Ken Blow is considering going into business by opening a food store. He has foun
ID: 2490045 • Letter: K
Question
Ken Blow is considering going into business by opening a food store. He has found suitable premises. However, before the bank will grant him an overdraft and lending facility, he has been asked to draw up a cash budget for the first three months of trading (February, March and April, 2016).
Ken has $100 000 of his own money that he is able to invest into the business.
He will need to rent his premises one month before he opens the store, and he will also have to have his stock (inventory) and his staff on hand two weeks before he opens the doors. He also has the following relevant information:
Expected sales for each of the first three months of trading are February - $75 000, March - $90 000 and April - $110 000 respectively. It is assumed that the sales will be even over each four-week period.
Staff costs are expected to be $1 500 per week; rent is $2 000 per week, payable one month in advance; electricity and phone are expected to be $500 per week, payable a month in arrears; insurance is $10 000 per annum payable a year in advance; equipment of $45 000 will need to be purchased when the store is first rented and will be depreciated, straight line, over ten (10) years with no residual value.
Ken is allowing a 25% mark up on all goods sold. As he is a new customer, all suppliers will require him to pay for goods within seven (7) days. Inventory is ordered three weeks before it is required and there will be a weekly delivery.
The bank is prepared to grant overdraft and lending facilities to the extent of $10 000, if the cash budget indicates that the business should be successful. Interest on the overdraft will be charged at 16% per annum. The bank is also prepared to lend Ken a long-term loan of $50000 with an interest rate of 12% per annum with interest to be paid quarterly. The long-term loan must be taken in full, whether or not Ken requires the whole amount (simple interest calculations only are required).
Ken further estimates that his weekly turnover in twelve (12) months’ time will be $175 000 per week.
Some assumptions you may consider
Assume 4 weeks to a month
Assume all sales are cash sales
Depreciation will not affect the cash budget
Loan
Assume $50,000 borrowed in first week of January (interest paid quarterly – 12 weeks later)
Wages
Paid weekly
Rent
Assume rent is paid weekly but payable one month in advance
Electricity / Phone
Assume electricity / phone required when office rented.
Assume paid monthly in arrears
Electricity / Phone will therefore need to be paid from week 1 in February
Stock
Needs to have stock on hand two weeks before opening
Required
A cash budget covering all the information given until the end of April. (9.5 Marks)
Do you think the business will be successful, based on the forecasts? Give reasons for your answer. (1.5 Marks)
Given Ken’s estimation that the turnover will increase within twelve months, what other costs would you expect to increase? Why? (1.5 Marks)
Explanation / Answer
Cash Budget Jan Feb Mar Apr Total Receipts/Op.bal 94000 83000 85000 Own Investment 100000 100000 Expected Sales 75000 90000 110000 275000 Total Receipts 100000 169000 173000 195000 375000 Payments: For Inventory 60000 72000 88000 220000 Staff Costs 3000 6000 6000 6000 21000 Rent 8000 8000 8000 8000 32000 Electricity& phone 2000 2000 2000 6000 Insurance 10000 10000 Equipment 45000 45000 Total Payments 56000 86000 88000 104000 334000 Surplus/Deficit 44000 83000 85000 91000 41000 Borrowings 50000 50000 Int. on Borrowings 1500 1500 Ending Cash balance 94000 83000 85000 89500 89500 2) The business will be successful as it is expected to generate sales and forecasts cash surplus as at the end of the quarter 3)As sales increase cash expenses like selling and advertising are bound to increase.
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