Cash Budget Kota Fibres produces nylon fiber at its only plant in Kota, India, and is preparing its

cash budget for the month of September 2003 through December 2003. Expected sales from September 2003 to February 2004, as well as realized sales in July and August 2003 are depicted in Table 2 (in thousands of rupees (Rs)). For delivery and manufacturing reasons, Kota's purchases, which usually amount to 70% of sales, have to be made two months in advance and the material has to be paid in cash, i.e. Kota's actual supplier does not provide any credit at all. Collections of accounts receivables, on the other hand, are as follows: The cash from 40% of sales is collected after one month and the remaining 60% is collected after two months. Kota has a line of credit with Bank of India but no other type of debt. The interest it pays each month is computed as 1.25% Line of Credit Balance at the End of the Previous Month. Other cash expenses are as follows: ? Wages are 35% of the previous month purchases (there are no other salaries). That is, the production cycle is as follows: Raw material is purchased in a given month, processed by the employees in the following month and sold the month after (this could be improved, of course). ? Rent is Rs10,000 per month. ? A dividend of Rs20,000 will be paid to Kota's shareholders (mainly family members) at the end of September and at the end of December. ? A tax payment of Rs25,000 will be made in November. ? A fixed asset outlay of Rs150,000 is expected in October. 5 In order to keep its line of credit with Bank of India, Kota must clear it before the end of December. Failure to do so would result in the termination of the line of credit, which would severely hamper Kota's activities. Kota's minimum cash balance is Rs25,000 and its line of credit balance at the end of August is Rs45,000. Month Jul-03 Aug-03 Sep-03 Oct-03 Nov-03 Dec-03 Jan-04 Feb-04 Sales 210 220 440 500 380 320 220 200 Table 2: Sales expectations for Kota Fibres (in Rs000)

(a) (10 points) Complete Kota's monthly cash budget from September 2003 to December 2003 using the above figures. Under the current assumptions, is Kota repaying its line of credit by the end of December? Answer: Kota's purchases in a given month are 70% of the sales expected two months later, and all purchases are made cash. For example, cash purchases in Septenmber are 70% of sales in November. Cash disbursement from September to December are as in Table 3. Note that interest payments in a given month depend on the line of credit at the end of the previous month and thus cash flows in a given month must all be determined in order to compute the cash flows in the following month. Cash receipts, on the other hand, are as in table 4, and the cash budget is depicted in Table 5. Note that assuming a line of credit balance of Rs45,000 at the end of August implies that ending cash in August, and thus beginning cash in September, is -Rs20, 000. We can see on the cash budget table that Kota's line of credit is not reimbursed at the end of december, so something has to change in the way it runs its business. (b) (20 points) Using sensitivity analysis, compare Kota's debt at the end of December under (i) different credit arrangements with its current supplier, (ii) different credit policies with its customers, (iii) a more efficient manufacturing and delivery

process (i.e. some of the raw material could be purchased one month before being 6 Month Sep-03 Oct-03 Nov-03 Dec-03 Cash purchases 266.0 224.0 154.0 140.0 Rent 10.0 10.0 10.0 10.0 Wages and salaries 122.5 93.1 78.4 53.9 Taxes 0.0 0.0 25.0 0.0 Fixed asset outlays 0.0 150.0 0.0 0.0 Interest payments 0.6 3.1 5.3 2.9 Dividends 20.0 0.0 0.0 20.0 Total disbursements 419.1 480.2 272.7 226.8 Table 3: Kota's cash disbursements in the base case (in Rs000) Month Sep-03 Oct-03 Nov-03 Dec-03 Cash sales (0%) 0 0 0 0 Collections of A/R Lagged one month (40%) 88 176 200 152 Lagged two months (60%) 126 132 264 300 Total cash receipts 214 308 464 452 Table 4: Kota's cash receipts in the base case (in Rs000) sold (note that this would affect how wages are calculated)), (iv) different sales levels. Answer: (i) Different Credit Arrangements with Suppliers Suppose Kota is able to find suppliers that would allow it to pay its purchases after one month instead of immediately. Let's see what happens to Kota's excess cash or required financing on December 31 when 2%, 4%, 6%, 8% and 10% of the purchases in a month are paid in the following month, the rest being paid cash at the time of the purchase. Everything else remains as in the base case. Note that 7 Month Sep-03 Oct-03 Nov-03 Dec-03 Cash receipts 214.0 308.0 464.0 452.0 Less: Cash disbursements 419.1 480.2 272.7 226.8 Net cash flow -205.1 -172.2 -191.3 225.2 Add: Beginning cash -20 -225.1 -397.3 -206.0 Ending cash -225.1 -397.3 -206.0 19.2 Less: Minimum cash balance 25.0 25.0 25.0 25.0 Excess cash 0.0 0.0 0.0 0.0 Required financing 250.1 422.3 231.0 5.8 Table 5: Kota's cash budget in the base case (in Rs000) this can only be done with the purchases that will take place in September, October, November and December, i.e. purchases in July and August have already been paid for. The results of this analysis are shown in Table 6, where a negative excess cash means a positive line of credit balance. Proportion of purchases paid after one month Sep-03 Oct-03 Nov-03 Dec-03 2% -244.7 -417.7 -227.8 -2.8 4% -239.4 -413.2 -224.6 0.0 6% -234.1 -408.6 -221.4 3.0 8% -228.8 -404.1 -218.2 6.0 10% -223.5 -399.6 -215.0 9.0 Table 6: Kota's excess cash under softer credit arrangements with suppliers.

(ii) Different Credit Arrangements with Customers Suppose cash sales remain zero but Kota wants to put some pressure on its customers so that some of them switch from a two-month to a one-month credit term. More specifically, let's see what happens to Kota's line of credit when the collections of accounts 8 receivable lagged one month are 42%, 44%, 46% 48% and 50% (there being no cash sales, collections of accounts receivable lagged two months are simply one minus the proportion of collections lagged one month). Note that collections of accounts receivable for sales that took place in July and August remain 40-60 since these arrangements cannot be changed. Arrangements on new sales only can be changed. The results of this analysis are shown in Table 7. We can see from this table that excess cash at the end of December is more sensitive to the time customers take to pay their bills than to the time Kota takes to pay its own bills. This is because collections of accounts receivable involve larger sums than purchases. In a real-life scenario, however, it may be more reasonable to assume that a firm may lose some of its customers if it reajusts its credit policy in a way that penalizes its clients. This could be represented by a decrease in the growth rate of sales, for instance. Proportion of sales paid after one month Sep-03 Oct-03 Nov-03 Dec-03 42% -250.1 -413.5 -220.9 2.0 44% -250.1 -404.7 -210.7 10.0 46% -250.1 -395.9 -200.6 18.0 48% -250.1 -387.1 -190.5 26.0 50% -250.1 -378.3 -180.4 33.0 Table 7: Kota's excess cash under stricter customer credit policies. (iii) More Efficient Manufacturing or Delivery Process What happens to excess cash at the end of December if some material is purchased one month in advance instead of two months in advance, all else constant? Suppose, for instance, that purchases in December consists of one half of 70% of January sales and one half of 70% of February sales? Again, here, you must remember that purchases in July and August were for sales in September and October, 9 respectively, and thus the material for these months has been purchased and this cannot be changed. Hence you have to be careful with what you do to September purchases. You must also be careful with wages. In our 50-50 example, these would be 35% of half of the previous month purchases plus 35% of half of the current month purchases. Let's see what happens to excess cash when 98%, 96%, 94%, 92% and 90% of the material has to be purchased two months in advance, the remaining fraction being purchased one month in advance. Then excess cash at the end of December is, in thousands of Rs, -0.2, 5, 11, 17 and 22, respectively. Hence excess cash is also quite sensitive to the timing of purchases. (vi) Different Sales Levels Here you should find that excess cash at the end of December is Rs5,000 when sales in September through December are 20% less than expected, Rs200 when sales are 10% less than expected, -Rs11, 300 when sales are 10% more than expected and -Rs16, 800 when sales are 20% more than expected. That is, more sales makes the problem worse. In fact, reducing growth would help Kota repay its debts. (c) (10 points) Using what you found in (a) and (b) what recommendations would you make to Kota to help it repay its debt by the end of December?

Answer: Anything that makes sense. Take care of credit policies with customers first, then try to find a more efficient delivery process, reduce growth if necessary and try to get better credit terms with suppliers. 3. Financial Planning Using the financial statements for Brick Enterprises in Table 8, answer the following questions. (a) (10 points) Suppose that sales in 2003 are expected be 25 percent greater than in 2002. Complete Brick's pro forma financial statements for 2003 using the following assumptions and guidelines: ? COGS, depreciation and all assets are a constant fraction of sales. 10