Case 6b: Chester Wayne Is A Regional Food Distributor

Case 6b Chester Waynechester Wayne Is A Regional Food Distributi

Prepare a cash budget for each month of the fourth quarter and for the quarter in total, including supporting schedules as needed. Additionally, analyze how changes in gross margin, inventory levels, and collection policies could impact cash flow and borrowing requirements. Discuss the implications of your findings with the company management, considering their concerns and proposed policy changes.

Paper For Above instruction

Chester & Wayne, a regional food distribution company, faces the complex task of managing its cash flow efficiently amidst fluctuating sales, expenses, and strategic decisions. The core challenge lies in maintaining adequate liquidity while supporting growth and operational needs. This paper develops a detailed cash budget for October, November, and December—key months marked by significant transactions—including equipment acquisition and dividend payouts—and assesses the potential impact of various operational adjustments on cash flow and borrowing needs. The analysis combines financial data, sales projections, and management policies to provide insights into the company's liquidity management strategies and their sensitivities.

To begin, the cash budget process involves synthesizing monthly cash inflows and outflows based on sales projections, collection policies, payment timing for purchases and expenses, and extraordinary items like equipment purchase and dividends. In October, the forecasted sales amount to $826,800, with 40% of the previous month’s sales collected within 10 days offering a 2% discount, and 25% collected in the same month without discount, with the remaining 30% collected in the second month after billing. The company anticipates an additional cash inflow of $24,000 from warehouse rentals. Given the collection pattern, the cash receipts for October are computed by summing the collections from September sales (30%) and October sales (45%), including the cash discount effect. Similar calculations are executed for November and December, considering their respective sales forecast, the timing of collections, and the collection policy’s efficiency.

Cash outflows encompass purchases, administrative expenses, selling expenses, advertising, equipment acquisition, and dividends. Purchases are based on last month’s costs, with ending inventory set at 25% of the next month’s expected cost of goods sold, ensuring sufficient stock without overinvestment. Payments for purchases are split evenly between current and next month, reflecting the company's payment policy of 60% in the month incurred, and 40% in the subsequent month. Selling and administrative expenses are 5% of current sales plus $75,000, which includes depreciation, and advertising expenses are budgeted at 3% of sales.

For October, the anticipated expenses include variable S&A costs at 5% of $826,800 sales, equating to $41,340, plus fixed expenses totaling $75,000, and advertising of approximately $24,804 (3% of $826,800). These are adjusted accordingly for November and December based on forecasted sales. The gross profit margin assumption of 30% indicates that cost of goods sold for October is estimated at $578,760, with corresponding inventory levels derived using the ending inventory policy based on next month’s projected COGS.

Special considerations include the equipment purchase in November costing $250,000, and dividend payout of $45,000 in December. Cash on hand at the start of October is $142,100 with marketable securities valued at $200,000. The company maintains a minimum cash balance of $120,000 and prioritizes using marketable securities to bridge shortfalls before resorting to borrowing. Any excess cash after meeting minimum balances is invested in marketable securities or used to repay borrowings, according to policy. The cash flow projections are tabulated month-by-month, highlighting periods of surplus or deficit, and identifying borrowing requirements and investment opportunities.

Moreover, the company is evaluating the impact of strategic changes proposed by management. For instance, reducing the gross margin from 30% to 27.5% due to rising purchase costs would decrease profitability, possibly increasing reliance on borrowing to cover cash shortfalls. An increase in inventory levels from 25% to 30% or 40% of next quarter’s sales would elevate holding costs and tied-up capital, thereby affecting liquidity and investment capacity. Changing collection policies to delay customer payments by an additional 20% from the month of billing to the next month could diminish immediate cash inflows, increasing liquidity pressures, especially in months with high expenses or investment outlays.

When discussing the implications of these scenarios with management, it is crucial to evaluate the impact on cash flow stability and financial flexibility. A lowered gross margin reduces net cash flows, potentially increasing short-term financing needs. Higher inventory levels, although reducing stock-out risk, require more working capital and could necessitate additional financing. Delaying collections amplifies cash flow gaps, prompting the need for more aggressive management of receivables or financing solutions. Conversely, policy adjustments like removing cash discounts might decrease discounts offered but could slow cash inflow, impacting liquidity if not managed carefully. Increasing discounts to 3% could accelerate cash collections, but at the expense of profit margins, which necessitates a careful trade-off analysis.

Overall, the cash budget and sensitivity analysis serve as vital tools for financial planning, enabling Chester & Wayne to optimize liquidity, manage operational risks, and support strategic decisions. The findings suggest that maintaining a flexible approach to cash management, alongside proactive inventory and receivables policies, will be fundamental for sustaining the company's growth and operational integrity.

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