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.

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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.

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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. B 6. D 11. A 16. C 21. C

2. B 7. C 12. C 17. B 22. A
3. E 8. C 13. C 18. C 23. B
4. C 9. C 14. C 19. B 24. C
5. C 10. D 15. D 20. C 25. A

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III. Problems

Problem 1

a. Februar March April May June

y
Sales ₱60,000 ₱70,000 ₱75,000 ₱95,000 ₱110,000
Credit sales 54,000 63,000 67,500 85,500 99,000
Collections:
Cash
(10% of Sales) 6,000 7,000 7,500 9,500 11,000
60% first month
after sale 37,800 40,500 51,300
40% second
month after sale 21,600 25,200 27,000
Total Receipts ₱66,900 ₱75,200 ₱89,300

b. Receivables at End of June:

90% of June Sales ₱ 99,000
40% of May Credit Sales 34,200
₱133,200

Problem 2

January February March April May

Cash ₱4,200 ₱6,000 ₱7,800 ₱6,600 ₱5,400
Credit 9,800 11,400 18,200 15,400 12,600
Collections:
Cash 7,800 6,600 5,400
40% on the following month 5,600 7,280 6,160
60% on the second month 5,880 8,400 10,920
Total Collections ₱19,280 ₱22,280 ₱22,480

Cash Budget
Collections ₱19,280 ₱22,280 ₱22,480
− Payments 21,300 19,100 22,400
Cash Flow (2,020) 3,180 80
+ Beginning Cash Balance 2,000 2,000 2,000
Cumulative Cash Balance (20) 5,180 2,080
Loan (Repayment) 2,020 (3,180) (80)
Cumulative Loan Balance 4,020 840 760

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Ending Cash Balance ₱2,000 ₱2,000 ₱2,000

Problem 3

a. February March April May June

Sales ₱60,000 ₱80,000 ₱100,000 ₱120,000 ₱110,000
Credit sales 54,000 72,000 90,000 108,000 99,000
Collections:
Cash
(10% of Sales) 10,000 12,000 11,000
70% 1 month
following sale 50,400 63,000 75,600
30% 2 months
following sale 16,200 21,600 27,000
Monthly Cash
Receipts ₱76,600 ₱96,600 ₱113,600

b. Accounts receivables at the End of June:

90% of June Credit Sales ₱ 99,000
30% of May Credit Sales 32,400
Total Receivables Balance ₱131,400

Problem 4

a. April May June Total

February sales:
₱230,000 × 10% ₱ 23,000 ₱    23,000
March sales:
₱260,000 × 70%, 10% 182,000 ₱ 26,000 208,000
April sales: ₱300,000 ×
20%, 70%, 10% 60,000 210,000 ₱ 30,000 300,000
May sales:
₱500,000 × 20%, 70% 100,000 350,000 450,000
June sales:
₱200,000 × 20%                                   40,000        40,000
Total cash collections ₱265,000 ₱336,000 ₱420,000 ₱1,021,000

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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% ₱ 50,000

From June sales: ₱200,000 × (70% + 10%)  160,000
Total accounts receivable at June 30 ₱210,000

Problem 5

Unit volume (3,000 x 1.20) 3,600

Price (₱200 x 1.10) ₱ 220
Total sales ₱792,000
Returns (5%) 39,600
Net sales ₱752,400

Problem 6

Projected sales 40,000 units

Desired ending inventory 6,000 (15% x 40,000)
Beginning inventory 8,500
Units to be produced 37,500

Problem 7

Projected sales 12,000 units (8,000 x 1.50)

Desired ending inventory 600 (5% x 12,000)
Beginning inventory 400
Units to be produced 12,200

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Problem 8

Projected sales 50,000 units

Desired ending inventory 5,600 (40% x 14,000)
Beginning inventory 14,000
Units to be produced 41,600

Problem 9

September October November December

Credit sales ₱50,000 ₱40,000 ₱35,000 ₱60,000
20% Collected in
month of sales 8,000 7,000 12,000
70% Collected in
month after sales 35,000 28,000 24,500
Total cash receipts ₱43,000 ₱35,000 ₱36,500

Problem 10

April May June Quarter

Budgeted sales in units 50,000 75,000 90,000 215,000
Add: Desired ending inventory*   7,500   9,000   8,000     8,000
Total needs 57,500 84,000 98,000 223,000
Less: Beginning inventory  5,000   7,500   9,000     5,000
Required production 52,500 76,500 89,000 218,000

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

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