CASE STUDY: Create a Project Financial Plan (CASH BUDGET):
LILY CORPORATION operates a rapidly expanding specialist fashion and design project. The Project Manager is in the process of formulating a financial plan for next year. The Project director of marketing has completed her sales budget and is confident that sales estimates will be met or exceeded. The following budgeted sales figures show the growth expected and will provide the planning basis for other corporate departments.
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Budgeted Sales in £
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January
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1,800,000
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February
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2,000,000
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March
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1,800,000
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April
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2,200,000
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May
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2,500,000
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June
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2,800,000
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July
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3,000,000
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August
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3,000,000
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September
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3,200,000
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October
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3,200,000
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November
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3,000,000
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December
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3,400,000
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You as a newly qualified director with an MSc in Project Management, has been given the responsibility for formulating the cash budget, a critical element during a period of rapid expansion. The following information provided by operating managers will be used in preparing the cash budget:
1. Lily has a corporate policy of maintaining an end-of-month cash balance of £100,000. Cash is borrowed or invested monthly, as needed, to maintain this balance. Interest expense on borrowed funds is budgeted at £8,000 for the second quarter, all of which will be paid during June.
2. Lily Corporation has experienced an excellent record in debtors' (accounts receivable) collection and expects this trend to continue. 60% of billings are collected in the month after the sale and 40% in the second month after the sale. Uncollectable accounts are negligible and will not be considered in this analysis.
3. The purchase of raw materials is Lily's largest expenditure; the cost of these items equals 50% of sales. 60% of the raw materials are received and paid in the month they are purchased and 40% are paid in the following month.
4. Hourly wages depend on sales volume and are equal to 20% of the current month's sales. These wages are paid in the month incurred.
5. General and administrative expenses are budgeted to be £2,640,000 for the year. The composition of these expenses is given below. All of these expenses are incurred evenly throughout the year except the property taxes. Property taxes are paid in four equal installments in the last month of each quarter.
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Salaries
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£480,000
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Promotion
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£660,000
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Property taxes
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£240,000
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Insurance
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£360,000
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Utilities
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£300,000
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Depreciation
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£600,000
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6. Corporation tax payments are made by Lily in the first month of each quarter based on the profit for the prior quarter. Lily's tax rate is 40%. Lily's taxable profit for the first quarter is projected to be £612,000
7. Equipment and warehouse facilities are being acquired to support the company's rapidly growing sales. Purchases of equipment and facilities are budgeted at £28,000 for April and £324,000 for May.
8. Lily uses a calendar year reporting, i.e. its year starts on 1st of January and closes on 31st December.
Required:
a) Prepare a cash budget for Lily Corporation by month and in total for the second quarter only (i.e. for the months of April, May and June). Be sure that all receipts, disbursements and borrowings / investments amounts are shown for each month. Ignore any interest income associated with amounts invested.
b) Discuss the consequences of budget bias (budgetary slack) for cost control.
c) Critically discuss the relative merits of periodic budgeting and continuous budgeting.