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Lahore School of Economics. Advance Corporate Finance. MBA II . Winter 2014. Dr.

Sohail Zafar

Lectures 9 & 10
Financial Planning Case Study . This is a case about a start-up trading business
You and your six cousins have planned to start a new business by subscribing each of you 100,000 shares of Rs 10
par value in a proposed new company thus each of you providing 1 million rupees as the seed money. You
estimate that monthly sales for the first three months would be rupees 100,000 , 120,000 and 150,000. To attract
customers you plan to offer liberal credit terms, so that 90% sales of a month would be collected next month
while, 10% would never be collected. Therefore you intend to record each months bad debt expense in that
months income statement as if the bad debt expense has been incurred. You have discovered since you have no
credit history, therefore suppliers of inventory would demand cash for your purchases of inventory. Your estimate
of inventory purchases per month is Rs 90,000 per month so that you slowly build up your stocks of inventory in
your shop rather than buying it in one go in the start of business; this is also important from the marketing view
point because designs/fashions/fads keep changing so fast that old stocks become obsolete very quickly thus over
stocking is risky.
You have negotiated for a 3,000 square feet shop in liberty market. PAGRI is 5 million rupees. It is a type of good
will money you have to pay to the present tenant or owner of the shop, hopefully when you leave this shop after a
few years you will receive Pagri from the next tenant of this shop. In well established markets such as Liberty
Market, Pagri is huge amount. Monthly rent of shop is Rs 10,000 and will be paid in advance for one year. Fixtures
including shelves, carpeting, AC, neon signs, etc would require Rs 600,000 and would be depreciated over five
years on straight line basis. In first month of operation you plan to spend 100,000 Rs on advertising and on
subsequent two months Rs 50,000 per month. You plan to act as manager and intend to hire 2 sales persons:
total monthly salaries of all three persons would be Rs 60,000. Electric, Phone and other bills are estimated to be
Rs 20,000 per month. Both salaries and utility bills of a month would be paid beginning of next month. You would
need a license from the government of Lahore City costing Rs 6,000 and you intend to amortize this on monthly
basis over one year.

Initial cost to set up the corporation including legal fees and SECP requirements are

estimated Rs 10,000 and you intend to amortize this organizational cost over 5 years by charging monthly
amortization expense in your income statement.
It is your estimate that gross profit margin on sales would be 60%. You plan to maintain minimum cash balance of
Rs 200,000 end of each month. Cash that is in excess of Rs 200,000 would be invested in a bank deposit account
to earn percent per month and interest would be received on the last day of the same month; and in the month
cash is short you plan to borrow from bank at 1% per month, and interest expense on loan would be paid monthly
at the end of the same month.

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Lahore School of Economics. Advance Corporate Finance. MBA II . Winter 2014. Dr. Sohail Zafar

Required:
Please prepare monthly cash budget for three months and also the total for the three-month period.
Please prepare income statements for each month to show results of operations of each month as well as prepare
income statement for the three month period.
Please prepare balance sheets as of last day of each of the three month.

Cash Budget
Please note M stands for month
Cash Inflows

M1

M2

M3

TOTAL

Investment by owners

7,000,000

7,000,000

Collection of Sales

90,000

108,000

198,000

Total inflows (a)

7,000,000

90,000

108,000

7,198,000

Pagri

5,000,000

5,000,000

Purchases

90,000

90,000

90,000

270,000

Business License

6,000

6,000

Organizational Cost

10,000

10,000

Advance Rent

120,000

120,000

Fixture & Furniture

600,000

600,000

Advertising

100,000

50,000

50,000

200,000

Salaries

60,000

60,000

120,000

Phone/Utilities

20,000

20,000

40,000

Total Outflows (b)

5,926,000

220,000

220,000

6,366,000

Net Cash Flows (a b)

1,074,000

-130,000

-112,000

832,000

1,078,370

952,110

Cash Outflows

+Beginning Cash Balance

- Minimum Cash

-200,000

-200,000

-200,000

-200,000

Surplus/Shortage of Cash

874,000

748,370

640,110

632,000

% Interest Income

4,370

3,740

3,200

11,310

Cash after Interest income

878,370

752,110

643,310

643,310

Ending Cash Balance

1,078,370

952,110

843,310

843,311

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Lahore School of Economics. Advance Corporate Finance. MBA II . Winter 2014. Dr. Sohail Zafar
Please note: Ending cash Balance = Cash After Interest income + Minimum Cash . Please also note that ending cash
balance of this month becomes beginning cash balance for the next month. Ending cash balance goes on the asset
side of balance sheet of each month. Ending cash balance at the end of M 3 and ending cash balance for the whole
three-month period must be same, in this case it is 843,311, because it is the same date when M3 ends as well as
the three- month period , that is Quarter 1,ends, so cash on that date must be the same amount.
Projected Income statements for each of the three months and for the whole three-month period
M1

M2

M3

TOTAL

Sales

100,000

120,000

150,000

370,000

CGS (40% of sales)

40,000

48,000

60,000

148,000

GP 60% of sales

60,000

72,000

90,000

222,000

Operating Expenses
Rent

10,000

10,000

10,000

30,000

Salaries

60,000

60,000

60,000

180,00

Advertising

100,000

50,000

50,000

200,000

Utilities

20,000

20,000

20,000

60,000

License amortization

500

500

500

1,500

Depreciation Expense fixture

10,000

10,000

10,000

30,000

Amortization Organization cost

166

166

166

500

12,000

15,000

37,000

Bad debt expense (10% of sales) 10,000


------------------------------------------- ------------

--------------

--------------

---------------

Total Operating Expenses

210,666

162,666

165,666

538,998

Operating Profits (EBIT)

-150,666

-90,666

-75,666

-317,000

+Interest Income

4,370

3,741

3,200

11,311

EBT

-146,296

-86,925

-72,466

-305,689

Corporate Income Tax

NI

-146,296

-86,925

-72,466

-305,689

===

========

=======

=======

=========

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Lahore School of Economics. Advance Corporate Finance. MBA II . Winter 2014. Dr. Sohail Zafar

Note: To work out Retained Earnings (RE) balance that goes in the OE portion of balance sheet of each month
please use the following equation format of statement of changes in RE:

M1

M2

M3

Ending RE

= Beginning RE +

Ending RE

= 0

Ending RE

= -146,296

Ending RE

= -146, 296

Ending RE

=-233,221

Ending RE

= -233,221

Ending RE

=-305,687

NI

- cash dividends stock dividends (bonus shares)

+ -146,296

-0

-0

+-86,925

-0

-0

+-72,466

-0

-0

Please note: due to loss shown in each months income statement the negative balance of RE in the balance sheet
is rising at the end of each month; if there were profits in each month the RE balance would have been positive
and rising. In this case such negative balance of RE is termed Accumulated Losses.
Projected Balance Sheets on the last day of each month
M1

M2

M3

Cash

1,078,370

9,521,10

8,433,10

R/A (90% of sales)

90,000

108,000

135,000

Inventory

50,000

92,000

122,000

Fixtures

600,000

600,000

600,000

-Accumulated depreciation

(10,000)

(20,000)

(30,000)

Fixture (net)

590,000

580,000

570,000

Organizational cost

9,834

9,668

9,502 (Amortization 166Rs/month)

License fee

5,500

5,000

4,500 (Amortization 500 Rs/month)

Prepaid Rent

110,000

100,00

90,000

Pagri

5,000,000

5,000,000

5,000,000

Total Assets

6,933,704

6,846,778

6,774,312

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Lahore School of Economics. Advance Corporate Finance. MBA II . Winter 2014. Dr. Sohail Zafar

Salaries Payable

60,000

60,000

60,000

Utilities Payable

20,000

20,000

20,000

TL

80,000

80,000

80,000

Paid up Share Capital

7,000,000

7,000,000

7,000,000

RE

-146,296

-233,221

-305,687

OE

6,853,704

6,766,779

6,694,313

TL+OE

6,933,704

6,846,779

6,774,313

Please note: the difference of 1 Rs in 2 sides of balance sheet is due to rounding of amortization of 166.66 to 166.
To estimate R/A ( accounts receivable) and inventory amounts that go in the balance sheets of each month, the
following analytical accounting equations were used to estimate ending balance of accounts receivables and
ending balance of inventory at the end of each month.
Beg R/A + Sales - Ending R/A - Bad Debt expense = Cash collected from customers
M1

+ 100

Ending R/A

- 10

90 = Ending R/A

M2

90

+ 120 Ending R/A - 12 = 90

108 = Ending R/A

M3

108

+ 150 Ending R/A - 15 = 108

135= Ending R/A

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Lahore School of Economics. Advance Corporate Finance. MBA II . Winter 2014. Dr. Sohail Zafar

Beginning inventory +Purchase of inventory -Ending inventory = CGS


M1

+ 90

- Ending inventory =40

50 = Ending inventory

M2

50

+ 90

- Ending inventory =48

140 - 48 = Ending inventory


92 =

M3

92

Ending inventory

+90

- Ending inventory = 60

182- 60 = Ending inventory


122 = Ending inventory
Please note that this planning exercise has certain important managerial lessons as well. For example you saw this
businesss operations did not do well and it has losses in all three months; but on the other hand its financial
health ( or financial position) in quite strong because its TL as compared to OE is very small, an TL are financing
only a small %age of TA, though over three months this %age is increasing yet it is less than 1% of TA that are
financed by TL . So due to poor profitability , the solvency is deteriorating. On the other hand , liquidity of this
business is quite high, its current ratio is more than 10 in each month . You also learnt that operating
performance is embodied in the income statement while financial health is embodied in the balance sheet. You
have learnt the linkages between cash budget, income statement, and balance sheet.

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