It is New Year's Day and you are trying to help your sister's new boyfriend with a finance problem. Fred is an international arms dealer. When he gets an order, he purchases the weapons on terms of net 30 and then sells them to his clients on terms of net 30 or net 60 days, depending on how dangerous they are. That is, if Fred sells guns in January, he pays his supplier in February and gets paid by his customer in either February or March. About 20 percent of Fred's customers pay after 30 days and the other 80 percent pay after 60 days. Fred is still collecting on his November sales($30,000) and his December sales ($60,000) Fred needs to keep some money laying around to grease the skids, pay bribes, and pay his toadies and he never wants the cash account to drop below 125,000. Right now, just after Christmas, the cash account is down to $110,000

Projected sales, product costs, and period costs are shown below for the upcoming year, as well as the sales for last November and December. Fred's cost of goods sold (product cost) is about 80percent of sales, and operating expenses (period costs) are roughly $40,000 per month, all in cash. Fred don't pay no stinking taxes. In year's past, Fred has had to go to his uncle Freidrich for cash during the months when he came up short. Uncle Freidrich is now doing 10 years in prison following an unfortunate incident that we do not speak of, so that line of credit is now gone. Fred wants to arrange a line of credit with a shady Central American bank to fund his operation but isn't sure how much to ask for, and he darn sure wants to be sure that he can pay them back from his ill-gotten gains because they are very serious about collecting on debts. They charge 2% interest on the outstanding balance from the prior month, rounded UP to the nearest $1,000. For example, if Fred owes $120,000 the interest expense before rounding would be $2,400 which would round UP to $3,000. Tough bank.

Help Fred out by showing him how to project the cash flows from his business. The accounting profits (Sales - Expenses = Profits) are already calculated, but you need to convert that into cash flows.

Remember, about 20% of the revenue comes in one month after the sale, the other 80% comes in 60 days later. The cash product costs are paid one month after the sale. The monthly operatingexpenses are paid that same month. He starts out January 1 with $110,000 in the bank. Any time that the bank account drops below $125,000 at the end of the month, he needs to borrow enough to bring it back up to $125,000.. Keep track of the cumulative loan balance. Any month where he has extra cash, he can use it to pay down the loan. His maximum loan needs would be the highest balance during the year. Fred has to pay a commitment fee for the line of credit, whether he uses it or not, and that commitment fee is a percentage of the credit limit.

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Interest Paid on Op Exp Cash Before Loan or Balance Repayment Period Loans Taken This Loans Repaid Cumulative This Period Prior Month Operating Profit 34,000 -28,000 Loan Acct Product Costs 24,000 60,000 48,000 200,000 160,000 300,000 240,000 40,000 380,000 304,000 420,000 336,000 40,000 450,000 360,000 350,000 280,000 250,000 200,000 150,000 120,000 96,000 80,000 72,000 40,000 Period Begin Revenue Acct COGS Revenue 30,000 Cash Collected Paid Paid Balance End Cash Recvble Payable 40,000 40,000 40,000 Costs Prior Nov Prior Dec Jan Feb Mar Apr May Jun Jul Aug Sep 110.000 20,000 36,000 44,000 50,000 30,000 10,000 -10,000 -16,000 -20,000 -22,000 30,000 40,000 40.000 40.000 40,000 40.000 40,000 40,000 40,000 40.000 120,000 100,000 Oct 90,000 Nov Dec 50,000 Yearly Total "2,860,000 2,288,000 480.000 92.000