Cash budget for the period that will end 31st Dec 201X.
Hulme’s Income statement
For the period that will end 31 Dec 201X.
Income statement workings
Sales revenue is calculated by finding out the total number of products sold. The total number of products sold is multiplied by the proportion and the price for each segment. The total number of goods sold is 11,459 units. It covers both cash received and debtors. Sales = (11,459*50%*55) + (11,459*20%*65) + (11,459*30%*80) = £739,106.
Cost of goods sold (COGS) is obtained by subtracting inventory from the total of cash to suppliers found in the last column of the cash budget. COGS = total of raw materials – inventories, COGS = £394,424 – £50,656 = £343,768. The raw materials purchased in December are meant for January’s production. It is the inventory value. The COGS is the cost of raw materials used for goods sold.
Gross profit is obtained when COGS is deducted from sales revenue (£739,106 – £343,768 = £395,338).
The values of expenses are taken directly from the totals from expenses’ rows found in the cash budget. Accruals are added to the total of the last column. Staff-factory-on-cost = £34,320 + (25%*17,600) = £38,720, it is the total cost paid, and 25% of December factory staff pay. Staff-shop-on-costs = £8,190 + (25%*4,200) = £9,240. Energy costs are the total of the cash budget plus the accrual. Energy factory = £42,782 + (1,689 * 4 per unit) = £49,536. Energy shop = £4,300 + (5weeks*60hours a week*2 per hour) = £4,900.
Rent is the total value of the cash budget less the one month prepayment, and the deposit. Rent = £36,000 – £3,000 – £9,000 = £24,000. Land rate is obtained by deducting the 3,600 prepayment from the total value of the cash budget. Rates = £21,600 – £3,600. The £3,600 is obtained by multiplying the £400 monthly prepayment by the 9 months on which it is paid.
Depreciation for the assets is calculated by first deducting the disposal value, and then distributing the remaining cost on the years in which the asset will be in use. For example, the plant involves equipment purchased at £100,000. It has a disposal value which is 20% of its original cost. It will last for 4 years. The depreciation cost is calculated as shown below. Plant depreciation = ((100,000 – (20%*100,000)) /4) = (100,000 -20,000) /4 = 80,000/4 = £20,000. Van’s depreciation (= £25,000 – £5,000) /5 = £4,000) is the value used in production divided by the life of the asset. Renovations depreciation assumes that the value of the renovations will last for the 7 years according to the property agreement. The cost is distributed equally over the 7 years. Renovation depreciation = £60,000/ 7 = £8,571.
The marketing cost is taken as the total from the cash budget because it does not have any accruals.
Operating profit is calculated by deducting total expenses (£391,807) from the gross profit (£395,338) which gives a positive value (operating profit = gross profit – total expenses). The firm has an operating profit of £3,530.
Interest on the loan is obtained from the totals of the cash budget. The interest is deducted from operating profit to obtain the earnings before income tax (EBIT). EBIT = operating profit – interest on loan = £3,530 – £7,875 = -£4,345. Taxes are not charged because the firm operates under a loss. The profit after tax is similar to the EBIT.
Workings on the balance sheet
The non-current assets are obtained by subtracting the depreciation value from the cost of the asset. The values on depreciation are obtained from the income statement.
Receivables are calculated by adding the November (20%*1,608 units) and December (20%*1,689 units) values for sales on the exporter, and the values of December (50%*1,689) for the retail segment. The sales quantities are multiplied by the price. For the exporter, receivables = ((20%*1,608 units) + (20%*1,689 units) * £65) = £42,856. The retail value = ((50%*1,689 units) * £55) = £46,434.
The last rent was paid in the beginning of November. It covers November and December with only a single month (January) remaining as prepayment. Each month has a value of 9,000/3 = £3,000.
Staff on-costs are obtained from the month of December on the cash budget as accrued expenses. The staff on-cost is 25% of the wages in December for the shop, and the factory. Staff on-cost = 0.25* (£17,600+£4,200) = £5,450.
Accrued energy/water costs are obtained by multiplying according to the number of units produced in the factory in December, and the number of hours spent in the shop. Energy-factory = £4 * 1,689 = 6,754. Energy-shop = £2 per unit * 60 hours a week *5 weeks = 600.
Bank overdraft is the negative closing balance of the cash budget on 31st December. Total owner’s equity is the sum of the net loss and share capital. Total capital employed (£307,979) is the sum of owner’s equity (£45,655), long-term debt (£150,000), and current liabilities (£112,324). Gilbertson & Lehman (2009, p. 188) explain that assets are equal to liabilities, and owner’s equity (assets = liabilities + owner’s equity). On the other hand, current capital is calculated as current capital = capital account balance – net loss – drawing account balance (Gilbertson & Lehman 2009, p. 189). Owner’s equity is the net loss deducted from the initial share capital. The balance sheet may have a difference of £4 which may have been derived from rounding off the values. Damodaran (2012, p. 195) explains that the capital employed is calculated by adding up the book value of debt and equity, and deducting the value of cash held at the end of that period.
Return on capital employed
Return on capital employed = EBIT/ capital employed = -£4,345/ £307,979 = 0.014108 = -1.41%
The product of the return on capital and the reinvestment rate are used to show the rate at which a company is likely to grow (Damodaran 2012, p. 195). Ann’s firm is likely to grow into more debt. The debt is likely to grow at a slower rate if the current net earnings are maintained.
Cash conversion cycle
It shows the number of days it takes to convert input pounds into output pounds. Stoltz (2007, p. 317) explains that it is the “period of time when cash is tied up in the inputs and debtors”.
Cash conversion cycle = average collection period + days inventory held – days payable outstanding (Stoltz 2007, p. 317)
Cash conversion cycle= 27 days + 30 days – 0 days = 57 days
Average collection days = (50% of 30 days) + (20% of 60 days) + (30% of 0 days) = 15 days + 12 days + 0 days = 27 days
Days inventory held = 30 days
Days payable outstanding = 0 days, Ann will have to purchase supplies using cash on delivery.
Ann must have cash that can cover operations for two months without receiving any cash from sales. Stoltz (2007, p. 317) explains that a firm with a long conversion cycle needs to borrow money to cover a longer period for its daily operations. It can be seen that Ann’s company needs a big proportion of overdrafts to cover the 57 days conversion cycle. The firm’s conversion cycle will improve when suppliers start offering her raw materials on credit.
Gearing
Gearing (long-term debt to total capitalization) = long-term debt / (long-term debt + total equity) (Khan & Jain 2007, p. 6-15).
Gearing = £150,000/ (£150,000 + £45,655) = 0.767 = 76%
It shows that 76% of the company has been financed by long-term debts. It indicates a high risk for the owner’s equity. The owner will have to service debts before she can use the profits for her own benefits. She has to pay a large debt before she can recover her equity in case of a complete closure.
Interest cover
Interest coverage = EBIT/ Interest (Khan & Jain 2007, p. 6-16) = -£4,345/ £7,875 = -0.552 times
Interest coverage ratio measures the ability of a firm to service its debts (Khan & Jain 2007, p. 6-16). The formula uses profit before taxes because the interest is deducted before tax income is charged. The negative value shows that the firm will be unable to pay interest on loans with its current net earnings.
Current ratio
Current ratio = current assets/ current liabilities = £146,546/ £112,324 = 1.30
It shows the company has the ability to pay out all of its current debts. Weil, Schipper & Francis (2014, p. 233) explain that a company with “a current ratio of at least 1.0 has sufficient funds to cover its obligations due in that year”.
Reference List
Damodaran, A 2012, Investment valuation: tools and techniques for determining the value of any asset, 3rd edn, John Wiley & Sons, Hoboken, NJ.
Gilbertson, C & Lehman, M 2009, Fundamentals of accounting, 9th edn, South-Western Cengage Learning, Mason, OH.
Khan, M & Jain, P 2007, Financial management, 5th edn, Tata McGraw-Hill, New Delhi.
Stoltz, A 2007, Financial management: fresh perspectives, Pearson South Africa, Cape Town.
Weil, R, Schipper, K, & Francis, J 2014, Financial accounting: an introduction to concepts, methods, and uses, 14th edn, South-Western Cengage Learning, Mason, OH.