Case 1: Cash Management
Ms. Am Truly is the new CFO of M and B, 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 M and B, Inc. The CEO of the company, Mr. LJackson, 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):
- 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?
- Why is depreciation expense (a large amount) not included in the cash budget?
- 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?
- 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?
- The sales estimates were provided by the sales department. Can we trust these figures? What can be done to overcome the forecasting risk?
Notes
- Mr. 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.
- 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.
- 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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