Question

In September 2017 you joined Adams Shoes, Inc. as the assistant to Mark Barrymore, the Budget Director of the company. Towards the end of December 2017 Mark asked you to prepare a cash budget for 2018. As he explained, he was going to use this cash budget to appraise the company’s short-term financing needs for 2018 so the company can make arrangements with its bank, First Federal Bank, to secure the necessary funds. Mark indicated to you that the firm’s Treasurer was planning to meet with First Federal Bank’s loan officer on December 30, 2017 to request a line of credit. To facilitate your task, Mark provided an abundance of valuable information for what he referred to as the “most likely scenario.” Adams Shoes sells its products (dress and casual shoes, sport shoes, work boots, and accessories) in the U.S. and abroad. Upon Mark’s request, the firm’s marketing department has supplied the following sales figures:

2017 November	$ 620,000
December	$ 670,000
2018 January	$ 750,000
February	$ 780,000
March	$ 800,000
April	$ 600,000
May	$ 550,000
June	$ 600,000
July	$ 650,000
August	$ 680,000
September	$ 700,000
October	$ 750,000
November	$ 680,000
December	$ 700,000
2019 January	$ 800,000
February	$ 820,000

The sales for the last two months of 2017 are actual sales; the sales for 2018 and 2019 are estimates. Mark also indicated to you that Adams Shoes gives a two percent discount if payment is made within the month of sale; otherwise, payment in full is due in the month following the month of the sale. For example, if a $2,000 sale is made on January 5, payment will be $1,960 for customers who pay in the month of January but customers who pay in the month of February must pay the full $2,000. Nevertheless, company records show that three percent of the sales are never collected (i.e., three percent of the customers do not pay for their purchases) while the balance is collected as follows: 25 percent of the firm’s customers take the discount, 65 percent pay within the month following the month of the sale, while the remaining 10 percent “stretch the credit” and pay in full two months after the month of the sale. Furthermore, Mark pointed out that production of goods starts two months before the anticipated date of sale. Production is based on the expected (or estimated) sales posted above, meaning that all production expenses are set by contract at the start of the one year forecast period. As a result, Adams Shoes will not be able to adjust its production costs downward during the planning period even if sales turn out to be below the forecasted levels. Variable production costs consist of labor and raw materials. Labor costs are 40 percent of expected sales; 45 percent of the labor costs are paid two months prior to the sale and 55 percent one month before the sale. Raw materials are 35 percent of forecasted sales. Adams Shoes buys the raw materials two months before the sale of the finished goods; however, it pays 60 percent of the raw materials cost one month after their purchase and the remaining 40 percent in the month following the sale of the finished goods. Regarding the firm’s other costs Mark explained that in 2018 Adams Shoes expects its fixed costs to be $25,000 a month, its selling, general and administrative expenses to be $70,000 a month, and its miscellaneous expenses to be $35,000 a month. In addition, 2018 Federal and state income tax payments of $150,000 must be made in March and September. Also, the company plans to buy a $500,000 piece of equipment in November of 2018. Depreciation of the existing fixed assets of Adams Shoes is expected to amount to $100,000 per month in 2018. On the financing side, Adams Shoes has an outstanding bank loan of $1,500,000 with an annual interest rate of five percent; interest for 2018 is scheduled to be paid semiannually in June and December. Adams Shoes also has one million shares of common stock outstanding and in 2018 it expects to pay a $.10 quarterly dividend per share in March, June, September, and December. However, Mark explained that Adams Shoes owns shares of preferred stock in some blue chip companies and expects to collect a quarterly amount of $75,000 of preferred dividends in March, June, September, and December 2018. Finally, Mark explained to you that Adams Shoes requires a minimum cash balance of $200,000 at all times; this amount will be on hand on January 1, 2018. Adams Shoes deposits any surplus funds, in a savings account at First Federal Bank which pays an annual interest rate of one percent; assume that money in this savings account at the first of a month will earn interest for the full month. Nevertheless, if the company needs to borrow funds, First Federal Bank has agreed to provide the funds at a three percent annual interest rate; assume that Adams Shoes will pay interest for the full month on any short-term debt outstanding at the beginning of a month.

Given all the above information, Mark asked you to:

For the above “most likely scenario” construct the 2018 cash budget and financial plan for Adams Shoes. (Note: Explain in detail your calculations for June 2018 for the cash budget and for February 2018 for the financial plan.)

Explain how large of a line of credit Mark would recommend the Treasurer of Adams Shoes requests from First Federal Bank.

All else the same, determine the impact a 5 percent shortfall of actual sales below expected sales will have on your “most likely scenario” findings.

Answer 1