Sweet Beginnings Co. Case Study
Sweet Beginnings Co. is currently the most talked about clothing shop in town. Not only was the shop filled with customers every day, but t hey have been a major supplier of clothing to other shops. Ms. Muff, the owner of the shop has remained confident that the operations will go smoothly until one early morning when there had been problems with the delivery that was supposed to leave the shop. The clothes which were scheduled to be delivered were already packed and waiting on the loading bay. It was past 30 minutes of the scheduled delivery and no delivery truck was in sight. Ms. Muff decided to call the delivery contractor to find out what was taking the trucks so long. “You’ve been one month late from your scheduled payment for our delivery service,” the frustrated delivery contractor said. “We’ve been sending you notices every day for the t he past week and your company doesn’t seem to be responding. Unless you will be able to pay the amount due by this morning, we will
not send any truck to deliver your goods. Ms. Muff was astounded to hear of the unpaid fee. To clear up the mishap, Ms. Muff hurriedly approached the company’s accountant, Mr. Phil in hopes of drawing cash from the company. Mr. Phil regrettably reported that the company does not have cash to pay the delivery contractor. In fact, the company has been consistently borrowing short term funds for three months from the start of the year. The company has yet to pay any of these borrowings and Mr. Phil informed Ms. Muff that the short term lenders have been reluctant to lend money at this point. As a result, the shipments will not be delivered to the customers until the company figures out how to pay their delinquency with the delivery contractors. The outside customers have been understanding enough to acknowledge that there will be a delay on the deliveries for this day. However, too much delay may frustrate these customers and may cause bad reputation to the company. Ms. Muff is looking into taking a loan from Fresh Rural Bank to pay for the delinquent fees. The bank manager of Fresh Rural Bank has requested a meeting with Ms. Muff to discuss the financial condition of Sweet Beginnings Co. and plans for restoring its liquidity. Outraged, Ms. Muff told Mr. Phil, “Why don’t we have any balance in our cash account? Our company has been very profitable but we seem to be depending on loans to finance our operations. We need to figure out what is going wrong. Otherwise, we may lose our customers.”
Company Background Sweet Beginnings Co. was founded in 20X0 as a manufacturer of summer clothes. The first shop was located near a calm beach with sky blue waters and powdery sands. Families and tourist would usually flock to the beach on summer weekends which gave the c lothing shop foot traffic and gained the market’s attention. Due to its high quality products, the clothing store became a popular stop shop for vacation goers. In 20X1, a known blogger fancied the clothing line displayed in Sweet Beginnings and published an article promoting the shop. This earned the company nationwide publicity which led to other clothing stores offering shelf space for Sweet Beginning’s brand. In 20X3 it expanded its garment productions due to the increasing demand of their products. To this day, the company maintained its position as a summer clothing store since this line has brought its brand equity.
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Clothing Market The demand for clothing was characterized by a stable year-to-year growth. Unit demand increased with both population and individual income. However, the season al character of the company’s product has resulted to cyclical sales. Competition among other clothing shops in the town is unlikely to clash with the company’s sales growth.
The company believes it will maintain its average growth rate for sales for the succeeding years. Sales Forecast Sweet Beginnings Co. had been consistently profitable. Moreover, sales had grown at an annual rate of 18 percent in 20X5. Gross sales were projected to grow at 20% of the sales of the same months on the first quarter, 30% of sales of the same months on the second quarter and 25% of sales of the same months on the third and 4th quarter. This g rowth rate is expected to be constant until 20X8. Financial Information To prepare a forecast on a business-as-usual basis, Ms. Muff and Mr. Phil agreed on various parameters. Cost of goods sold would run at 73.7% of gross sales —a figure that was up from recent years because of increasing price competition. Operating expenses would be about 6% of sales —also up from recent years to include the addition of a quality-control department and two new sales agents. Depreciation is at 10% of cost of property, plant and equipment (PPE). Additions during 20X6 is expected to amount to PHP1,200,000 which will be paid on January 20X7. The Company’s policy is to expense full year’s depreciation on the date of purchase. The Company expects inventory level for 20X6 to be the same as 20X5. The company’s income tax rate was 30% paid for each quarter in May, August, November, and April of
the following year, respectively. The company opts to use optional standard deduction of 40% from the company’s gross profit to arrive at t he taxable income for the quarter. The delivery contractor’s fee (at 3% of sales) was collected at the loading gate as trucks left to make deliveries to customers. Ms. Muff proposed to pay dividends of PHP450,000 per quarter. For years Sweet
Beginnings had paid high dividends. Mr. Phil observed that sales collections in any given month had been running steadily at the rate of 40% of the last month’s sales plus 60% of the sales from the month before last. The value of raw materials paid in any month represented on average 55% of the value of sales expected to be made two months later. Wages and other expenses in a given month were equivalent to about 34% of purchases in the previous month. As a matter of policy, Ms. Muff wanted to see a cash balance of no less than PHP640,000. Sweet Beginnings Co. had a line of credit from F resh Rural Bank, where it also maintained its cash balances. Fresh Rural Bank’s short-term interest rate was currently 16%. Return on investment for short term investments is at 12%.
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Historical Information Sweet Beginnings Co. Historical Income Statements 2014 2015
Sweet Beginnings Co. Monthly Sales 2015 2015 January
Php 1,361,240
Gross Sales
Php 55,546,936
Php 66,306,050
38,327,385
46,398,029
February
2,035,060
March
3,008,340
Cost of goods
April
6,193,650
Gross profit
17,219,551
19,908,021
May
10,617,680
1,666,408
1,989,182
June
13,449,060
July
12,475,770
Delivery fees Operating expenses Depreciation
3,012,444
4,159,275
869,600
869,600
910,000
1,240,000
10,761,099
11,649,965
3,099,519
3,583,444
Php 7,661,580
Php 8,066,521
August
6,282,130
September
3,539,230
October
3,008,340
Interest expense
November
2,388,980
Pretax profit
December
1,946,570
Income tax
Year
Cash Accounts receivable Inventories Short-term investments Total current assets
Php 66,306,050
Net profit
Sweet Beginnings Co. Balance Sheet December 31, 2015 Php 641,123 Accounts payable
3,379,958
Short term borrowings
1,076,000
Payable to PPE supplier
Php 654,234 587,575
Accrued taxes
1,321,900
5,097,081
Total current liabilities
2,563,709
Gross PPE
8,696,000
Owners equity
9,950,872
Accumulated depreciation Net PPE
1,278,500 Total liabilities and equity
Php 12,514,581
Total Assets
7,417,500 Php 12,514,581
Problem Ms. Muff needs to prove that the company will be liquid enough to pay for its loans with Fresh Rural Bank so that it will be allowed to ask for another loan to meet the delivery contactor’s fee. How should Ms. Muff explain to First Rural Bank that the company is in a good financial position? Moreover, should the company prove to have financial liquidity problems, what can to company do to cope with their need for cash? 3|Page
Learner’s Guide
1. Assume that you are Ms. Muff and you will be presenting to the Fresh Rural Bank. Convince the bank that you are in a good financial position evidenced by your cash budget and projected financial statements. 2. Prepare a monthly cash budget for Sweet Beginnings Co. for the year ending December 20X6. Start with the monthly sales forecast (Tip: Forecast sales up to Feb 20X7). 3. The following table format may be used for t he cash budget: Jan
Feb
…
Nov
Dec
Total
Cash Receipts From Collections Less: Purchase of Raw Materials Less: Payment for Salaries and Wages Less: Payment to Delivery Contractors Less: Dividends Paid Less: Income Tax Paid _____________________________________ Net Cash Flow Add: Beginning Cash Less: Required Ending Balance Add: Return on Investment (12%) Less: Interest on Borrowing (16%) Less: Repayment of Principal Add: Liquidation of Investment _____________________________________ Required Financing Excess Cash _____________________________________
Loan Balance – Beginning Add: Required Financing Less: Repayments
Jan 587,575
Feb
…
Nov
Dec
Total
Jan
Feb
…
Nov
Dec
Total
Investment Balance – Beginning Add: Excess Cash Less: Liquidations Investment Balance - End 4. Forecast Financial Statements. Start w ith income statement. Gross Sales Cost of goods Gross profit Delivery Fees Operating expenses Depreciation Interest expense Pretax profit 4|Page
Total of monthly forecasted sales 73.7% of Sales 3% of sales 6% of sales 10% of Total PPE cost Total of Interest from borrowings and return of investment from cash budget
Income tax Net profit
Gross profit x (1-40%) x 30%
5. Forecast Financial Statements. Start w ith income statement. Cash Accounts receivable Inventories Short term investments Total current assets Gross PPE Accumulated depreciation Net PPE Total Assets Accounts payable
Short term borrowings Payable to PPE supplier Accrued taxes Total current liabilities Owners’ equity Total liabilities and equity
Required cash balance Accounts receivable beginning + Sales - Collections from Customers Same as last year Resulting balance from cash budget Beginning balance + current year additions Beginning balance + depreciation expense
Accounts payable 20X5 + Purchases* + Operating Expense - Cash payment for raw materials - Cash P ayment for Salaries and Wages *Purchases = Cost of goods sold + Inventory 20X6 – Inventory 20X5 Resulting balance from cash budget Additions to PPE payable on January 20X7 Tax payable for the last quarter Owners’ Equity 20X5 + Net Income - Dividends paid
Format of Paper/Presentation Prepare a paper containing the following: 1. Letter to Fresh Rural Bank explaining that the company is in a healthy financial position and has capacity to pay loans when they come due. 2. Cash Budget for 2016 in good form. 3. Projected Financial Statements for 2016 in good form. 4. Supporting computations.
Presenting Group Prepare a 20-minute presentation using the following outline
Case Background: Brief explanation of the problem of the Company. Methodology: Explain why the cash budget and projected financial statements was made in order to help the company in their dilemma. Budgets and Projections: Present the resulting budgets and implications of the figures that were derived. Explain in class how you were able to derive your figures. Conclusion: Was the company performing well based on the budgets and projections and will it be able to sustain its operations?
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