The Issue of Cash Budgeting - Term Paper Example

Executive summary This report contains the information that the management requested on various issues regarding the management of the company. The report starts with an introduction of the issues that have been addressed in the report. The report then looks at the importance of cash budget before presenting the company’s cash budget for the months of February to April. The company’s target units that should be produced in a bid to attain a target profit of $280,000 have also been calculated. The report then looks at whether the company should accept a special order given its capacity and relevant financial factors. Finally, the company’s decision to abandon production of snow skateboards has been analyzed. Table of Contents Executive summary 1 Table of Contents 2 Introduction 3 Cash budget 3 The quantity to produce and sell for target profit of $280,000 4 Whether to accept the special order 6 Non-financial factors for accepting/declining special order 8 Whether the company should discontinue production of Snow skate and increase production of Surfskate. 9 Conclusion 11 References: 12 Appendix 13 Introduction The issue of cash budgeting is very important for any given company to be taken lightly. This is because it gives the financial direction for the company. In this regard, the company is able to gauge its financial requirements and hence organize for financing. In addition, the company can plan on how to use its idle cash productively. In addition, it is important that every company plans its production carefully in such a way that it is able to know whether the current products that it produces would be profitable or there would be need to discontinue production of some production lines. Management accounting also helps the company decide whether to accept special orders since the company can run into risk of rejecting orders that would boost its profitability are accepting orders that would plunge it into loss making. As such, this report addresses all these issues with an aim of enhancing FreeAir Skate Pty Ltd managerial decision making. Cash budget A cash budget will be useful to the company in computing approximately the outflows and inflows of the cash for the company for a specific time period. In this regard, the company is able to know whether it will have adequate cash to carry on its daily operations while ensuring that cash does not lay idle in an unproductive way. The cash budget will also give an exact picture of the company’s cash position and hence help the company in deciding the extent to which it can give credit to customers before the company can have credit crisis (Jerry, 2015). For instance in our case, we should tighten our credit policy to ensure that we don’t have liquidity issues as have been revealed by the cash budget below in this case, we should be able to correct all debts within 2 months. The cash budget will also be helpful to the company in helping us decide our financing needs and hence plan in advance how much to borrow from the bank so that we don’t exceed our credit limit of $200,000 and hence get into financial difficulties In addition, the cash budget will give us a true picture of all our transactions and hence help us in the process of cost reduction. For instance, the salaries have been constant at $158,000 yet from the budget; our cash receipts have not been constant. Through the cash budget, we are able to decide on ways in which we can peg our payments on our production so that when there is no much activity, the level of salaries paid can also be low. The company’s cash budget for the quarter beginning February to April is shown below with the appendix (in excel) showing the cash receipts and disbursement schedules. The quantity to produce and sell for target profit of $280,000 Break even quantity is given by =Q= F/ (P-V) In computing the amount required to attain the $280,000 profit, it is assumed that every product is profitable and that its profitability depends on the percentage it contributes to total sales. In this regard, Snow skate would be expected to contribute the least profit at 5%, surf skate would contribute 60% profit while Dirt skate would contribute 35% of the profit (Colin, 2015). It is also assumed that the same criteria would be applicable in allocating fixed costs. In this regard, it is assumed that fixed cost occurs evenly throughout the year and hence within the quarters. Annual fixed cost = $420,000 Quarterly fixed cost = $420,000/4 = $105,000 Fixed cost for Snow skate = 5% * $105,000 =$5,250 Fixed cost for Surf skate = 60% * 105,000 =63,000 Fixed cost for Dirt skate = 35% * 105,000 =$36,750 Target profit for each type of skateboard Snow skate = $280,000*5% = $14,000 Surf Skate = $280,000*60% =$168,000 Dirt Skate = $280,000* 35% = $98,000 Units for target profit is given by; Targeted income volume = (F+ (It+) 1-t))/p-v Where; F= Fixed cost It= Income after tax P= Selling price V = Variable cost per unit T = Taxes at 30% Snow skate = ($5250+ (14000)/0.7))/265-251 = (5,250+20000)/14 = 25,250/14 = 1,803.57 = 1,804 Units Surf Skate = ($63,000+ (168,000/0.7))/235-184 = 63,000+ 240,000/51 = 303,000/51 =5,941.18 = 5,942 units Dirt Skate = 36,750+ (98,000/0.7))/195-135 =36,750 +140,000/60 = 176,750/60 = 2,945.83 = 2,946 Units From the above analysis, the company will need to produce and sell 1,804 units of snow skate, 5,942 units of Surfskate and 2,946 units of Dirt skate if it is to achieve the target profit of $280,000 within the February to April quarter. Whether to accept the special order Original production of surf skate NB// we use the quarter production created above to examine whether the company should accept the new order or not. Original plan for February to April Sales = 5,942 unita@235 per unit = $1,396,370 Variable costs = 5,942@184per unit = $1,093,328 Contribution margin = $303,042 Fixed costs =$63,000 Tax = $72,012.6 Profit = $168,029.4 Alternative 2 with special order Sales = 6,942 units @as follows Sales of 5,942units @ 235 per unit =$1,396,370.00 Sales of 1000 units @ 195 per unit = $195,000.00 Total sales = $1,591,370.00 Variable cost@184 per unit = $1,279,168.00 Fixed cost = $63,000.00 Taxes = $74,760.60 Profit = $174,441.40 Comparison of profits between the two alternatives Alternative 2 profit $174,441.40 Alternative 1 profit $168,029.40 Increase in profit $6,412.00 NB// Fixed cost does not vary with the level of production and hence it will remain constant regardless of whether the company accepts the special order or not. It is noted that if the company was to accept the special order request, it would make an extra $6,412.00 in terms of profit after tax (Principlesofaccounting.com, 2015). As such, I would advise the company to accept the special order if financial aspects only were to be considered. Non-financial factors for accepting/declining special order From a non-financial viewpoint the order by the surfboard ought not to be accepted. In this regard, the following non-financial factors that have been considered include; First, the company’s idle capacity has been considered. The company is currently operating at 90% capacity. It is assumed that the company will produce 5,942 units in order to achieve the target profit. This means that with the remaining 10% capacity, the company will only be able to manufacture an extra 660 units. This means it might not be able to hit the required 1000 units. It implies that the company will have to turn away regular customers who are more profitable to make room for the special order (Johansen, 2014). This implies that the company ought to reject the special order since it does not have the capacity. However, if it still wants to accept the offer, there is need to discuss this with the client to see if they can accept the 660 units while they buy the rest of the units at discounted price. In addition, the company should consider whether the order is permanent in which case, it might consider investing in some extra capacity with the hope that better rates can be negotiated for in future. Whether the company should discontinue production of Snow skate and increase production of Surfskate. There are two alternatives Alternative 1: Keeping all the product lines Alternative 2: Dropping the snow skate line In making the decision, we use the last year’s performance figures. Surf skate Dirt Skate Snow Skate Total Sales $2,100,000 $1,225,000 $175,000 $3,500,000 Variable costs $1,540,000 $857,500 $157,500 $2,555,000 Fixed costs $234,000 $155,000 $64,000 $453,000 Total cost $1,774,000 $1,012,500 $221,500 $3,008,000 Operating income/(loss) $326,000 $212,500 ($46,500) $492,000 In alternative 2, it should be taken into account that Surf skate division will benefit from increased sales by 15%. In this regard, it is then assumed that the division will take over the fixed costs initially incurred by the snow skate division. Thus, the alternative 2 performance would like as shown below; Sales of Surf skate division will be as follows; $2,100,000 * 1.15 =$2,415,000 Variable costs will also increase by 15% as follows $1,540,000 * 1.15 = $1,771,000 Fixed costs $234,000 + $64,000 = $298,000 Alternative 2 performances will thus be as follows; Surfskate Dirt skate Total Sales $2,415,000 $1,255,000 $3,670,000 Variable costs $1,771,000 $857,500 $2,628,500 Fixed costs $298,000 $155,000 $453,000 Total costs $2,069,000 $1,012,500 $3,081,500 Operating income $346,000 $212,500 $588,500 A comparison between the two alternative will be as follows; Differential analysis Alternative 1 Alternative 2 Differential amount Alternative 1 is Sales revenue $3,500,000 3,670,000 -170,000 lower Variable costs $2,555,000 2,628,500 -73500 lower Contribution margin $945,000 1,041,500 -96,500 lower Fixed costs $453,000 453,000 0 - Profit $492,000 588,500 -96,500 lower Result of dropping snow skate Sales revenue gained $170,000 Variable costs increase $73,500 Contribution margin gained $96,500 Differential fixed cost - Gain from dropping product line $96,500 By dropping the snow skate production line, the company will be able to achieve an increase in profit worth $96,500. However, it should be noted that dropping the product line will imply; a) Remodeling the manufacture space and show room at a cost of $65,000. However, this is a one-time cost which implies that it will not be incurred in subsequent years (unf.edu, 2015). b) The current machine with one year useful life is worth $125,000 and will have to be resold at $45,000 implying a further one-time loss of $80,000 which does not have to be incurred in subsequent years. c) The new machine to be bought will cost $324,000 and will have a useful life of $324,000 implying that it will have to be depreciated at $108,000 every year. However, given that the current snow skate machine currently has a current value of $125,000 and will have zero value at the end of one year, it means that the new machines depreciation is lower by $17,000. This implies savings on depreciation of $17,000 every year which is a boost on the company’s profit. d) The remaining $48,000 worth of snow skate do not affect the decision whether to continue or discontinue with the product line. Conclusion Based on the above analysis, it is clear that discontinuing the production of snow skate and hence increasing production of snow skate would be the more beneficial alternative for the company. As such, my advice to the company is that it should go ahead and discontinue the production of Snow Skate and increase production of Surf Skate all other factors held constant. References: Jerry, J2015, Managerial accounting tools for business decision making, New York, John Wiley & Sons. Colin, D2015, Management and cost accounting, retrieved on 2nd June 2015, from; https://books.google.co.ke/books?id=8SaARYOflPIC&pg=PA188&lpg=PA188&dq=Management+ accounting+Non+financial+factors+for+accepting+special+order&source=bl&otsjYOSd6QGd&sig =CgRezvixY3TRyXfKkZSzPBnafMk&hl=en&sa=X&ei=4lFtVZfPJor_7Abe4oPoCA&redir_esc=y#v=on epage&q=Management%20accounting%20Non%20financial%20factors%20for%20accepting%20 special%20order&f=false David, P2015, Key performance indicators, New York, John Wiley & Sons. Principlesofaccounting.com, 2015, Analytics for managerial decision making, retrieved on 2nd June 2015, from; http://www.principlesofaccounting.com/chapter24/chapter24.html Johansen, B2014, Management accounting, London, Rutledge. unf.edu, 2015, Special order decisions, Retrieved on 2nd June 2015, from; http://www.unf.edu/~dtanner/dtch/dt_ch20.htm Appendix In the attached excel sheet. Read More