Preparation of budgeted balance sheet

INTRODUCTION

Early one morning in March, Jordan Buford was preparing

his daily work when his boss, Olivia Anton, approached

him and announced, “Little Annin Flagmakers (LAF) has

submitted an application for a line of credit (LOC) for April

through June. I want you to prepare budgeted financial

statements similar to the ones you prepared for our last

LOC applicant. I need this by 3 p.m. today for the 4 p.m.

credit committee meeting. Be prepared to make a loan

recommendation and to address questions from the credit

committee. I have cleared your schedule. Let me know if

you need anything.”

Kent Bank is a state bank with multiple branches that

offers a variety of services for personal and commercial needs.

The bank has been serving the local community for more

than 110 years and prides itself on its personalized approach

to provide financial services, local management, long-term

stability, and a full range of deposit and lending products and

services. Commercial credit decisions at Kent Bank are made

by the Commercial Credit Committee, which consists of the

senior commercial credit analyst and two vice presidents.

Buford was recently hired by Kent Bank as a commercial

credit analyst to provide analysis for commercial loan

applications. During his undergraduate studies, he studied

accounting and finance, and shortly after graduation

passed the CMA® (Certified Management Accountant)

examination. Buford reports directly to Anton, the senior

commercial credit analyst who has been with Kent Bank for

10 years.

As Buford began the work, he recalled his last LOC

analysis and how well received it was. He had taken the

information provided by the company and developed master

budgets in Excel that used an input section with numbers

that could be changed for assessing different scenarios. The

committee had specifically asked about the effect of a sales

reduction of 2%, 5%, and 10% on the applicant’s cash needs.

He wanted to be prepared for these types of questions.

LITTLE ANNIN FLAGMAKERS BACKGROUND

LAF manufactures one product, a large durable 8’ × 12’

American flag, which it sells for US$120. Because of the large

size of the flag, this product is not sold in stores; rather it is

sold through a relatively small number of online retailers.

Each quarter, retailers estimate sales for the upcoming five

months, revising proximate sales as necessary. In general,

the retailers are reasonably good at estimating their sales

needs, but some variation in demand does occur, and the

retailers expect to be able to adjust orders as needed. LAF

allows retailers to adjust each month’s purchases to 80% to

120% of the estimated sales levels. Flags are shipped to retail

customers using JIT distribution so that the online retailers

do not have to store inventory.

Typical sales for the flag are 1,800 units per month with

seasonal increases in April through August. Sales estimates are

2,500 units in April, 6,000 units in May, 3,000 units in June, 2,500

units in July, and 2,000 units in August. Customers historically

have paid 40% of their purchases in the month of the sale, 55%

in the following month, and the remaining 5% is uncollectible.

I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 1 1 , N O . 4 , A R T. 4 , D E C E M B E R 2 0 1 81

ISSN 1940-204X

Cash Is King: Master Budgets to Inform a Credit Decision

Anne M.A. Sergeant, CMA, PhD Seidman College of Business Grand Valley State University Grand Rapids, MI

Neal VandenBerg, CPA, PhD Seidman College of Business Grand Valley State University Grand Rapids, MI

© 2 0 1 8 I M A

MANUFACTURING AND SG&A COSTS

The flags are made in one plant, which has a capacity of

6,200 units per month. LAF budgets have 20% of next

month’s sales in finished goods inventory at the end of each

month. There is plenty of storage space for finished goods.

Fabric is the only direct material and each flag requires

five pounds of fabric at US$7 per pound. LAF plans to

have 40% of next month’s fabric needs on hand at the end

of the month. Fabric is purchased on credit with 40% paid

in the month of purchase and 60% paid the next month.

The standard direct labor hours to manufacture one flag is

0.50 hours at US$40 per hour. For simplicity, direct labor

costs are budgeted as if they were paid when incurred.

Manufacturing overhead rates are computed quarterly and

applied based on direct labor hours. Fixed manufacturing

overhead costs are estimated to be US$57,950 per month, of

which US$20,000 is property, plant, and equipment (PPE)

depreciation. Variable manufacturing overhead, including

indirect materials, indirect labor, and other costs, is estimated

at US$10 per direct labor hour.

The selling and administrative expenses include variable

selling costs (primarily shipping) of US$1.25 per unit and

fixed costs of US$63,000 per month, of which US$10,000

is depreciation of the administrative office building and

equipment.

FINANCIAL STATEMENT DETAILS AND CASH PLANNING

LAF uses first in, first out (FIFO) inventory valuation. As of

March 31, the expected finished goods inventory is 410 units,

valued at US$75 per unit. The company expects to have

4,600 pounds of fabric on hand, valued at US$7 per pound.

Other expected account balances include accounts payable at

US$55,000, accounts receivable at 132,000, cash at US$37,745,

land at US$520,000, and building and equipment at

US$1,800,000 with accumulated depreciation of US$750,000.

LAF has no long-term debt; common stock is valued at

US$500,000 and is not expected to change during the quarter;

expected retained earnings as of March 31 are US$1,247,695.

LAF budgets for US$30,000 ending cash balance each

month and is requesting a line of credit that will allow it to

adjust for its cash needs. The dividends of US$15,000 are paid

each month. During the quarter, LAF planned to purchase

equipment in May and June for US$47,820 and US$154,600,

respectively. This equipment is being purchased to increase

capacity and is not expected to come on line until after the

quarter, thus not affecting the manufacturing overhead costs.

LOAN DETAILS

LAF has requested a line of credit of US$60,000 to cover

production costs during the seasonal increase in business.

Kent Bank uses the following terms on its lines of credit. All

borrowing is done at the beginning of the month in whole

dollar increments. All repayments are made at the end of the

month in whole dollar increments. The full line of credit is

expected to be paid off by the end of the quarter with all the

interest repaid at the end of the quarter. The interest rate on

this loan is 16% per year.

REQUIRED

1. Using the data input provided (Exhibit 1), prepare LAF’s

master budgets in Excel. Do not hard-code numbers into

the spreadsheet, except in the financing section of the

cash budget.

2. Conduct a sensitivity analysis, decreasing sales 2%, 5%,

and 10% for April through August. New sales levels are

provided in Exhibit 2. Adjust the financing and cash

needs at these new sales levels.

3. Determine a credit recommendation for Kent Bank, to

lend or not. Be prepared to justify your credit decision.

4. Explain why the cash budget is more important to a bank

than the accounting net income when determining a

credit decision.

5. Explain why decreases in sales is examined in a

sensitivity analysis for a credit decision.

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