CAPE CHEMICAL: CASH MANAGEMENT

Journal of the International Academy for Case Studies, 2008 by Kunz, David, Dow, Benjamin L III

CASE DESCRIPTION

The primary subject matter of this case concerns the development and use of a cash budget as a key component in a cash management system. The case also allows an examination of the difference between accounting profit (based on accrual accounting) versus cash flow. The case requires students to have an introductory knowledge of accounting, finance and general business issues, thus the case has a difficulty level of three (junior level) or higher. The case is designed to be taught in one class session of approximately 1.25 hours and is expected to require 3-4 hours of preparation time from the students.

CASE SYNOPSIS

Cape Chemical is a regional distributor of liquid and dry chemicals. Growth has been steady since its beginning, but cash to pay employees and vendors in a timely manner has frequently been a problem. While the company ended its last year with a healthy cash balance, there were many occasions during the year that it was necessary to delay vendor payments or obtain short-term bank loans in order to keep the company operating. On one occasion when a major vendor threatened to stop shipments until all outstanding balances were current and the bank credit was fully used, company credit cards were used to obtain $20,000 to pay (satisfy) the vendor. In an effort to resolve the cash problems, the company has developed a projected income statement, balance sheet and cash flow statement for the next year of operation. Cape Chemical's bank officer suggested the company prepare a monthly cash budget as another cash management tool and as an additional test of the adequacy of the current $200,000 line of credit.

INSTRUCTORS' NOTES

Case Overview

Cape Chemical is a relatively new, regional distributor of liquid and dry chemicals, headquartered in Cape Girardeau, Missouri. The company, founded by Ann Stewart, has been serving southeast Missouri, southern Illinois, northeast Arkansas, western Kentucky and northwest Tennessee for three years and has developed a reputation as a reliable supplier of industrial chemicals. Stewart's previous business experience provided her with a solid understanding of the chemical industry and the distribution process. As a general manager for a chemical manufacturer Stewart had Profit & Loss (P&L) responsibility, but until beginning Cape Chemical she had limited exposure to company accounting and finance decisions.

To improve management of the accounting and finance area, Stewart hired Kathy Ford, an accountant who had worked with the accounting firm that conducted Cape's first audit. Ford was hired near end of the second year of operation.

During the first three years of operations, Cape Chemical operated with a sales forecast and a few operating budgets but a complete set of pro forma statements were not prepared. In an effort to resolve the cash problems, Stewart, with the help of Ford, developed a projected income statement, balance sheet and cash flow statement for the next year of operation (tables one, two and three).

Ford thought the statements indicated the company's cash problems where solved. "Look Ann, if our forecasts are correct, and our forecast should be accurate, since our assumptions were based on historical data and current market conditions, we are in a very good financial position. We begin the year with a cash balance of $226,350 and our projections indicate an ending cash balance of $85,645, well above our target of a minimum balance of $20,000. The income statement projects our highest profit ever and while our ending cash balance is lower than our higher cash balance, we will not have used any of the $200,000 bank line of credit. Our cash problems should be history." Stewart agreed the projected performance looks good, but she was still not ready to agree that cash problems were history.

When Stewart and Ford were reviewing the projections with Cape Chemical's bank officer, he suggested the company prepare a monthly cash budget as another cash management tool and as an additional test of the adequacy of the current $200,000 line of credit. Stewart liked the idea. Later when Stewart and Ford discussed preparing a cash budget, Stewart indicated she had no experience in preparing or using a cash budget. Ford stated that she also had limited experience preparing and using a monthly cash budget but she thought it was similar to preparing forecasted financial statements. The big difference is that monthly rather than annual projections would be needed. The Ford stated the first step would be to prepare a list of monthly operating assumptions.

DISCUSSION QUESTIONS

1. Construct a monthly cash budget for Cape Chemical for the period January through December 2007. Assume that all cash flows occur on the 15th of each month. Is the current $200,000 line of credit sufficient to meet the needs of Cape Chemical during the year? Explain your answer.

The complete cash budget is provided in Table One. A summary of the budget is as follows: (based on a collection schedule of 25% collected in the month of the sale, 60% collected in the month following the sale and 15% collected in the second month following the sale). For example, 25% of January sales will be collected in January, 60% of January sales will be collected in February and 15% of January sales will be collected in March.