The CEO of Wayne, a food distribution company in the region, is being asked to help prepare cash-flow information for the last three months of the year. The interim balance sheet as of September 30 displays various account balances such as $142 for Cash, $354,155 for accounts payable, and $200 for Marketable securities. Additionally, there is a theater payable balance of $53,200 and also Accounts receivable and Inventories totaling $150,388. COIF Mr. Wayne noted that all sales are billed on the last day of each month based on management policy since they are credit sales.
Customers who pay their bills within 10 days can enjoy a 2% cash discount. During the month following the billing date, 40% of sales are settled within this period to avail of the discount while an additional 25% is paid during that same month but does not qualify for th
...e said incentive.
The company sets its ending inventory at 25% of the next month's budgeted cost of goods sold and has an average gross profit of 30% of sales. The formula for selling and administrative expenses is 5% of current month's sales plus $75,000, inclusive of a $5,000 depreciation. Advertising expenses are budgeted at 3% of sales. The company's actual and budgeted sales information is as follows: Actual: August $826,800, September $787,750. Budgeted: October $868,200, November $911,600, December $930,000 and January. The company will purchase equipment with a cash cost of $250,000 in November.
The company plans to distribute $45,000 in dividends in December while ensuring a minimum cash balance of $120,000 at month-end. Excess funds will be allocated towards paying off short-term debts and investing in marketable securities
In the event that additional cash is necessary to meet the minimum balance, the company policy dictates selling marketable securities before resorting to borrowing. Below is the monthly cash budget for Q4.
If inventory levels go up, it can lead to increased sales but also increased borrowing as extra funds might be needed. Mr. Wayne wants to stop using cash for prompt payments, and suggests that an additional 20% of sales could be delayed from billing month to the next. Mr. Chester disagrees and suggests increasing the discount to 3%, which would encourage customers to pay earlier and result in collecting 20% more in the current month. Any delay in collecting payment can have a bigger impact on borrowing from banks, as the initial collections may not be enough to cover immediate costs.
Although discontinuing the discount is recommended, the final verdict must have regard for the potential expense of early payments if a larger discount results in decreased borrowing.
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