Rusty Spears, CEO of Rusty's Renovations, a custom building and repair company, is preparing documentation for a line of credit request from his commercial banker. Among the required documents is a detailed sales forecast for parts of 2016 and 2017:

Estimates obtained from the credit and collection department are as follows: collections within the month of sale, 15%; collections during the month following the sale, 65%; collections the second month following the sale, 20%. Payments for labor and raw materials are typically made during the month following the one in which these costs were incurred. Total costs for labor and raw materials are estimated for each month as shown in the table.
General and administrative salaries will amount to approximately $15,000 a month; lease payments under long-term lease contracts will be $5,000 a month; depreciation charges will be $7,500 a month; miscellaneous expenses will be $2,000 a month; income tax payments of $25,000 will be due in both September and December; and a progress payment of $80,000 on a new office suite must be paid in October. Cash on hand on July 1 will amount to $60,000, and a minimum cash balance of $40,000 will be maintained throughout the cash budget period.
a. Prepare a monthly cash budget for the last six months of the year.
b. How much must Spears borrow each month to maintain the target cash balance?
c. Would the cash budget be accurate if inflows came in all during the month but outflows were bunched early in the month?
d. If the company operates on a seasonal basis, how would this affect the current ratio and the debt ratio?
e. If its customers began to pay late, this would slow down collections and thus increase the required loan amount. Also, if sales dropped off, this would have an effect on the required loan. Do a sensitivity analysis that shows the effects of these two factors on the max loan requirement. Assume the purchases of labor and raw material also vary by the sales adjustment factor.

Transcribed Image Text:

May 2016 June July August September October November December January 2017 Sales 60,000 100,000 130,000 120,000 100,000 80,000 60,000 40,000 30,000 Labor and Raw Materials $75,000 90,000 95,000 70,000 60,000 50,000 20,000 20,000 NA