COMPREHENSIVE BUDGETING PROBLEM
Cindy Smith has been a successful marketing executive for various consumer products companies. Having recently cashed out her stock options, she is planning to quit her current position and realize her life-long dream of owning her own boutique, to be called The White Rabbit. She has done some market research, and is exploring arrangements with landlords, suppliers, etc. Her target date for opening is July 1, 2014, and she would operate on a June 30 fiscal year.
Even though she has personal funds available to invest, it will still be necessary to obtain a bank loan for initial financing, and she has had discussions with bank loan officers. Total financing needs are estimated to be $110,000. First National Bank has indicated that they would be willing to make a loan equal to 50% of the long-term financing of the company, with Cindy s owner s equity in the corporation (contributed capital) forming the other 50%. The note would be secured by the inventory and Cindy s personal guarantee. The loan will be taken out on June 1st. The company would be required to maintain a minimum cash balance of $5,000 in an account at First National Bank. No principal payments would be required for the first three years, but interest would be payable at .6% (six-tenths percent) per month. In order to qualify for the loan, Cindy must provide the bank with monthly cash budgets and forecast annual financial statements for the first two fiscal years of operation.
Cindy will operate the business as a sole proprietorship, which does not constitute a separate taxable entity. Therefore, income taxes can be disregarded.
Cindy expects to rent a storefront in a strip mall. Rent would be $5,700 per month, payable in advance the first day of each month. In addition, a $5,000 deposit would be required upon signing of the lease on June 1, 2014. Fixtures costing $24,000 would be installed in June, 2014 and paid for immediately. They would be depreciated on the straight-line method over 72 months, starting July 1, with no salvage value.
Cindy expects to keep two months worth of sales in inventory. In May, she will order the merchandise expected to be sold in July and August. This will be received and stocked in June. Then expected September sales will be ordered in June to be received and stocked in July, etc. According to her suppliers normal practices, purchases are paid for 50% in the month received, and 50% in the following month.
Other information about operating expenses:
Insurance:Cost is $3,800 per year, payable in advance (June).
Telephone:$200 deposit required in June, 2014. Monthly phone bill is expected
to be $290.
Payroll: Payroll costs are expected to be $5,600 per month, plus 10% in payroll
taxes. It is assumed that all payroll costs are paid in the month incurred.
Because of seasonality of the business, payroll costs are expected to be
40% higher than normal in November and December, and 20% higher in
January. One-time payroll costs of $4,000 for stocking and training will
be incurred in June, but not paid until July. These are to be treated as a
July expense.
Advertising:Advertising expense is expected to be $500/mo., with extra
promotional expenses of $500 in each of November, December, and
June. Cindy expects to spend $5,000 in June of 2014 promoting her
Grand Opening. These promotion costs will be paid in July, and are to
be treated as July expense.
Miscellaneous:Miscellaneous expenses are expected to be $250/month, starting
in July.
Sales are expected to be made as follows: 10% cash, 30% check, 60% credit cards. Credit card sales, net of an average fee of 2%, are received in the month of sale. Ten percent of the checks received are expected to be returned NSF. Of these, half will never be collected, and the other half will be collected on average in the third month following the sale (i.e., October for July sales). Fees charged to delinquent customers are expected to equal the costs of collection.
Gross margin is expected to be 50%, except that in January and June, it will be 40% because of markdowns.
Cindy expects the following monthly sales, in thousands of dollars:
2014 2015 2016
January 60 65
February 22 23
March 28 30
April 43 47
May 30 32
June 45 50
July 36 30 32
August 17 21 22
September 30 33 35
October 23 25 26
November 64 70 80
December 59 65 70
REQUIRED: Prepare the following (rounding all amounts to the nearest dollar):
1. Monthly cash budgets for the first two fiscal years of operation. Note that for the first year, it will be a 13-month budget, including June of 2014.
2. Forecast income statements for The White Rabbit, Inc. for the first two fiscal
years of operation. Expenses incurred in June, 2014 are to be added to
July s expenses for income statement purposes, rather than preparing a
separate income statement for June.
3. Forecast balance sheets as of June 30, 2015 and 2016.