Making a master budget for a company


Case Problem:

You have just been hired as the management trainee by Cravat Sales Company, a nation-wide distributor of a designer’s silk ties. The company has an exclusive franchise on the distribution of the ties and sales have grown so fast over the last few years that it has become essential to add new members to the management team. You have been given responsibility for all planning and budgeting. Your first assignment is to make a master budget for the next three months, starting from April 1. You are anxious to make a favorable impression on the president and have assembled the information beneath.

The company desires a minimum ending cash balance each month of $10,000. The ties are sold to retailers for $8 each. Recent and forecasted sales in units are as follows: January (actual) . . . . . . . . . . . . . . . February (actual) . . . . . . . . . . . . . . March (actual) . . . . . . . . . . . . . . . . April . . . . . . . . . . . . . . . . . . . . . . . . . May . . . . . . . . . . . . . . . . . . . . . . . . 20,000 24,000 28,000 35,000 June  . . . . . . . . . . . . . . . . . July. . . . . . . . . . . . . . . . . . August  . . . . . . . . . . . . . . . September  . . . . . . . . . . . . 60,000 40,000 36,000 32,000

The big build up in sales before and throughout June is due to Father’s Day. Ending inventories are supposed to equal 90% of the next month’s sales in units. The ties cost the company $5 each. Purchases are paid for as given: 50% in the month of purchase and the remaining 50% in the following month. All sales are on credit, with no discount, and payable in 15 days. The company has found, though, that only 25% of a month’s sales are collected by month-end. The additional 50% is collected in the given month and the remaining 25% is collected in the second month following sale. Bad debts have been negligible. The company’s monthly selling and administrative expenses are illustrated below:

Variable: Sales commissions. . . . . . Fixed: Wages and salaries. . . . . . Utilities  . . . . . . . . . . . . . . . Insurance  . . . . . . . . . . . . . Depreciation  . . . . . . . . . . . Miscellaneous . . . . . . . . . . $1 per tie $22,000 $14,000 $1,200 $1,500 $3,000

All the selling and administrative expenses are paid throughout the month, in cash, with the exception of depreciation and insurance expired. Land will be purchased all through May for $25,000 cash. The company declares dividends of $12,000 each quarter, payable in the first month of the given quarter. The company’s balance sheet at March 31 is shown below:

Assets Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts receivable ($48,000 February sales; $168,000 March sales)  . . . . . . . . . . . . . . . . . . . . . . Inventory (31,500 units)  . . . . . . . . . . . . . . . . . . . . . . . Prepaid insurance. . . . . . . . . . . . . . . . . . . . . . . . . . . . Fixed assets, net of depreciation  . . . . . . . . . . . . . . . . Total assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Liabilities and Stockholders’ Equity Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends payable  . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital stock. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retained earnings  . . . . . . . . . . . . . . . . . . . . . . . . . . . Total liabilities and stockholders’ equity  . . . . . . . . . . . $ 14,000 216,000 157,500 14,400 172,700 $574,600 $ 85,750 12,000 300,000 176,850 $574,600

The company has an agreement with a bank which permits it to borrow in increments of $1,000 at the starting of each month, up to a total loan balance of $40,000. The interest rate on such loans is 1% per month, and for simplicity, we will suppose that interest is not compounded. At the end of the quarter, the company would pay the bank all of the accumulated interest on the loan and as much of the loan as possible (in increments of $1,000), while still retaining at least $10,000 in cash.

Required:

Make a master budget for the three-month period. Comprise the given detailed budgets:

1)
a) The sales budget by month and in total.
b) The schedule of expected cash collections from sales, by month and in total.    
c) The merchandise purchases budget in units and in dollars. Illustrate the budget by month and in total.
d) The schedule of expected cash disbursements for merchandise purchases, by month and in total.

2) A cash budget. Illustrate the budget by month and in total.

3) A budgeted income statement for the three-month period. Use the contribution approach.

4) The budgeted balance sheet.

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Macroeconomics: Making a master budget for a company
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