Question

Jeremy Slacker started the Del Fuego Surf Shop on January 1 after determining that business school classes conflicted with his preferred activity. He invested $62,000 in the shop—$47,080 of his own savings and $31,000 borrowed from an acquaintance. The loan is to be repaid in 5 years. Jeremy will pay the lender annual interest at a rate of 8 percent.

Shortly after opening, Jeremy realized that he is not the best financial planner and has come to you for help. With some prodding, you are able to establish that Jeremy plans to sell only two models of surfboard, the Zuma and the Coronado, for at least the first year. Data on the boards are given as follows.

	Zuma			Coronado
Expected annual sales (units)		768			384
Retail price (per unit)	$	410		$	710
Purchase cost (per unit)		340			460

Additional information on the planned operations for the year includes the following.

1. Equipment costing $52,000 was purchased for cash when the store opened. The equipment will be depreciated over five years using straight-line depreciation.
2. Because of the fantastic weather in Del Fuego, Jeremy expects sales to occur uniformly over the year. Sales will be both for cash (60 percent) and on account (40 percent). Sales on account are assumed to be collected in two months.
3. Jeremy will maintain inventory equal to one-half of a month’s sales. All boards will be purchased from the manufacturer on credit with payment made one month after purchase.
4. Annual cash selling, general, and administrative expenses are $15,248 fixed plus 10 percent of revenues.
5. Jeremy’s tax rate is 40 percent.

Problem 13-64 (Algo) Cash Budgets and Sensitivity Analysis in a Retail Firm (LO 13-5, 6, 7, 9)

Required:

a. Prepare a cash budget for the year.
b. Jeremy wants to ensure that he has cash on hand at the end of the year equal to 150 percent of the current accounts payable balance on December 31. Will he meet that requirement?
c. Consider only the assumption about the percentage of sales that will be made on account (currently 40 percent). What percentage would exactly achieve the goal set by Jeremy in requirement (b)?

Answer 1

a.
DEL FUEGO SURF SHOP
Cash Budget for the year
Opening Balance	-
Receipts
Own contribution	$47,080
Borrowings	$31,000
Cash Sales	$352,512
Receipts from Accounts receivable	$195,840
Total Receipts	$626,432
Payments
Investment in Shop	$62,000
Purchase of equipment	$0
Payment to Accounts payables	$419,520
Paid against Variable expenses	$58,752
Paid against Fixed expenses	$15,268
Interest on borrowings	$2,480
Tax paid	$25,144
Total Payments	$583,164
Closing balance	$43,268
b.
Computation of required cash balance at the year end
Accounts payable balance as on December 31		$36,480
Required cash balance at 150% of accounts payable as on December 31( $ 36,480 * 150%)		$54,720
Actual cash balance as per cash budget		$43,268
Shortfall		($11,452)
Since,there is a shortfall of $ 11,452, the requirement of maintaining cash
balance at 150% of account payable balance as on Dec 31
has not been met
c.
Computation of annual cash receipts required to meet the requisite
cash balance at 150% of accounts payable balance
Cash receipts as per cash budget		$548,352
Add: Shorfall of cash balance as computed in (b)		$11,452
Required Cash receipts to meet the requisite cash balance levels		$559,804
Computation of accounts receivable and sales on account the cash
receipts level computed above
Total Annual Sales		$587,520
Required Cash receipts to meet the requisite cash balance levels		$559,804
Accounts receivable balance		$27,716
Credit period in months		2.00
Monthly sales on account ( $ 27,716/2)		$13,858
Annual sales on account		$166,296
Bifurcation of Sales to achieve the goal set for cash balance
	Value	Percentage
Sale on accounts	$166,296	28%
Cash sales(balancing figiure)	$421,224	72%
Total Annual Sales	$587,520	100%
Computation of Cash receipts
Cash sales		$421,224
Sales on account	$166,296
Less: Accounts rec. balance	$27,716	$138,580
Total cash receipts		$559,804
Opening Balance	-
Receipts
Own contribution	$47,080
Borrowings	$31,000
Cash Sales	$421,224
Receipts from Accounts receivable	$138,580
Total Receipts	$637,884
Payments
Investment in Shop	$62,000
Purchase of equipment	$0
Payment to Accounts payables	$419,520
Paid against Variable expenses	$58,752
Paid against Fixed expenses	$15,268
Interest on borrowings	$2,480
Tax paid	$25,144
Total Payments	$583,164
Closing balance	$54,720
Working Notes
Computation of Total Sales
	Zuma	Coronado
Expected annual sales(units)	768.00	384
Retail price per unit	$410	$710
Sales Value	$314,880	$272,640
Total Sales Value		$587,520
Cash Sales @ 60%		$352,512
Sales on account @ 40%		$235,008
Computation of Accounts Receivable
Sales on account		$235,008
Monthly sales on account		$19,584
Credit period in months		2.00
Accounts receivable balance		$39,168
Computation of Purchase Value
	Zuma	Coronado
Total Quantity Sold	768.00	384
Total Quantity Consumed	768.00	384
Monthly quantity consumed	64.00	32.00
Inventory level at one half of next month's sales	32.00	16.00
Total Quantity Consumed	768.00	384
Required Inventory Levels	32.00	16
Total Purchase Quantity	800.00	400.00
Purchase Cost per unit	$340	$460
Purchase Cost	$272,000	$184,000
Total Purchase Cost		$456,000
Since,extra quantity is purchased in the first month to maintain required inventory levels,the purchase breakup would be as under
	Zuma	Coronado
Purchase in January
Monthly quantity consumed	64.00	32.00
Required Inventory Levels	32.00	16.00
	96.00	48.00
Purchase Cost per unit	340.00	460.00
Total Purchase Cost	$32,640	$22,080
Total Purchase Cost in January		$54,720
Computation of Accounts payable on Dec 31
Annual Purchase		$456,000
Less: Purchase in January		$54,720
Total Purchase in February to December		$401,280
Average Monthly Purchase in February to December		$36,480
Accounts Payable @ one month's purchase		$36,480
Computation of Tax payable
Income Statement for the year
Revenue		$587,520
Less:
Cost of goods sold		$437,760
Gross profit		$149,760
Expenses
Variable expenses		$58,752
Fixed expenses		$15,268
Depreciation		$10,400
Interest		$2,480
Profit before tax		$62,860
Less: Tax @ 40%		$25,144
Profit after tax		$37,716
Computation of Depreciation on equipment
Purchase cost of equipment		$52,000
Useful life in years		5.00
Depreciation on straight line method		$10,400
Computation of interest on borrowings
Amount borrowed		$31,000
Rate of interest		8%
Annual interest		$2,480