Canton Toy Company: Prepare the cash budget of the Canton Toy Company for the second half of 1984 (and more)...

Financial Management

CANTON TOY COMPANY

The Canton Toy Company enjoyed a rapid growth in business. In the spring of 1984, it anticipated a further substantial increase in sales. But, despite good profits and a $300.000 line of credit with its bank, Canton Toy experienced a shortage of cash. It estimated that required borrowings from July through September would add several hundred thousand dollars to its bank loan of $300,000 at the beginning of the budget period.
Robert Jordan, president of the company, scheduled a luncheon appointment with Doug Mitchell, the commercial loan officer who handled Canton's account. The two men had recently discussed the possibility of increasing Canton Toy's line of credit from $300,000 to $500,000. They agreed that $500,000 would be sufficient to handle the company's estimated working capital needs for 1984. Mr. Jordan asked that his accountant, Jean Bell, prepare a cash budget for the six months ending December 31, 1984. The cash budget would be used to support the company's request for an increased line of credit.
The Canton Toy Company manufacturers a wide variety o for toys such as billiard sets automobiles, trucks, guns, rockets, and satellites. The plastic toy industry was a highly competitive business, populated by many companies. New competitors easily entered the industry because capital requirements were relatively small and the technology was relatively simple. On the other hand, fierce design and price competition resulted in short product lives and numerous failures.
Canton Toy's sales forecast indicates expected sales of $6.24 million for 1984. Demand for its plastic toys has always been highly seasonal. Approximately 70 percent of sales were expected in the last six months of the year. With 35% of annual sales concentrated in September and October. The company's production schedules were also highly seasonal because it produced toys in response to customer orders. One change in this practice was that on November 7, 1983 the company decided to adopt level monthly production for 1984.
Miss Bell collected the information for a cash budget based on cash receipts and disbursements. She estimated sales for the last six months of 1984 as given in Exhibit 1. These sales are 90% for credit and 10% for cash. Analysis of past collections indicated that 20% of credit sales are collected in the month of sale, and 80% in the month after sale. At the beginning of July, Canton Toy had accounts receivable of $320,000(80% of $400,000 credit sales in June) which was to be collected in July. The company had a cash balance of $100,000 on June 30, 1984. This amount is the minimum cash balance which should be maintained throughout the budget period. Monthly purchases of raw materials are $288,000. The company buys its raw material on 30 day terms and pays its bills on time. With level production and no projected increase during period in wages and salaries, the payroll is expected to be $120,000 per month. Payments of overhead expenses such as heat, light and power, insurance, telephone bills, and rental payments are forecasted to be $52,000 per month. Cash outlays to cover selling expenses are estimated to be $60,000 per month. Monthly payments of general and administrative expenses are forecasted to be $30,000.
Than company's capital budget calls for the purchase of a new machine for $80,000 its payments will be made in September. Income tax payments of $38,000 each are due in September and in December. A $60,000 installment payment on principal of a $600,000 term loan is due on December 31 interest of $54,000 (9% of the $600,000 term loan) is also due on December 31. A semiannual dividend payment of $50,000 is planned on December 15.

EXHIBIT 1

Canton Toy Company
Sales Estimates for Last Six Months of 1984
(In thousands)

July $ 500
August 600
September 1,000
October 1,200
November 600
December 400

Questions

1. Prepare the cash budget of the Canton Toy Company for the second half of 1984. In preparing the cash budget, disregard both the interest on any bank loan the company may need and income on surplus funds.

2. Estimate cumulative loan balances or surplus funds for each month during the budget period. Will a proposed $500,000 line of credit be sufficient to cover the forecasted deficits?

3. What are the values of the cash budget to the company?

4. What are advantages and disadvantages of the level production plan