With regard to financial management, one of the most important steps of financial strategy is the development of cash budget and evaluation of borrowing needs of the company. The purpose of this paper is to prepare a cash budget for Sharpe Corporation, covering first seven months of year 2004, analyze cash flows during this period, estimate borrowing needs and adjust the budget with regard to borrowing expenses. It is also necessary to determine whether Sharpe Corporation will be able to repay $200,000 notes payable in July 2004.
Overall, cash budget of the company represents the evaluation of the company’s receipts and disbursements for some selected period of time in future (Moyer, McGuigan & Kretlow, 2008). Commonly, cash budget of a company is prepared on yearly basis, and is then subdivided into months. For more sophisticated estimates, cash budgets can be prepared on weekly and even daily basis. The goal of cash budget is to determine whether the company might need to borrow cash to provide for short-term cash shortages, and to determine the situations when there are possible cash surpluses in order to invest these funds in an efficient way (Moyer, McGuigan & Kretlow, 2008). Cash budget results are also important for the company’s control and coordination activities.
There are three common methods of preparing cash budget: the method of receipts and payments, adjusted profit and loss method and the method of balance sheet (Williams & Meigs, 2002). The method of receipts and payments is generally used for preparing short-term cash budgets (1 year period or less), while balance sheet method and adjusted profits and loss method are frequently used for preparing cash budgets for long-term periods (Horngren et al, 2007).
In order to analyze cash flow, budget and borrowing of Sharpe Corporation it is necessary to identify all cash transactions taking place during the selected period, to determine cash collections and cash disbursements (Horngren et al, 2007). Basing on this information, it will be possible to forecast monthly cash flows for Sharpe Corporation and to consider the budget of the company as well as its needs for borrowing with regard to every month of the target period (first 7 months of 2004).
For determining cash collections, it is necessary to take into account that 10% of the company’s sales are collected during the same month, 60% of the sales are collected during the next month, and the remaining 30% are collected two months later. Thus, cash collections for every month will include 10% of the sales for the current month, 60% of sales of the previous month, and 30% of sales which took place two months ago.
Cash disbursements of Sharpe Corporation include such elements as fixed expenses such as rent and other expenditures, tax prepayments, payment for raw materials, interest payments on possible borrowing, and the repayments of the short-term debts. Raw materials are purchased two months before actual sales are projected, and payment for these materials takes place one month after the purchase of raw materials. The cost of raw materials is 60% of the projected sales; thus, payments related to purchase of raw materials constitute 60% of the projected sales of the next month. Rent is fixed ($10,000 per month) as well as other expenditures ($20,000 per month). Tax prepayments of $22,500 take place every quarter, and the first tax prepayment of the target period will take place in March 2004; thus, second tax prepayment will take place in June 2004. On short-term loans there is 12% annual interest payment, which is 1% of the borrowing per month, and it is supposed that Sharpe Corporation will repay its short-term debts next month after the debt was borrowed.
Cash budget of Sharpe Corporation should be constructed in order to maintain a minimal balance in the end of the month equal to $15,000. Initial balance of Sharpe Corporation by the end of December 2003 is $22,000. Total cash collections of Sharpe Corporation for the projected period are $180,000 in January 2004, $118,500 in February, $112,500 in March, $141,000 in April, $214,500 in May, $279,000 in June and $274,500 in July. The values of total cash disbursements for these months (excluding possible repayments of borrows and interest payments) are: $102,000 in January, $111,000 in February, $196,500 in March, $210,000 in April, $192,000 in May, $187,500 in June, and $120,000 in July. As a result, expected monthly cash flows of Sharpe Corporation are $78,000 in January, $7,500 in February, -$84,000 in March, -$69,000 in April, $22,500 in May, $91,500 in June, and $154,500 in July. It is possible to determine that Sharpe Corporation will experience the lack of cash in April and May 2004 as a result of negative cash flows in the previous periods, mostly due to the high projected sales of future months, and associated payments for raw materials in these months combined with a shift in collecting.
In the end of January, the balance of Sharpe Corporation will be $100,000; in the end of February, it will reach $107,500, and in March this balance will be $23,500. In April, expected cash balance will be -$45,500, and Sharpe Corporation will need to borrow $60,500 to maintain a minimal balance of $15,000 by the beginning of May. Interest payment on this borrowing in May will be $605, and in May the borrowing of April should be repaid. Taking into account repayment of April debt and interest payment, cash balance of Sharpe Corporation in the end of May will be -$23,605. In May, the company should borrow $38,605, with interest payment in June equal to $386, and repayment of $38,605 in June. Expected balance in the end of May will be $15,000, in the end of June $67,509, and in the end of July it will be equal to $222,009. Table 1 contains cash budget and borrowing estimates for Sharpe Corporation for January-July 2004.
Overall, the major source of cash shortage for Sharpe Corporation is the need to purchase raw materials and to pay for them during one month. It is possible to recommend to Sharpe Corporation to negotiate more favorable payment conditions with their suppliers; for example, 20% of the payment could be done at the same month when raw materials were purchased, 60% of the payment could be done at the next month, and the remaining 20% could be paid two months after purchasing raw materials. This will help to balance cash disbursements and cash collection, and as a result, Sharpe Corporation could better manage short term finance, mitigate risks associated with forecasted sales and receivables.
By the end of July 2004, Sharpe Corporation is expected to have $222,009 in cash. It is known that Sharpe has $200,000 in notes payable due in July that must be repaid or renegotiated for an extension. If these notes payable can be paid right in the end of July, after receiving all cash collectables, Sharpe Corporation will be able to repay its notes payable, and it will also have $22,009 in cash after all payments, which corresponds to the minimal cash requirement of the corporation. However, if these payments should be done in the beginning or in the middle of July, Sharpe Corporation might negotiate for extension or pay part of this sum, depending on the dynamics of receiving collectables. Most likely, Sharpe Corporation will be able to repay its notes payable in July.
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