CASE 5-1 You are the Chief Financial Officer (CFO) for Zen Distributors, Inc., a
ID: 2461517 • Letter: C
Question
CASE 5-1
You are the Chief Financial Officer (CFO) for Zen Distributors, Inc., a media broker that secures shelf space in independent bookstores for small publishing companies. As a member of the company’s executive team, you are preparing the operating budget for the fourth quarter of 2015. Your intent is to summarize the budget for team members and provide them with detailed schedules that support your overview.
Zen’s general ledger provides you with current account data on September 30, 2015 (the end of the third quarter) of operations:
Accounts (account amounts in thousands of dollars)
Debit
Credit
Cash
$ 8,000
Accounts receivable
20,000
Inventory
36,000
Buildings and equipment, net of depreciation
120,000
Accounts payable
$ 21,750
Common stock
150,000
Retained earnings
12,250
Totals
$184,000
$184,000
Jack Closer, Vice President of Sales, estimated that sales should increase slightly from their fourth quarter levels of the previous year. Per your request, he forwarded his monthly fourth quarter sales estimates to you, along with the current month’s actual sales and his forecast for January 2016.
Month
Sales
September (actual)
$ 50,000
October
60,000
November
72,000
December
90,000
January 2016
48,000
You next met with Mary Balance, Zen’s Controller. Ms. Balance informed you that the company prices its products in order to ensure a 25% gross profit margin on sales. Zen has met that margin throughout the first three quarters of 2006, and she was confident that the firm would meet this target margin in the near term. Mary also told you that, on average, 60% of Zen’s customer pay in cash. Those customers receive a one percent discount on the invoice price. The remaining 40% of the customers pay on account.
Credit sales terms are n/2EOM. This means credit customers must pay the full invoice price by the end of the month following the month in which they purchased merchandise. Mary explained, “Our customers are pretty sophisticated, and they constantly manage their cash flows--just as we do. Consequently, if we make a credit sale in October, they will pay us by the end of November.”
Mary also stated that Zen typically writes off 1% of credit customer accounts as uncollectible. She added that despite this policy, no writes offs were currently pending as of September 30 and none were expected to originate from third quarter activity. She stated, “In other words, we have a clean slate for the fourth quarter budget. We will collect all of the $20,000 accounts receivable balance at September 30 by the end of October. Therefore, bad debt expense and the allowance for doubtful accounts have zero balances at September 30, and we need to reestablish them for fourth quarter bad debts. We will write off 2015 fourth quarter bad debts sometime during 2016.”
Mary also provided you with third quarter monthly expense data to assist in constructing your budget. The next table presents that information:
Monthly Expense Item
Amount
Administration
$2,500
General
6% of sales
Commissions
12% of sales
Depreciation
$850
She concluded that, “As you know, we pay our operating expenses in the month we accrue them.”
Procurement officer Jim Washburn managed inventory so that its ending balance equaled 80% of the next month’s cost of goods sold. He also stated that the accounts payable clerk pays one-half of each month’s inventory cost in the month of acquisition, and the remaining 50% in the following month.
Ashleigh McNamara, head of capital expenditures, informed you that Zen will make a cash purchase of $1,500 worth of hand-held scanning devices in early October. Per corporate policy, the firm will depreciate this equipment over thirty months on a straight-line basis. Ashleigh added, “They’ll be useless at the end of that time, so we will scrap them.”
In your role as CFO, you insist that Zen maintain an ending monthly cash balance of $4,000 in order to remain financially flexible. The company has an open line of credit with its banking partner to ensure that it can meet its cash balance goal. This agreement mandates a 12% annual interest rate for all short-term borrowings. Financing must take place at the beginning of the month in thousand dollar multiples. Repayments of borrowing must also occur in thousand dollar increments, and the bank only accepts interest payments when Zen repays principal.
Required:
Compose a memorandum to Zen’s management team that highlights the key aspects of the 2015 fourth quarter operating budget. Supplement your summary with budgetary schedules and attach them to the executive summary. The budgetary flow that you select is as follows:
Cash collections
Inventory purchases
Cash disbursements for purchases
Cash disbursements for operating expenses
Overall cash budget (collections, disbursements, and financing)
You construct each of the above budgets on a monthly and quarterly basis. You may find it beneficial to construct your budgetary schedules in the manner presented in this chapter.
Finally, you conclude your budgets with a projected (pro-forma) income statement for the fourth quarter and a pro-forma balance sheet as of December 31. The company has a zero percent income tax rate, due to previous tax losses.
Accounts (account amounts in thousands of dollars)
Debit
Credit
Cash
$ 8,000
Accounts receivable
20,000
Inventory
36,000
Buildings and equipment, net of depreciation
120,000
Accounts payable
$ 21,750
Common stock
150,000
Retained earnings
12,250
Totals
$184,000
$184,000
Explanation / Answer
Cash Collection Oct Nov Dec Fourth Qtr january Sales $60,000 72000 90000 $222,000 48000 Sept 20000 - - $20,000 Oct $35,640.00 $23,760.000 $59,400 Nov - $42,768.00 28512 $71,280 Dec - - 53460 $53,460 Totals 55640 66528 81972 $204,140 Accounts Receivable on 31 Dec 90000*40% 36000 Gross: Add (60000+70000)*..004 528 Total 36528 Allowance for 3 months $888.000 Cash sale is 59.4% after discount Credit sale is 39.6% after allowance Inventory Purchases October November December 4th Quarter January Beginning inventory 36000 $43,200.00 $54,000.00 36000 Purchases $52,200.00 $64,800.00 $42,300.00 $159,300 Goods available $88,200.00 $108,000.00 $96,300.00 $195,300 Ending inventory 80% of COGS of next month $43,200.00 $54,000.00 $28,800.00 $28,800.00 COGS $45,000.00 $54,000.00 $67,500.00 $166,500.00 $36,000.00 Cash Disbursements for October November December 4th Quarter Purchases and Operating Expenses Last month's Inventory Purchases 21750 $26,100.00 $32,400.00 80250 This month's Inventory Purchasees $26,100.00 $32,400.00 $21,150.00 79650 Administration 2500 2500 2500 7500 General $3,600.00 $4,320.00 $5,400.00 13320 Commission $7,200.00 $8,640.00 $10,800.00 26640 Equipment 1500 0 0 1500 62650 73960 72250 208860 Cash Budget Oct Nov Dec Fourth Qtr Beg. balance 8000 4990 4558 8000 Cash collections 55640 66528 81972 204140 Cash inflow 63640 71518 86530 212140 Cash payment 62650 73960 72250 208860 Net cash 990 -2442 14280 14280 Borrowing 4000 7000 -10000 -10000 Repayment ofprincipal 0 Repayment of interest 0 -260 -260 (4000*0.03)+(7000*0.02) Ending balance 4990 4558 4020 4020 Pro Forma Income Statement October November December 4th Quarter Revenues $60,000 $72,000 $90,000 $222,000 COGS $45,000.00 $54,000.00 $67,500.00 $166,500.00 Gross margin $15,000.00 $18,000.00 $22,500.00 $55,500.00 General & Commission (Combined) $10,800.00 $12,960.00 $16,200.00 $39,960.00 Adminstration 2500 2500 2500 $7,500.00 Depreciation 900 900 900 $2,700.00 Sales discounts $360.000 $432.000 $540.000 $1,332.000 Bad debt expense $240.000 $288.000 $360.000 $888.000 Interest expense 40 110 110 $260.000 Net Income $160.00 $810.00 $1,890.00 $2,860.00 Pro Forma Balance Sheet Cash 4020 A/R (gross) 36528 Less: AFDA* $888.000 $35,640.000 Inventory $28,800.00 Net current assets 68460 Fixed assets 121500 Less: depreciation $2,700.00 $118,800.00 Total assets $187,260.00 Accounts payable $21,150.00 Notes payable (line of credit) 1000 Current liabilities $22,150.00 Stockholders' Equity: Common stock 150000 Retained earnings $15,110.00 Total S/Equity $165,110.00 Total Liab. and S/E $187,260.00 * Allowance for doubtful accounts
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