PLEASE SHOW WORK RR’S CASH BUDGET FOR JANUARY AND FEBRUARY November December Jan

Question

PLEASE SHOW WORK

RR’S CASH BUDGET FOR JANUARY AND FEBRUARY

November December January February March April Sales

(1) Sales (Gross) $71,218 $68,212.00 $65,213.00 $52,475.00 $42,909 $30,524

Collections:

(2) During Month Of Sale

(0.2)(0.98)(Month’s Sales) 12,781.75 10,285.10

(3) During First Month After Sale

0.7(Previous Month’s Sales) 47,748.40 4 5,649.10

(4) During Second Month After Sale

0.1(Sales 2 Months Ago) 7,121.80 6,821.20

(5) Total Collections (Lines 2 + 3 + 4) $67,651.95 $62,755.40

Purchases:

(6) 0.85(Forecasted Sales

2 Months From Now) $44,603.75 $36,472.65 $25,945.40

Payments

(7) Payments For Purchases 44,603.75 36,472.65

(8) Wages And Salaries 6,690.56 5,470.90

(9) Rent 2,500.00 2,500.00

(10) Taxes

(11) Total Payments $53,794.31 $44,443.55

Net Cash Flows

(12) Cash At Beginning Of Forecast $ 3,000.00

(13) Net Cash Flow: Collections – Payments $13,857.64 $18,311.85

(14) Cumulative NCF (Prior mos. + this mos. NCF) 16,857.64 35,169.49

Cash Surplus (or Loan Requirement)

(15) Target Cash Balance 1,500.00 1,500.00

(16) Surplus Cash Or Loan Needed $15,357.64 $33,669.49

4. Should depreciation expense be explicitly included in the cash budget? Why or why not?

5. In her preliminary cash budget, Johnson has assumed that all sales are collected and thus that RR has no bad debts. Is this realistic? If not, how would bad debts be dealt with in a cash budgeting sense? (Hint: Bad debts will affect collections but not purchases.)

6. Johnson’s cash budget for the entire year, although not given here, is based heavily on her forecast for monthly sales. Sales are expected to be extremely low between May and September but then to increase dramatically in the fall and winter. November is typically the firm’s best month, when RR ships its holiday blend of coffee. Johnson’s forecasted cash budget indicates that the company’s cash holdings will exceed the targeted cash balance every month except for October and November, when shipments will be high but collections will not be coming in until later. Based on the ratios shown earlier, does it appear that RR’s target cash balance is appropriate? In addition to possibly lowering the target cash balance, what actions might RR take to better improve its cash management policies, and how might that affect its EVA?

7. What reasons might RR have for maintaining a relatively high amount of cash?

Explanation / Answer

Answer:

4. No, depreciation expense is a noncash charge ad should not appear in the cash budget that focus on the actual cash flowing into and out of a firm. However, a firm's depreciation expense impact the tax liaiblity and hence affect RR's quarterly payments.

5. It is not right to assume zero bad debts. When credit is granted, bad debts should be expected. Each month collections would reduced the percentage of bad debts. Payment would not be changed, therefore the result would be the loan balances would be greater and cash surplus balances would be smaller by the difference in the collection amounts.

6. The company's turnover and projected cash budget indicate that the company is holding too much cash. RR can improve its EVA by investing the cash in productive assets or returning the cash to the shareholders. If RR uses cash for profitable investments, its costs remains the same but its operating income will increase, hence increasing EVA. Also, if the company returns the cash to the shareholders by increasing the dividend or repurchasing the shares, the company's revenue would remain the same, but its cost of capital and hence increasing EVA.

7. If sales turn out to be considerable less than expected, the company can face a cash shortfall. A company may hold large cash amounts if it does not have faith in its sals forecast or it is very conservative. Unfortunately, given the current pressure to perform, RR's management does not have luxury to be conservative.

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