91Ó°ÊÓ

Refer to the information in Problem \(6-44\) All purchases made in a given month are paid for in the following month, and direct material purchases make up all of the accounts payable balance and are reflected in the accounts payable balances at the beginning and the end of the year. Sales are made to customers with terms net 45 days. Fifty percent of a month's sales are collected in the month of the sale, \(25 \%\) are collected in the month following the sale, and \(25 \%\) are collected two months after the sale and are reflected in the accounts receivables balances at the beginning and the end of the year. Direct manufacturing labor, variable manufacturing overhead and variable marketing costs are paid as they are incurred. Fifty percent of fixed manufacturing overhead costs, \(60 \%\) of fixed marketing costs, and \(100 \%\) of fixed distribution costs are depreciation expenses. The remaining fixed manufacturing overhead and marketing costs are paid as they are incurred. Selected balances for December \(31,2017,\) follow:Hazlett has budgeted to purchase equipment costing \( 145,000\) for cash during 2018 . Hazlett desires a minimum cash balance of \( 25,000\). The company has a line of credit from which it may borrow in increments of \( 1,000\) at an interest rate of \(12 \%\) per year. By special arrangement, with the bank, Hazlett pays interest when repaying the principal, which only needs to be repaid in 2019 1\. Prepare a cash budget for 2018 . If Hazlett must borrow cash to meet its desired ending cash balance, show the amount that must be borrowed. 2\. Does the cash budget for 2018 give Hazlett's managers all of the information necessary to manage cash in \(2018 ?\) How might that be improved? 3\. What insight does the cash budget give to Hazlett's managers that the budgeted income statement does not?

Step by step solution

01

Calculate Monthly Sales Collections

To calculate the cash inflows from sales in each month, we will use the information provided: - 50% of a month's sales are collected in the month of the sale - 25% are collected in the month following the sale - 25% are collected two months after the sale We will first determine total sales for each month and then apply these percentages to find the cash collections.

02

Calculate Monthly Payments for Direct Materials and Other Costs

Direct material purchases make up all the accounts payable balance and are paid in the following month. We will use this information to calculate monthly payments for direct materials. We will also calculate payments for direct manufacturing labor, variable manufacturing overhead, variable marketing costs, fixed manufacturing overhead costs, fixed marketing costs, and fixed distribution costs.

03

Calculate Monthly Cash Flow from Operations

To determine the monthly cash flow from operations, we will subtract the total cash outflow (payments for direct materials, labor, overhead costs, etc.) from the total cash inflow (sales collections) for each month.

04

Calculate Monthly Cash Flow after Non-Operating Activities

Next, we will incorporate the cash flow impact of non-operating activities, such as the purchase of equipment and any interest payments on borrowing. We will calculate these cash flow impacts and update the monthly cash flow accordingly.

05

Calculate Required Borrowing and Cash on Hand

Hazlett desires a minimum cash balance of $25,000. We will calculate the required borrowing to maintain this balance in each month. We will also calculate the cash on hand at the end of each month, taking into account the minimum cash balance desired and any borrowing.

06

Assemble Complete Cash Budget for 2018

With all the calculations from the previous steps, we can now create a cash budget table for Hazlett for the year 2018, summarizing the cash flows in and out of the business and the total cash on hand at the end of each month. With the cash budget prepared, we can now address the other questions: 2. The cash budget provides Hazlett's managers with important information regarding cash inflows and outflows, but it may not be enough to manage cash optimally during 2018. To improve cash management, Hazlett's managers could track actual cash collections and payments, monitor any deviations from the budget, and adjust the cash budget accordingly. They could also use techniques such as cash flow forecasting, scenarios analysis, or cash reserves planning to improve cash management further. 3. Compared to the budgeted income statement, the cash budget provides a more detailed picture of the company's cash position throughout the year, which may be helpful for planning and decision-making purposes. The cash budget can alert management to potential cash shortfalls or surpluses and help them make adjustments to their financial strategies, whereas the budgeted income statement only provides information on profitability and does not address liquidity concerns or timing issues related to cash flows.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Sales Collection Schedule

Understanding how a company's sales are converted into cash is essential for effective cash budgeting. In the Sales Collection Schedule, we outline the timing and proportion of sales that transform into actual cash inflows. For example, if a business collects 50% of its sales within the month of sale, 25% in the following month, and the remaining 25% two months later, these percentages help forecast when the company will have cash available. This staggered collection method affects liquidity and requires careful cash management planning.

Creating a sales collection schedule involves:

• Calculating total sales revenue for each month.
• Applying the collection percentages to determine cash inflows.
• Monitoring the accounts receivable to ensure collections are on track.

A well-prepared sales collection schedule helps predict cash flow patterns, enabling businesses to maintain sufficient liquidity and avoid financial strain.

Accounts Payable and Receivable Management

Managing accounts payable and receivable is crucial for maintaining healthy cash flow. Accounts payable refer to the obligations a company needs to settle, usually concerning purchases made on credit, while accounts receivable represent the payments the company expects to receive from its customers.

For accounts payable management:

• Aim to negotiate favorable credit terms with suppliers to optimize cash outflow timing.
• Ensure timely payments to maintain good supplier relationships and avoid penalties.

For accounts receivable management:

• Implement efficient collection processes to expedite cash inflows.
• Monitor outstanding receivables and follow up on delinquent accounts promptly.

By effectively managing both, a company can balance its cash flow, ensuring it has enough liquidity to cover operational costs while minimizing idle cash.

Fixed and Variable Costs

Fixed and variable costs have different implications on a company's cash flow and budgeting. Fixed costs, such as rent or salaried wages, do not change regardless of the production volume, providing predictability but also a constant cash outflow that needs to be planned for each month.

Variable costs, including raw materials and business utilities, fluctuate with production levels. During high production periods, variable costs increase, whereas they decline when production slows down.

When preparing a cash budget, it's essential to:

• Accurately forecast variable costs based on anticipated activity levels.
• Provide for the regular payment of fixed costs to prevent interruption of operations.

Understanding these costs helps in determining the necessary cash reserves to cover expenses while maintaining business agility.

Cash Flow Forecasting

Cash flow forecasting involves predicting the money coming into and going out of a business over a given period, crucial for maintaining financial solvency. A cash flow forecast helps identify potential shortfalls in advance and can guide strategic decisions.

Steps for effective cash flow forecasting include:

• Analyzing historical financial data to predict future trends.
• Incorporating planned capital expenditures, like equipment purchases, into the forecast.
• Reviewing market trends to anticipate changes in revenues or costs.

Regular forecasting helps managers adjust spending, manage inventory, or seek additional financing to ensure that the company does not face unexpected cash shortages. It not only aids in meeting immediate financial obligations but also supports long-term financial planning.