The company will have
to take a finance of total outflow amount in the first month i.e. 5 days receipts of cash in
that month. This amount can then be repaid by the end of the month. In this way the
estimate of cash budget can be prepared.

d. Bowers’ sales are seasonal; and her company produces on a seasonal

basis, just ahead of sales. Without making any calculations, discuss how the company’s
current and debt ratios would vary during the year if all financial requirements were
met with short-term bank loans. Could changes in these ratios affect the firm’s ability to
obtain bank credit? Explain.

The company will continue to produce goods during the off season. Secondly, the
short-term bank loan will increase the company’s debt ratio. Thirdly, because of
increase in production there will be an increase in stock. This will in turn result in the
increase in current assets thereby increasing the current ratio of the company.
Because of seasonal sales, there will be a mismatch in the company’s working
capital. On overall the credit position of the company will remain the same. However, it
will only be able to obtain short term loans but not long term ones.