Advance Corporate Finance

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CASE STUDY ON CASH BUDGETING

Party Favours Limited (PFL) distributes party supplies and novelties through a network of independent, dedicated sales people across Canada. PFL plans to expand its network of sales distribution network into western Canada and consequently forecasts sales to total $5.6 million and $5.8 million in calendar years 2011 and 2012 respectively.

PFL has been in operation for over ten years, and therefore has a strong understanding of the seasonal sales cycle that party favours experiences as well as its other operating costs. For example, PFL knows that monthly sales closely follow a consistent pattern each year as indicated below: MONTH| Percentage of total annual sales|

January| 2.0%|
February| 2.0%|
March| 2.0%|
April | 5.0%|
May | 10.0%|
June| 10.0%|
July| 2.0%|
August| 2.0%|
September| 10.0%|
October| 20.0%|
November| 25.0%|
December| 10.0%|
TOTAL| 100.0%|

PFL offers net 30 trade credit terms to its distributors; however the following pattern of cash receipts from sales occurs based on past experience:
* 10% of sales are received in the form of cash in the month they occur * 50% of sales are received in the month following the sale * The remaining 35% is received in the second month following the sale 5% of sales remain uncollectable.

* Sales in November and December of 2010 for PFL were $450,000 and $500,000 respectively. * PFL has $100,000 invested in a managed fund that pays investment income of $1,350 in February, April, June, August, October and December each year. * PFL does expect to receive $10,000 in April, 2011 and $11,000 again in September that represents income from licensing agreements with distributors in western Canada as that network gets built. As far as operating expenses, again, PFL has tracked its expenses historically. Payments to suppliers is always 60% of the current month’s sales. Supplies and postage amount to 1% of current month’s sales and Delivery expenses are 5% of current month’s sales.

The following fixed expenses are incurred each month:
Salaries & Benefits| $ 50000|
Advertising & Promotion| 2000|
Travel| 4000|
Legal & Accounting Fees| 3000|
Rent| 2500|
Utilities| 1200|
Communication| 600|
Taxes | 5000|
Loan Payment| 8000|

* PFL pays $3,000 for insurance premiums in January, March, May, July, September and November. * PFL has forecast depreciation charges against income in 2011 of $85,600 when reporting to shareholders. * The firm must spend $50,000 in January on necessary office equipment (capital expenditures). * Maintenance expenses of $30,000 will be paid in February. * The firm usually pays $20,000 in cash dividends to its shareholders in each quarter of the calendar year (March, June, September and December).

1. Prepare a monthly cash budget forecast of PFL for calendar year 2011. Assuming the firm’s opening cash balance is $35,000.

SOLUTION
Party Favours Ltd Cash Budget for 2011

Sales in 2011 - $56,00,000
10 % sales is received in the form of cash i.e. Cash sales – 10% 50% of sales are received in the 1st month
Cash sales for 2nd month – 35 %
Sales in December 2010= $450,000
Sales in November 2010 = $500,000

Sales Forecast = Sales in 2011 * % of Total Annual Sales
Calculation of Cash Receipts
Months| Jan| Feb| Mar | Apr| May| Jun| July| Aug| Sept| Oct| Nov| Dec| Cash Sales| $11,200| $11,200| $11,200| $28,000| $56,000| $56,000| $11,200| $11,200| $56,000| $112,000| $140,000| $56,000| 1st Month*| 250,000| 56,000| 56,000| 56,000| 140,000| 280,000| 280,000| 56,000| 56,000| 280,000| 560,000| 700,000| 2nd Month*| 157,500| 175,000| 39,200| 39,200| 39,200| 98,000| 196,000| 196,000| 39,200| 39,200| 196,000| 392,000| Investment Income| |...
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