Chapter 16 - Answer

Solutions Manual

CHAPTER 16 FORECASTING SHORT-TERM (OPERATING) FINANCIAL REQUIREMENTS SUGGESTED ANSWERS TO THE REVIEW QUESTIONS AND PROBLEMS I. Questions 1. The pro forma financial statements and cash budget enable the firm to determine its future level of asset needs and the associated financing that will be required. Furthermore, one can track actual events against the projections. Bankers and other lenders also use these financial statements as a guide in credit decisions. 2. The collections and purchase schedules measure the speed at which receivables are collected and purchases are paid. To the extent collections do not cover purchasing costs and other financial requirements, the firm must look to borrowing to cover the deficit. 3. The more rapid the turnover inventory, the greater the need for purchase and replacement. Rapidly turning inventory makes for somewhat greater ease in foreseeing future requirements and reduces the cost of carrying inventory. 4. Rapid growth in sales and profits is often associated with rapid growth in asset commitment. A ₱100,000 increase in sales may occasion a ₱50,000 increase in assets, with perhaps only ₱10,000 of the new financing coming from profits. It is very seldom that incremental profits from sales expansion can meet new financing needs. 5. Level production in a cyclical industry has the advantage of allowing for the maintenance of a stable work force and reducing inefficiencies caused by shutting down production during slow periods and accelerating work during crash production periods. A major disadvantage is that a large stock of inventory may be accumulated during the slow sales period. This inventory may be expensive to finance, with an associated danger of obsolescence. 16-1

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6. The percent-of-sales forecast is only as good as the functional relationship of assets and liabilities to sales. To the extent that past relationships accurately depict the future, the percent-of-sales method will give values that reasonably represent the values derived through the pro forma statements and the cash budget. 7. a. Sales forecast – a forecast of a firm’s unit and peso sales for some future period; generally based on recent sales trends plus forecasts of the economic prospects for the nation, region, industry and so forth. b. Projected financial statement method – a method of forecasting financial requirements based on forecasted financial statements. c. Spontaneously generated funds – funds that are obtained automatically from routine business transactions. d. Dividend payout ratio – the percentage of earnings paid out in dividends. e. Pro forma financial statement – same as letter (b) f.

Additional funds needed (AFN) – funds that a firm must raise externally through borrowing or by selling new common or preferred stock. AFN formula = Required increase in assets – Spontaneous increase in liabilities – Increase in retained earnings

g. Capital intensity ratio – the amount of assets required per peso of sales (A/S). h. Lumpy assets – assets that cannot be acquired in small increments but must be obtained in large, discrete units. i.

Financing feedback – the effects on the income statement and balance sheet of actions taken to finance increases in assets.

8. A budget is a detailed quantitative plan for the acquisition and use of financial and other resources over a given time period. Budgetary control involves using budgets to increase the likelihood that all parts of an organization are working together to achieve the goals set down in the planning stage. 16-2

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9. a. Budgets communicate management’s plans throughout the organization. b. Budgets force managers to think about and plan for the future. In the absence of the necessity to prepare a budget, many managers would spend all of their time dealing with day-to-day emergencies. c. The budgeting process provides a means of allocating resources to those parts of the organization where they can be used most effectively. d. The budgeting process can uncover potential bottlenecks before they occur. e. Budgets coordinate the activities of the entire organization by integrating the plans of its various parts. Budgeting helps to ensure that everyone in the organization is pulling in the same direction. f.

Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent performance.

10. A master budget represents a summary of all of management’s plans and goals for the future, and outlines the way in which these plans are to be accomplished. The master budget is composed of a number of smaller, specific budgets encompassing sales, production, raw materials, direct labor, manufacturing overhead, selling and administrative expenses, and inventories. The master budget usually also contains a budgeted income statement, budgeted balance sheet, and cash budget. 11. The level of sales impacts virtually every other aspect of the firm’s activities. It determines the production budget, cash collections, cash disbursements, and selling and administrative budget that in turn determine the cash budget and budgeted income statement and balance sheet. 12. No. Planning and control are different, although related concepts. Planning involves developing goals and developing budgets to achieve those goals. Control, by contrast, involves the means by which management attempts to ensure that the goals set down at the planning stage are attained.

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13. The flow of budgeting information moves in two directions—upward and downward. The initial flow should be from the bottom of the organization upward. Each person having responsibility over revenues or costs should prepare the budget data against which his or her subsequent performance will be measured. As the budget data are communicated upward, higher-level managers should review the budgets for consistency with the overall goals of the organization and the plans of other units in the organization. Any issues should be resolved in discussions between the individuals who prepared the budgets and their managers. All levels of an organization should participate in the budgeting process—not just top management or the accounting department. Generally, the lower levels will be more familiar with detailed, day-to-day operating data, and for this reason will have primary responsibility for developing the specifics in the budget. Top levels of management should have a better perspective concerning the company’s strategy. 14. The direct labor budget and other budgets can be used to forecast workforce staffing needs. Careful planning can help a company avoid erratic hiring and laying off of employees. 15. The principal purpose of the cash budget is NOT to see how much cash the company will have in the bank at the end of the year. Although this is one of the purposes of the cash budget, the principal purpose is to provide information on probable cash needs during the budget period, so that bank loans and other sources of financing can be anticipated and arranged well in advance. II. Multiple Choice Questions 1. 2. 3. 4. 5.

B B E C C

6. 7. 8. 9. 10.

D C C C D

11. 12. 13. 14. 15.

A C C C D

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16. 17. 18. 19. 20.

C B C B C

21. 22. 23. 24. 25.

C A B C A

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III. Problems Problem 1 a. Sales Credit sales Collections: Cash (10% of Sales) 60% first month after sale 40% second month after sale Total Receipts

Februar y ₱60,000

March

April

May

June

₱75,000 67,500

₱95,00 0 85,500

₱110,000

54,000

₱70,00 0 63,000

6,000

7,000

7,500

9,500

11,000

37,800

40,500

51,300

21,600 ₱66,900

25,200 ₱75,20 0

27,000 ₱89,300

b. Receivables at End of June: 90% of June Sales 40% of May Credit Sales

99,000

₱ 99,000 34,200 ₱133,200

Problem 2 January Cash ₱4,200 Credit 9,800 Collections: Cash 40% on the following month 60% on the second month Total Collections

Collections − Payments Cash Flow

February ₱6,000 11,400

March ₱7,800 18,200

April ₱6,600 15,400

7,800 5,600 5,880 ₱19,280

6,600 7,280 8,400 ₱22,280

5,400 6,160 10,920 ₱22,48 0

Cash Budget ₱19,280 ₱22,280 21,300 (2,020) 16-5

19,100 3,180

₱22,48 0 22,400 80

May ₱5,400 12,600

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Forecasting Short-term (Operating) Financial Requirements

+ Beginning Cash Balance Cumulative Cash Balance Loan (Repayment) Cumulative Loan Balance Ending Cash Balance Problem 3 a. Sales Credit sales Collections: Cash (10% of Sales) 70% 1 month following sale 30% 2 months following sale Monthly Cash Receipts

2,000 (20) 2,020 4,020 ₱2,000

2,000 5,180 (3,180) 840 ₱2,000

2,000 2,080 (80) 760 ₱2,000

February ₱60,000

March ₱80,000 72,000

May ₱120,00 0 108,000

June ₱110,000

54,000

April ₱100,00 0 90,000 10,000

12,000

11,000

50,400

63,000

75,600

16,200

21,600

27,000

₱76,600

₱96,600

₱113,600

b. Accounts receivables at the End of June: 90% of June Credit Sales 30% of May Credit Sales Total Receivables Balance

99,000

₱ 99,000 32,400 ₱131,400

Problem 4 a. February sales: ₱230,000 × 10% March sales: ₱260,000 × 70%, 10% April sales: ₱300,000 × 20%, 70%, 10% May sales: ₱500,000 × 20%, 70% June sales: ₱200,000 × 20%

April

May

June

₱ 23,000

Total ₱ 23,000

182,000

₱ 26,000

60,000

210,000

₱ 30,000

300,000

100,000

350,000

450,000

40,000

40,000

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Forecasting Short-term (Operating) Financial Requirements

Total cash collections

₱265,000

₱336,000 ₱420,000

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₱1,021,000

Observe that even though sales peak in May, cash collections peak in June. This occurs because the bulk of the company’s customers pay in the month following sale. The lag in collections that this creates is even more pronounced in some companies. Indeed, it is not unusual for a company to have the least cash available in the months when sales are greatest. b. Accounts receivable at June 30: From May sales: ₱500,000 × 10% From June sales: ₱200,000 × (70% + 10%) Total accounts receivable at June 30

₱ 50,000 160,000 ₱210,000

Problem 5 (3,000 x 1.20) (₱200 x 1.10)

Unit volume Price Total sales Returns (5%) Net sales

3,600 ₱ 220 ₱792,000 39,600 ₱752,400

Problem 6 Projected sales Desired ending inventory Beginning inventory Units to be produced

40,000 units 6,000 (15% x 40,000) 8,500 37,500

Problem 7 12,000 units (8,000 x 1.50) 600 (5% x 12,000) 400 12,200

Projected sales Desired ending inventory Beginning inventory Units to be produced

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Problem 8 Projected sales Desired ending inventory Beginning inventory Units to be produced

50,000 units 5,600 (40% x 14,000) 14,000 41,600

Problem 9 Credit sales 20% Collected in month of sales 70% Collected in month after sales Total cash receipts

September ₱50,000

October ₱40,000

November ₱35,000

December ₱60,000

8,000

7,000

12,000

35,000 ₱43,000

28,000 ₱35,000

24,500 ₱36,500

Problem 10 April May June Quarter 50,000 75,000 90,000 215,000 7,500 9,000 8,000 8,000 57,500 84,000 98,000 223,000 5,000 7,500 9,000 5,000 52,500 76,500 89,000 218,000

Budgeted sales in units Add: Desired ending inventory* Total needs Less: Beginning inventory Required production

*10% of the following month’s sales in units.

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