CAPE CHEMICAL: CASH MANAGEMENT

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

The cash budget indicates that Cape Chemical will exceed the $200,000 line of credit during the months of April (borrowing required $249,185) through November (borrowing required $255,005). A peak borrowing requirement of $770,320 occurs in September. Based on the assumptions used to prepare the cash budget, the current $200,000 line of credit will fall well short meeting the needs of Cape Chemical.

Note: Students answers may vary by a few dollars due to spreadsheet rounding.

2. The cash budget contains both cash inflows and cash outflows. Which do you feel are likely to be the most accurate? Explain your answer.

Cash outflows result from expenditures (purchases of inventory, capital investments, selling expenses, general and administrative expenses and interest expense) controlled by Cape Chemical thus are likely to have a higher degree of accuracy (both the amount and timing of the outflow) than the inflows. Inflows depend upon sales activity and collections. Product must be sold and receivables collected. Cape Chemical has less control over the amount and the timing sales and collections, thus inflows are likely to be less accurate than the outflows.

3. Stewart thought it would be beneficial to prepare an additional cash budget based on the 2006 collection schedule (a less optimistic assumption).

Will the $200,000 line of credit be sufficient? Explain your answer.

Note: Assume $39,000 of November and $195,600 of December revenue will be collected in January. Assume $48,900 of December revenues will be collected in February.

The complete cash budget is provided in Table Two. A summary of the budget is as follows: (based on a collection schedule of 20% collected in the month of the sale, 50% collected in the month following the sale and 30% collected in the second month following the sale). For example, 20% of January sales will be collected in January, 50% of January sales will be collected in February and 30% of January sales will be collected in March.

The cash budget indicates that Cape Chemical will exceed the $200,000 line of credit during the months of April (borrowing required $321,185) through November (borrowing required $399,005). A peak borrowing requirement of $893,320 occurs in September. Not surprisingly, the slower collection schedule increases the cash needs of Cape Chemical. The current $200,000 line of credit will not be sufficient to meet the needs of Cape Chemical.

Note: Students answers may vary by a few dollars due to spreadsheet rounding.

4. Why is depreciation expense not part of the cash budget?

Depreciation is a non-cash expense, thus it is not explicitly included in the cash budget. Depreciation expense does reduce a firm's income tax payments thus it does have an indirect impact on the cash budget.

5. The monthly cash budget prepared assumes that all cash flows occur on the 15th of each month. Suppose most of Cape Chemical's outflows are at the beginning of the month, while its collections are toward the end of each month. How would this fact alter the cash budget?