CAPE CHEMICAL: CASH MANAGEMENT

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

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.

ASSUMPTIONS

The assumptions used to develop the pro forma financial statements were used by Stewart and Ford as a starting point. Historical information and current market conditions were also used in developing the cash budget assumptions.

1. A minimum $20,000 cash balance will be maintained.

2. The company has negotiated a $200,000 line of credit for short-term cash needs.

Cash Inflows

3. Ford stated that the primary cash inflow will be the collection of accounts receivables. Projected revenue for the year is $6,000,000 and monthly sales forecasts were provided by the marketing department.

4. Ford indicated that last year receivables were collected as follows:

Ford thought the new credit policy implemented by the new credit manager should allow an acceleration of collections in the coming year. The projected collection schedule for 2007 is:

Stewart suggested they use the 2007 collection assumptions for the cash budget. 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. Note: 15% of 2006 November sales and 60% of 2006 December sales will be collected in January and 15% of December 2006 sales will be collected during February. Ford stated there would a small amount of bad debts in 2007 but for planning purposes these would be ignored.

Cash Outflows

5. The purchase of inventory represents the largest cash outflow. Inventory is typically purchased two months prior to expected sales and is paid in the month of purchase. Example, inventory for January sales would be purchased in November and paid for in November. Inventory for February sales would be purchased and paid for in December, etc. Cost of Goods Sold in 2007 were 76% of sales, assume that 2008 cost of goods sold will also be 76% of sales.

6. Annual plant operating expenses were projected to total $688,500. Ford suggested that these expenses be distributed equally over the twelve months. She stated that in some cases this was probably an over simplification but a reasonable assumption. Stewart agreed. Example: One twelfth, or $4,375, of the annual manager salary and benefits of $52,500 will be distributed monthly.

7. Selling Expenses were projected at $301,500 for the year. Ford stated that most could be spread evenly over the twelve months. The exceptions would be Commissions and Promotion and Advertising. Commissions are paid in the month following the end of a quarter and will be allocated based on sales for the previous quarter. Example: ($30,000* first quarter sales/annual sales). The accounts payable on the 2006 year end balance sheet represents the fourth quarter 2006 commissions that will be paid in January of 2007. One fourth of the annual promotion and advertising expense will be spent during the first month of each quarter.