Question

Pet Treats, Inc. specializes in gourmet pet treats and receives all income from sales and has the following account details: Last year’s ending payables and receivables were $125M and $250M, respectively, while the cash balance was $80M. Historically, the average receivables turnover ratio has been 12.16667, while the average payables period has been 45 days. Recently, purchases have been approximately one half of sales but are purchased a quarter in advance. The firm likes to maintain a minimum balance of $50M. Other relevant expenses include the following: Wages, taxes, and other expense are 30% of sales, Interest and dividend payments are $50M, and a major capital expenditure of $200M is expected in the second quarter. The following sales estimates are projected

Sales estimates (in millions): Q1 = 500; Q2 = 600; Q3 = 650; Q4 = 800; Q1 next year = 550 a.

If the average inventory period is twice the receivables period, what is the cash cycle?

What are cash collections and ending receivables for quarters one and two?

What are cash payments and total disbursements for quarters one and two?

What is the net cash flow and cumulative surplus or deficit for quarters one and two, and what does it imply about the firm’s cash needs? What would the firm do about the surplus or deficit?

Answer 1

Answer 1:

Average payables period = 45 days

Average receivable period = 365 / average receivables turnover ratio = 365 /12.16667 =30 days

Average inventory period = Twice the receivables period = 2 * 30 = 60 days

Cash Cycle = Average inventory period + Average receivable period - Average payables period = 60 + 30 - 45 = 45 days

Cash Cycle = 45 days

Answer 2:

Average receivable period = 30 days

Last year’s ending receivables =$250 million

Sales in Q1 = $500 million

Sales in Q2 = $600 million

As such:

Cash collections in quarter one = Ending receivable of last year + 2/3 * Sales of Quarter one = 250 + 500 * 2/3 = $583.33 million

Ending receivables for quarters one = 1/3 * Sales of Quarter one = 1/3 * 500 = $166.67 million

Cash collections in quarter two = Ending receivable of quarter one + 2/3 * Sales of Quarter two = 166.67 + 600 * 2/3 = $566.67 million

Ending receivables for quarters two = 1/3 * Sales of Quarter 1 = 1/3 * 600 = $200 million

Hence:

Cash collections in quarter one = $583.33 million

Ending receivables for quarters one = $166.67 million

Cash collections in quarter two = $566.67 million

Ending receivables for quarters two = $200 million

Answer 3:

Cash payments and total disbursements for quarters one and two are calculated and given (highlighted) below:

Answer 4:

The net cash flow and cumulative surplus or deficit for quarters one and two are calculated and given (highlighted) below:

There is surplus of $138.33 million at the end of quarter one and deficit of $37.50 million at the end of quarter two. The firm needs to arrange:

1. with bank to get short term finance or cash credit or overdraft facility to tide over deficits and pay back when there are surpluses.

2. to invest surpluses in short term marketable securities