The November through February months represent a seasonal slow down for Green\'s

Question

The November through February months represent a seasonal slow down for Green's Lawn Care & Services Co. Green's has some winter services, but they do not generate as much revenue as their standard summer services. Because of this seasonal down turn, the firm develops a cash budget in order to plan for possible short falls. Based on historical trends, the firm's economic forecasting staff has provided the information below. All of Green's sales are on a credit basis, and 90% are collected in the month following the sale. The remaining 10% are collected two months after the sale. "Material expenses" are 40% of the current month’s sales and are paid in the month incurred. All wages and overhead are also paid in the month incurred. As part of the firm's extension of its services, a monthly payment for new equipment of $300 is required through the end of 2003. In February the firm must repay a $13,000 note. Due to a settlement of a lawsuit, Green's will receive $50,000 at the end of December, resulting in an end cash balance for December of $65,000. The firm’s required minimum cash balance is $60,000. The firm has an agreement with a bank; a line of credit allows it to borrow up to $45,000 and it is the firm’s policy to repay outstanding balances as soon as excess cash is available. Based on the cash budget you prepare for the months of January through March, will the firm have to increase its line of credit in order to meet its borrowing needs?

Month

Question options:

a) No, the firm’s maximum borrowing needs are $13,400

b) No, the firm’s maximum borrowing needs are $18,500

c) No, the firm’s maximum borrowing needs are $32,000

d) Yes, the firm’s maximum borrowing needs are $51,350

Month

Estimated Sales Wages Overhead (Cash) November, 2002 $25,000 $7,000 $3,000 December, 2002 27,000 8,000 4,000 January, 2003 25,000 7,000 3,000 February, 2003 10,000 5,000 2,000 March, 2003 50,000 10,000 7,000

Explanation / Answer

Based on the information provided in the passage, we have to calculate the Cash Budget for the Months of January 2003 to March 2003. However we will start the cash budget calculations from the Month of November 2002. As 90% of sales are collected in Following Month and 10% collected after 2 Month. That means 90% of sales of November 2002 are collected in December 2002 and 10% collected in January 2003

Maximum Borrowing Need = Borrowing Limit - Lowest Closing Balance of Credit

= 45000-26600= 18400.

Closest Correct Option is B

Item Januray 2003 February 2003 March 2003 Opening Cash Balance 60000 60000 60000 Cash Sales colletd in the Month 26800 25200 11500 Less Material Expenses at 40 % of sales for the current Month 10000 4000 20000 Less Wages 7000 5000 10000 Less Overheads 3000 2000 7000 Monthly payment for New Equipment 300 300 300 Repayment of Note - 13000 - Cash Surplus or (Deficit) 6500 900 (25800) Closing Balance Required 60000 60000 60000 Repayment of Bank Credit by Excess Cash 6500 900 (25800) Bank Credit Opening Available Balance for Use 45000 51500 52400 Bank Credit Available Balance 51500 52400 26600

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