CASE -
Manny Fold owns a factory that specializes in making titanium valves for high performance engines on a just in time basis. Thus, Manny produces what he sells in a particular month. There are no inventories of finished goods or work in process. However, Manny does require that an inventory of direct raw materials equal to 10% of next month's production requirement be available at the end of each month. To build his business and gain new customers Manny has extended generous credit terms to his customers. While Manny is confident about the fundamentals of his business, he is concerned about the possible cash flow implications.
Manny's clients drive a hard bargain because they can easily switch suppliers. They all do pay eventually, but many of them take their time about doing so and Manny is reluctant to get tough with them for fear they will take their business elsewhere. He tells you that all his sales are on credit (no cash sales). He typically collects only 20% of sales in the month of the sale, 40% of sales in the month after the sale and 40% of sales two months later (for example 20% of August sales are collected in August, 40% in September and 40% in October). On the other hand he pays for 70% of his materials purchases in the month of the purchase and only 30% in the month after.
Costs of labor and overhead other than depreciation property taxes and insurance are paid in the same month they are incurred. Property taxes for 3 months will be paid in October. Monthly fixed selling and administrative costs, other than interest, amount to $41,000, of which $10,000 is depreciation. These operating costs, excepting depreciation, are paid in cash in the month incurred. There are no variable selling or administrative costs. Manny has large tax loss carry forwards from a previous unsuccessful business venture. Therefore he does not expect to pay any income taxes this year. (In other words you may ignore income taxes).
Sales revenues in August were $315,000 and in September are expected to be $325,500. Purchases in September total $92,480. The budgeted selling price of valves for October, November, and December is $21 per valve. Because of market competition there is no flexibility to adjust the price and the price is expected to be stable over the 3 month period (however, Manny has given some small discounts to some customers in recent months) Manny provides the following information regarding his sales forecast in units for the next 3 months: October 18,000 units, November 20,000 units and December 21,000 units. After that production and sales in January are expected to decrease back to 18,000 units.
The variable costs of producing a valve are budgeted at $6 per valve (3/4 pound of titanium alloy costing $8 per pound for materials), $3 per valve for direct labor, and $5 per valve for variable manufacturing overhead. Fixed manufacturing overhead is budgeted at $75,600 per month. The detailed components of variable and fixed overhead are as listed below.
For variable overhead, supplies are budgeted at $1 per unit, electric power is budgeted at $2 per unit, and indirect labor is budgeted at $2 per unit. For fixed overhead depreciation is budgeted at $18,000 per month, Supervision and other factory salaries is budgeted at $27,000 per month, property tax and insurance combined are budgeted at $8,000 per month, maintenance is budgeted at $6,500 per month, licensing fees and permits to use proprietary technology are budgeted at $6,000 per month, and other miscellaneous fixed expenses are budgeted at $10,100 per month.
Assume Manny's opening cash balance on October 1 will be $10,000. Manny requires a minimum cash balance of $10,000 at the end of each month. If the budgeted month end cash balance will fall below this level Manny plans to borrow enough cash at the beginning of that same month to keep his ending balance up to the minimum level. Manny's bank charges him interest at the rate of 1 % per month on the balance outstanding during that month. Manny pays the interest at the beginning of the following month and plans to repay as much as he can at the beginning of that month without letting his budgeted cash balance go below $10,000 at month end. Manny's bank requires that borrowing and repayments are in $100 increments (for example, if $4321 is needed to get to the 10,000 minimum balance Manny would need to borrow $4,400). Assume no borrowings were outstanding as of October 1.
Required -
1) Construct Manny's budget for raw materials purchases in October, November, and December and the total for the 4th quarter. Use Exhibit 9-7 on page 524 as a guide.
2) Construct Manny's budgeted operating income statement for the 3 months: October, November, and December and the total for the 4th quarter. Use the template provided below. Show any necessary calculations.
3) Construct Manny's cash budget for the 3 months October, November, and December and the total for the 4th quarter. Use the templates provided below. Show any necessary calculations. Note: there are no capital expenditures budgeted for the 4th quarter and no dividends.
4) Explain why Manny will be facing a cash flow problem in October even though his business is profitable.
5) During October Manny actually produced and sold 18,500 valves. Actual sales revenues were $386,950. Actual costs were as detailed in the table below.
Complete the table by constructing a flexible budget and performance report including variances for October based on 18,500 valves. Your performance report should be similar to the performance report shown in exhibit 10.13 of page 611 except your report includes more detailed production cost line items. Use the template provided below for your answer.
6) Write a brief report explaining the most important reasons why Manny's profits were different from the amount projected in the master budget.