Question

Classique Household Furnishings & Appliances is a family-owned furniture store. You are the management accountant of the concern and have been given the task of preparing the cash budget for the business for the quarter ending September 30, 2018. Your data collection has yielded the following:

i)          Extracts from the sales and purchases budgets are as follows:

Month	Cash Sales	Sales On Account	Purchases On Account
May	$50,000	$480,000	$390,000
June	$65,000	$600,000	$360,000
July	$43,400	$720,000	$450,000
August	$52,800	$640,000	$400,000
September	$56,750	$800,000	$500,000

ii)            An analysis of the records shows that trade receivables (accounts receivable) for sales on account are settled according to the following credit pattern, in accordance with the credit terms 5/30, n90:

50% in the month of sale

35% in the first month following the sale

15% in the second month following the sale

iii)           Accounts payable are settled as follows, in accordance with the credit terms – 4/30, n60:

70% in the month in which the inventory is purchased

30% in the following month

iv)           Monthly rental is received from a tenant for storage space rented to him by Classique Household Furnishings & Appliances. The rental is $840,000 per annum and is received quarterly in advance. Rental relating to the quarter under review becomes due on July 1.

v)            Computer equipment, which is estimated to cost $350,000, will be acquired for cash in August. The manager has made arrangements with the seller to make a cash deposit of 50% of the amount upon signing of the agreement in August, with the balance to be settled in four equal monthly instalments, starting in September 2018.

vi)           An investment instrument purchased by the company with a face value of $480,000 will mature on July 20, 2018 and will be liquidated on that date. At the same time, quarterly interest computed at a rate of 8⅓ % per annum will also be collected.

vii)         Fixed operating expenses, which accrue evenly throughout the year, are estimated to be $1,920,000 per annum [including depreciation on non-current assets of $42,000 per month] and are settled monthly.

viii)        Wages and salaries are expected to be $2,304,000 per annum and will be paid monthly.

ix)           Other operating expenses are expected to be $144,000 per quarter and are settled monthly.

x)            In the month of August, furniture & fixtures, which cost $455,000, will be sold to an employee at a loss of $20,000. Accumulated depreciation on the furniture & fixtures at that time is expected to be $305,000. The employee will be allowed to pay a deposit equal to 60% of the selling price in August with the balance settled in two equal amounts in September & October.

Continued.......................................

Question 2 Continued.......................................

xi)           As part of its investing activities, the management of Classique Household Furnishings & Appliances is in the process of completing a major addition to the business property which is estimated to cost $1,200,000, and which is being funded by external borrowing. $460,000 of the principal, along with interest of $18,000 is due to be paid on July 15, 2018.

xii)         The cash balance on September 30, 2018 is expected to be an overdraft of $264,000.

Required:

(a)          The business needs to have a sense of its future cashflows and therefore requires the preparation of the following:

• A schedule of budgeted cash collections for trade receivables for each of the months July to September.                                                                                                            
• A schedule of expected cash disbursements for accounts payable for each of the months July to September.                                                                                                     

• A cash budget, with a total column, for the quarter ending September 30, 2018, showing the expected cash receipts and payments for each month and the ending cash balance for each of the months, given that no financing activity took place.                                      (25½ marks)

(b)          Upon receipt of the budget the team manager has now informed you that all companies in the industry in which Classique Household Furnishings operates are required to maintain a minimum cash balance of $140,000 each month. Based on the budget prepared, will the business be meeting this requirement? The business is already heavily indebted, so management does not wish to borrow any additional funds from outside sources. Suggest four (4) internal strategies that the business may employ in order to improve the organization’s monthly cash flow. Each strategy must be fully explained.                                                                                            (5½ marks)

Answer 1

Answer(a)

• Schedule of budgeted cash collections for trade receivables for each of the months July to September:

  Months	July	August	September
  Credit sales of May	$72,000 ($480000*15%)	-	-
  Credit sales of June	$199,500 ($600,000*35%)=$210,000 ($210,000-5% of $210000)=$199,500	$90,000 (600,000*15%)	-
  Credit sales of July	$342,000 ($720,000*50%)=$360,000 ($360,000-5% of $360,000)=$342,000	$239,400 ($720,000*35%)=$252,000 ($252,000-5% of $252,000)=$239,400	$108,000 ($720,000*15%)
  Credit sales of August	-	$304,000 ($640,000*50%)= $320,000 ($320,000-5% of $320,000)= $304,000	$212,800 ($640,000*35%= $224,000) ($224,000-5% of $224,000)= $212,800
  Credit sales of September	-	-	$380,000 ($800,000*50%)= $400,000 ($400,000-5% of $400,000)= $380,000
  Budgeted cash collections from trade receivables	$613,500	$633,400	$700,800

• Schedule of expected cash disbursements for accounts payable for each of the months July to September

  Months	July	August	September
  Credit Purchases of June	$103,680 ($360,000*30%)=$108,000 ($108,000-4% of $108,000)=$103,680	-	-
  Credit Purchases of July	$302,400 ($450,000*70%)=$315,000 ($315,000-4% of $315,000)=$302,400	$129,600 ($450,000*30%)=$135,000 ($135,000-4% of $135,000)=$129,600	-
  Credit Purchases of August	-	$268,800 ($400,000*70%)= $280,000 ($280,000-4% of $280,000)= $268,800	$115,200 ($400,000*30%= $120,000) ($120,000-4% of $120,000)= $115,200
  Credit Purchases of September	-	-	$336,000 ($500,000*70%)= $350,000 ($350,000-4% of $350,000)= $336,000
  Expected cash disbursements for accounts payable	$406,080	$398,400	$451,200

• Cash budget, with a total column, for the quarter ending September 30, 2018, showing the expected cash receipts and payments for each month and the ending cash balance for each of the months:

  Months	July	August	September
  Opening balance	-	$71,420	($148,580)
  Collections:	-
  Trade receivables	$613,500	$633,400	$700,800
  Rent for the quarter	$210,000	-	-
  Investment instrument Maturity Amount	$480,000	-	-
  Investment instrument interest Amount	$10,000 ($480,000* 8.33%)=$40,000 $40,000*3/12= $10,000	-	-
  Furniture & fixtures		$78,000 (W.N. 2)	$39,000 (W.N. 2)
  Total	$1,313,500	$782,820	$591,220
  Disbursements:
  Trade Payables	$406,080	$398,400	$451,200
  Computer equipment	-	$175,000	$43,750 ($175,000/4)
  Fixed Operating Expenses	$118,000 (W.N. 1)	$118,000	$118,000
  Wages and salaries	$192,000 ($2,304,000/12)	$192,000 ($2,304,000/12)	$192,000 ($2,304,000/12)
  Other operating expenses	$48,000 ($144,000/3)	$48,000 ($144,000/3)	$48,000 ($144,000/3)
  Loan Repayment	$478,000 ($460,000+18,000)	-	-
  Total	$1,242,080	$931,400	$852,950
  Closing Balance	$71,420	($148,580)	($261,730)

Working Note 1: Calculation of Cash fixed operating expenses

Cash fixed operating expenses per annum= Fixed operating expenses including depreciation – depreciation

$1,920,000 – ($42,000*12)= $1,416,000

Cash fixed operating expenses per month= $1,416,000/12= $118,000

Working Note 2: Calculation of cash receipt from sale of furniture & fixtures to employee

Carrying amount of furniture & fixtures = $(455,000 – 305,000) = $150,000

Selling price= $(150,000 – 20,000)= $130,000

Amount to be received in august= $130,000*60% =$ 78,000

Amount to be received in September= $ 78,000/2=$ 39,000

(b) The business is not meeting this requirement of maintaining a minimum cash balance of $140,000 each month which all the companies in the industry in which Classique Household Furnishings operates are required to maintain. Despite it have overdraft of $148,580 in August 2018 and $ 261,730 in September 2018. The business is already heavily indebted, so management does not wish to borrow any additional funds from outside sources.

Four internal strategies that the business may employ in order to improve the organization’s monthly cash flow are:

1. Revising the credit terms provided to the accounts receivable as full amount of cash is received from the accounts receivable in 3 months while most of the cash outstanding to accounts payable, i.e. 70% is paid in 2 months which leads to delay in cash collections.

2. Discount allowed to the accounts receivable is 5% if they paid the dues within 30 days while Classique Household Furnishings & Appliances gets the discount received from its account payables of 4% if payment made within 30 days. Such discount allowed to the accounts receivable should be revised to bring it in sync with the discount received from the account payable.

3. Monthly rental received from a tenant for storage space rented to him by Classique Household Furnishings & Appliances is received quarterly in advance. Rental relating to the quarter under review becomes due on July. Such rentals should be received monthly in order to improve monthly balance. Since it is received in advance on first month of the quarter, it shows a positive balance of cash in first month of the quarter while negative balance is presented in remaining months of the quarter.

4. Cash sales should be promoted more than sales on account (sales on credit) to improve monthly cash balance by giving cash discount if cash paid on sales immediately and advertising such policy in front of customers to emphasis them to place order of cash sales.