Refer to the opening feature about Sseko Designs. Assume that Liz Forkin Bohanno

Question

Refer to the opening feature about Sseko Designs. Assume that Liz Forkin Bohannon reports current annual sales at approximately $1 million and prepares the following income statement.

Sseko Designs Income Statement for year ended January 31, 2014

Net Sales……………………………….$1,000,000

Cost of sales…………………….……..…..610,000

Expenses (other than cost of sales)….….200,000

Net Income………………………...…..….$190,000

Liz Forkin Bohannon sells to individuals and retailers, ranging from small shops to large chains. Assume that she currently offers credit terms of 1/15, n/60, and ships FOB destination. To improve her cash flow, she is considering changing credit terms to 3/10, n/30. In addition, she proposes to change shipping terms to FOB shipping point. She expects that the increase in discount rate will increase net sales by 9%, but the gross margin ratio (and ratio of cost of sales divided by net sales) is expected to remain unchanged. She also expects that delivery expenses will be zero under this proposal; thus, expenses other than cost of sales are expected to increase only 6%. Required 1. Prepare a forecasted income statement for the year ended January 31, 2015, based on the proposal. 2. Based on the forecasted income statement alone (from your part 1 solution), do you recommend that Liz implement the new sales policies? Explain. 3. What else should Liz consider before deciding whether or not to implement the new policies? Explain.

Explanation / Answer

1. Chane in net sales = 1+9% = 1.09 times the old sales. Thus new sales after changing the credit terms = 1,000,000*1.09 = $1,090,000.

Now gross margin ratio = gross profit/sales. gross profit = net sales - cost of sales. Gross profit of the earlier situation = 1,000,000 - 610,000 = 390,000. Gross margin = 390,000/1,000,000 = 39%.

Now the gross margin will remain unchanged at 39%. Thus 39% = gross profit in the new situation/1,090,000

or gross profit = 39% of 1,090,000 = $425,100

Cost of sales = sales - gross profit = 1,090,000-425,100 = $664,900

Now, new expenses (other than cost of sales) = 1+6% = 1.06 times of old expenses = 1.06*200,000 = $212,000

1. Based on the calculations done above, the forecasted income statement is given below:

2. In the old situation, net margin was 190,000/1,000,000 = 19%. Net margin now is 213,100/1,090,000 = 20%. So, under the new scheme both the topline (revenue) as well as the bottom line (profit) are growing and hence the new sales policy should be implemented.

3. Liz should also consider the numebr of customers as a percentage of total customers are availing discount under the existing credit terms and how many more are expected to avail of higher discount under the new credit scheme. If very few people avail the credit terms then her cash flow position will not improve (which is her main goal).

Net sales 1,090,000.00 less: Cost of sales 664,900.00 Gross profit 425,100.00 less: expenses (other than cost of sales) 212,000.00 Net income 213,100.00

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