Question

Chapter 5 Case

You are the Chief Financial Officer (CFO) for Zen Distributors Inc., a media broker that secures shelf space in independent bookstores for small publishing companies. As a member of the company’s executive team, you are preparing the operating budget for the fourth quarter of 2020. Your intent is to summarize the budget for team members and provide them with detailed schedules that support your overview.  

         Zen’s general ledger provides you with current account data on September 30, 2020 (the end of the third quarter) of operations:

Accounts (account amounts in thousands of dollars)	Debit	Credit
Cash	$8,000
Accounts receivable	20,000
Inventory	36,000
Buildings and equipment, net of depreciation	120,000
Accounts payable		$ 21,750
Common stock		150,000
Retained earnings		12,250
Totals	$184,000	$184,000

         Jack Closer, Vice President of Sales, estimated that sales should increase slightly from their fourth quarter levels of the previous year. Per your request, he forwarded his monthly fourth quarter sales estimates to you, along with the current month’s actual sales and his forecast for January 2021.

Month	Sales
September 2020 (actual)	$ 50,000
October 2020	60,000
November 2020	72,000
December 2020	90,000
January 2021	48,000

         You next met with Mary Balance, Zen’s Controller. Ms. Balance informed you that the company prices its products to ensure a 25% gross profit margin on sales. Zen has met that margin throughout the first three quarters of 2020, and she was confident that the firm would meet this target margin in the near term. Mary also told you that, on average, 60% of Zen’s customer pay in cash. Those customers receive a one percent discount on the invoice price.

         The remaining 40% of the customers pay on account. Credit sales terms are n/2EOM. This means credit customers must pay the full invoice price by the end of the month following the month in which they purchased merchandise. Mary explained, “Our customers are pretty sophisticated, and they constantly manage their cash flows--just as we do. Consequently, if we make a credit sale in October, they will pay us by the end of November.” Finally, Mary said, “We screen our customers very carefully before extending them credit. Our customers pay what they owe us. We don’t have any bad debts, and we don’t expect any in the future.”  

    Mary also provided you with third quarter monthly expense data to assist in constructing your budget. The next table presents that information:

Monthly Expense Item	Amount
Administration	$2,500
General	6% of sales
Commissions	12% of sales
Depreciation	$850

She concluded that, “As you know, we pay our operating expenses in the month we accrue them.”

         Procurement officer Jim Washburn managed inventory so that its ending balance equaled 80% of the next month’s cost of goods sold. Washburn said, “We can construct monthly purchase budgets as follows: add desired ending inventory to cost of goods sold, which are 75% of sales, to determine required inventory for a month. Then we subtract that month’s beginning inventory to determine required purchases for the month.” Washburn also stated that the accounts payable clerk pays one-half of each month’s inventory cost in the month of acquisition, and the remaining 50% in the following month.

         Ashleigh McNamara, head of capital expenditures, informed you that Zen will make a cash purchase of $1,500 worth of hand-held scanning devices in early October. McNamara said “We will use operating cash to pay for the scanners because they are an inexpensive capital acquisition.” Per corporate policy, the firm will depreciate this equipment over thirty months on a straight-line basis. Ashleigh added, “They’ll be useless at the end of that time, so we will scrap them.”

         In your role as CFO, you insist that Zen maintain an ending monthly cash balance of $4,000 to maintain financial flexibility. The company has an open line of credit with its banking partner to ensure that it can meet its cash balance goal. This agreement mandates a 12% annual interest rate for all short-term borrowings. Financing must take place at the beginning of the month in thousand dollar multiples. Repayments of borrowing must also occur in thousand dollar increments, and the bank only accepts interest payments when Zen repays principal.

Required:

Compose a memorandum to Zen’s management team that highlights the key aspects of the 2020 fourth quarter operating budget. Supplement your summary with budgetary schedules and attach them to the executive summary. The budgetary flow that you select is as follows:

· Cash collections

· Inventory purchases

· Cash disbursements for purchases

· Cash disbursements for operating expenses

· Short-term financing budget (collections, disbursements, and financing)

You construct each of the above budgets on a monthly and quarterly basis.

         Finally, you conclude your budgets with projected (pro-forma) monthly and quarterly income statements and a pro-forma balance sheet on December 31. The company has a zero percent income tax rate, due to previous tax losses.

Answer 1

a.

Schedule of Cash Collections from Sales
	October	November	Sales	Quarter
Cash Sales	$ 36,000	$ 43,200	$ 54,000	$ 133,200
Collection of credit sales of
September	20,000			20,000
October		24,000		24,000
November			28,800	28,800
Total Expected Cash Collections	$ 56,000	$ 67,200	$ 82,800	$ 206,000

b.

Inventory Purchases Budget
	October	November	December	Quarter
Cost of Goods Sold	$ 45,000	$ 54,000	$ 67,500	$ 166,500
Add: Desired Ending Inventory	43,200	54,000	28,800	28,800
Total needs	88,200	108,000	96,300	195,300
Less: Beginning inventory	36,000	43,200	54,000	36,000
Budgeted Cost of Inventory Purchases	52,200	64,800	42,300	159,300

c.

Schedule of Cash Disbursements for Purchases
	October	November	December	Quarter
September purchases	$21,750			$ 21,750
October purchases	26,100	$ 26,100		52,200
November purchases		32,400	$ 32,400	64,800
December purchases			21,150	21,150
Total Expected Cash Disbursements for Inventory Purchases	$47,850	$58,500	$ 53,550	$159,900

d.

Schedule of Cash Disbursements for Operating Expenses
	October	November	December	Quarter
Administration Expense	$ 2,500	$ 2,500	$ 2,500	$ 7,500
General Expenses	3,600	4,320	5,400	13,320
Commissions	7,200	8,640	10,800	26,640
Total Expected Cash Disbursements for Operating Expenses	$13,300	$ 15,460	$ 18,700	$47,460

e.

Short Term Financing Budget
	October	November	December	Quarter
Beginning cash balance	$ 8,000	$ 4,350	$ 4,590	$ 8,000
Add: Cash collections	56,000	67,200	82,800	206,000
Total cash available	64,000	71,550	87,390	214,000
Less: Cash disbursements for
Inventory purchases	$47,850	$58,500	$ 53,550	$159,900
Operating Expenses	13,300	15,460	18,700	47,460
Capital expenditures	1,500	0	0	1,500
Total cash disbursements	62,650	73,960	72,250	208,860
Cash Surplus ( Deficiency )	1,350	(2,410)	15,140	5,140
Financing
Borrowings	3,000	7,000	0	10,000
Repayment	0	0	10,000	(10,000)
Interest	0	0	230	(230)
Total Financing	3,000	10,000	0	0
Ending Cash Balance	4,350	4,590	4,910	4,910

f.

Budgeted Income Statement
Fourth Quarter: 2020
	October	November	December	Quarter
Sales	$ 60,000	$ 72,000	$ 90,000	$ 222,000
Less: Cost of Goods Sold	45,000	54,000	67,500	166,500
Gross Profit	15,000	18,000	22,500	55,500
Less Operating Expenses
Administrative Expenses	2,500	2,500	2,500	7,500
General Expenses	3,600	4,320	5,400	13,320
Commissions	7,200	8,640	10,800	26,640
Depreciation	850	850	850	2,550
Interest Expense	30	100	100	230
Net Income	$ 820	$ 1,590	$ 2,850	$ 5,260

g.

Zen Distributors Inc. Budgeted Balance Sheet December 31, 2020
Assets
Cash	$ 4,910
Accounts Receivable	36,000
Inventory	28,800
Buildings and Equipment, net of depreciation	118,950
Total Assets	$ 188,660
Liabilities and Stockholders' Equity
Accounts Payable	21,150
Common Stock	150,000
Retained Earnings	17,510
Total Liabilities and Stockholders' Equity	$ 188,660