Question

Shiraz, Inc. is a small producer and distributor of a product called Alpha. Shiraz Company has become interested in the preparation of operating and financial budgets. The budgets are vitally needed for operational planning and cost control purposes. You have been asked to assist Sara, the accountant of the company, in the preparation of budgets for the first three months of year 20X2.

Sales Forecasting:

Sara knows that the first step for the preparation of budgets is to forecast sales. Sara has been able to identify two possible variables that drive/influence the sales of the company. They are: the level of distribution of Alpha (number of dealers) and the amount of money spent on advertising (advertising expenditures). Sara wants to use the Regression method for the development of a regression equation/model for forecasting the sales of the company. She has accumulated 12 months of recent data, 20X1, on sales units, advertising expenditures, and the number of dealers as shown in Table I.

TABLE I

Sales	Advertising	Number of
Units	Expenditures	Dealers
248,000	19080	300
256,000	19440	337
264,000	19800	375
304,000	27000	312
320,000	30600	318
272,000	21600	303
296,000	28800	315
216,000	19800	225
232,000	19440	247
240,000	19620	270
268,000	23400	306
280,000	25200	309

Shiraz expects the following for the first five months of year 20X2:

	January	February	March	April	May
Advertising Expenditures	$28,000	$25,000	$27,000	$26,500	$25,800
No. Of Dealers	290	300	208	285	265

Budgeting:

Management of Shiraz Company is interested in a number of budgets. The preferred formats for budgets are displayed in Exhibit I. As shown in Exhibit I, Sara’s Excel file has two sections. Section One contains the required data for the preparation of budgets. Section Two contains the budgets. Since management of Shiraz wants to simulate the budgets for various possible conditions, the content of budgets will be stated all in formulas. The only area where data should be entered manually is in the data section, under the January column only! (Hint: this will require the use of excel functions including: “IF”, “AND”, “SUM”, “ROUNDUP”, “ROUNDDOWN”, “ROUND” etc.). Sara has prepared the following data for the preparation of budgets:

1. Sales

• Selling price per unit of Alpha is expected to be $12 in January through February. Five percent increase in selling price is expected in March. Aril and May are expected to have the same selling price as in March.
• Seventy-five (75) percent of each month’s sales are collected in the month of sale. The remaining is collected in the following month.

2. Manufacturing Expenses

Production of each Alpha requires:

• Direct materials: 5 pounds of direct material @ $0.80 per pound (expected to increase by 10 cents each month)
• Direct Labor: ½ hour of direct labor @ $10 per hour
• Variable manufacturing overhead (each unit): $0.50 per unit
• Fixed manufacturing overhead: Total of $25,000 per month of which $3,000 is depreciation expense

3. Operating (Selling & Administrative) Expenses

• Sales Commission: $0.80 per unit
• Shipping and Handling: $0.60 per unit
• Fixed Operating Expenses: Total $12,000 per month of which $1,500 is depreciation expense.

4. Payment of Expenses

• Other than purchase of materials, all expenses are expected to be paid in the month incurred. Sixty (60) percent of purchases are paid in the month of purchase and the remaining is paid in the following month

5. Capital Expenditures

• Shiraz is in the process of expansion of its operations by adding new equipment. The expansion requires $400,000 cash outflow in the month of January and another $200,000 in the month of February.

6. Loan Repayments & Interest Expense

• The Company can borrow from its bank as needed to bolster the Cash account. Borrowings and repayments of principle must be in multiples of $1,000, unless you are paying off the entire balance. All borrowings and repayments take place at the end of a month. The annual interest rate is 12%. Interest is compounded every month and added to the principle. Compute interest on whole month (1/12, 2/12, and so on).

7. Inventory Policy

• It is the company's policy to maintain an inventory of Alpha at the end of each month equal to 20% of next month's anticipated sales.
• Company also maintains an inventory of raw materials equal to 25% of next month’s production needs.

8. Other Information

• Sales on December of previous year were $4,350,000.
• Direct material purchases for December of the previous year were $1,800,000.
• The balance of cash on December 31 of the previous year was $21,000.
• The Company desires to maintain a minimum balance of $20,000 cash on hand at all times.
• Applicable income tax rate is 30%.

Question:

There are rumors that the price of direct materials and direct labor for Alpha to be increased by 15% and 5%, respectively effective January 1, 20X2. Management of Shiraz wants to know the impact of this increase on its financial position. Recalculate the budgets by incorporating the expected increases in the price of direct materials and direct labor. Compute and discuss the percentages of change in the profit and cash balance of the company due to the increase in the price.

Answer 1