ACG 2071

Class Project

Due Monday, June 17, 2002

Harry Hooper
Out of 100 points

(Later submissions will NOT be accepted, even for partial credit. NO excuses. If youre
worried that you may be late, do it early you have plenty of time. If youre not worried
now, but something comes up later, you should have worried about it.)
Operating Budget
For this assignment, you will prepare a six-month budget for your manager. The work
product should consist of a brief summary document (about 3 pages, doublespaced,
explaining the key issues you have identified during the budgeting process, i.e. what are the
major problems or opportunities the company will experience during the 6-month period?)
Prepare supporting budget schedules for the first six months of the year 2003, together with a
data disk of the reports and document. These schedules must be printouts directly from Excel
or other spreadsheet programs, but make sure each attachment is self-explanatory. You should
assume an intelligent non-accountant reader, who should be able to obtain a mental picture of
operations for the six-month period from the report. (Dont explain how you prepared the
budget. Suggest ways you can improve the business forecast for next year. Test these
hypotheses using your model, and comment on the results.) Considerable weight will be
given to the clarity and readability of your work.
Be sure to include all relevant budget schedules, including pro forma income statements and
a cash budget. Clearly identify if any loans are required, and why.
INFORMATION:
1. Heron, Inc. is a company that re-sells one product, a particularly comfortable lawn chair.
(The product is made exclusively for Heron by an overseas contractor, so Heron has no
manufacturing-related costs.) For the first half of 2003 and July 2003, the estimated sales
(in units) are as follows:
Jan
Feb
Mar
Apr
May
Jun
July

10,000
11,400
12,000
15,600
18,000
22,000
18,000

2. The forecasted sales (in dollars) for November and December, 2002 are $135,000 and
$140,000 respectively.
3. Forty percent of any months sales are for cash, and the remaining 60% are on credit. Ten
percent of the credit sales are collected in the month of sale, 70% are collected in the
following month, and 18% are collected in the second month after the sale. The
remaining receivables are deemed uncollectible. Bad debts are written off in the month
the debt is deemed uncollectible (e.g. if the sale is made in January and is not collected by
the end of March, it is written off in March.) No accrual for estimated bad debts is made
in the month of sale.

ACG 2071

Class Project

Harry Hooper

4. The firms policy regarding inventory is to stock (i.e., have in ending inventory) 50% of
the forecasted demand in units (i.e., estimated sales) for the next month.
5. Monthly sales and administrative expenses consist of the following (if these are cash
expenses, they are paid when incurred):
Salaries and wages
Sales Commissions
Rent
Other variable
cash expenses
Supplies expense

$3,000
7% of sales revenue
$7,000
5% of sales revenue
$1,000

Other general and administrative overhead, not included above, is expected to be $48,000 per
month. Of this amount, $24,000 represents depreciation and other non-cash expenses. Cash
expenses for overhead items are paid when incurred.
6. Per a prior contract, a cash payment of $50,000 for equipment previously purchased is
due in January. Depreciation on the equipment previously purchased is included in the
overhead cost detailed in item 5 above. Also, dividends of $12,000 are to be paid in
March.
7. Each lawn chair costs Heron $6 per unit. The chair has a sales price of $12/unit.
8. Half of the inventory purchases are paid for in the month of purchase and the remaining
half are paid in the following month (i.e. all of the previous months Accounts Payable are
paid off by the end of any month.)
9. Per an existing contract, the cost of each chair is scheduled to increase by 5% on Mar 1,
2003. In addition, because of increasing costs of plastic webbing, the cost is anticipated
to increase by an additional 5% on May 1, 2003. To offset these increases, the company
plans to raise the sales price to $13.50/unit from May 1, 2003 on. The sales forecast (i.e.,
estimated sales in units) takes this price increase into account.
10. Heron uses the first-in, first-out (FIFO) method in accounting for inventories.
11. The company must maintain a minimum cash balance of $15,000. Borrowing can make
up shortfalls. For simplicity, assume that the bank will only lend (and accept repayments)
in $1,000 increments. Ignore interest on the loan in your calculations, but minimize the
amount borrowed and pay off any loans as soon as possible.
13. Cash on hand as of December 31, 2002 is expected to be $16,000. In addition, there will
be no notes payable as of this date.

ACG 2071
Notes & Hints...

Class Project

Harry Hooper

1. If you feel that some critical piece of information is missing, make and highlight an
appropriate assumption. If you wish, you can check with me about the need for and
validity of a particular assumption.
2. Do not try to derive the loan balances as a result of a formula. Review the cash flow
statement (i.e., cash budget) and plug in a suitable number for any loans needed and
repayments. Ignore interest expense in your income statement.
3. It will be helpful to construct a reference row for sales in unit terms.
4. I recommend constructing the statements for one month and then copying the formulas
over to the remaining months. I will look at the copy of your spreadsheet on the disk to
see what formulas you have used to develop your model.
5. Ignore taxes.
6. The following document is an example of the type of memo you should attach to your
manager:

ACG 2071
Class Project
Harry Hooper
SAMPLE MEMO TO MANAGEMENT (This memo is NOT based on the data
supplied.)
May 9, 2002
To: D. Clarke
From: Harry Hooper
Subject: July - Dec Budget, 2002
I have completed the budget for the first half of next year and have produced the following
analysis:
Profitability:
According to the budgeted income statement, we will begin the year profitably, with net
profit margins in the first three months exceeding 15%. However, from October, due to
projected increases in overhead costs, our profits will decline and, by December, our net
income will be a negative 3%. For the six-month period, our average net income will be
7.2%.
Proposal A) The decline in profitability, can be reduced by increasing prices by 5% in
October. Assuming this results in a 1% decrease in unit sales volume, we will still be
able to maintain margins in excess of 10%.
Proposal B) If we can increase sales in the 4th quarter, we can overcome the effect of
the increase in our fixed expenses. A 7% unit sales increase in October through
December will result in a net margin in excess of 10% for each of those months.
Cash Flows:
According to the Cash Budget, we will require an $85,000 loan in November. This is mainly
caused by the need to pay $100,000 in taxes in that month. The following proposals will help
to reduce the amount of loan required:
Proposal C) Improve collections on credit sales. If we increase collections from 30%
to 50% in the 30 days following the sale, we can reduce the loan requirement in
October to $33,000.
Proposal D) Defer capital purchases. The equipment purchase scheduled for August
could be delayed until December. Alternatively, credit terms may be obtainable from
the supplier. If payment is not made until December, no loan will be necessary.
Proposal E) Reduce inventory requirements. A 50% decrease in average ending
inventory each month, will reduce cash needs by 10% in November, and the loan will
be reduced to $60,000.
Sales Forecasts:
I have developed a best-case/worst-case scenario, assuming a variance in the sales forecast.
If sales are 25% below forecast, our net income for the period will be
etc., etc.