Swisshelm Clothing Store Inc by jennyyingdi

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									MGMT 437, Entrepreneurship and Innovation, Cash Flow Exercise



Ludey Clothing Store, Inc.
Joan Carmen has just bought a small clothing store for $120,000. She paid the sellers $30,000
cash and gave them a five-year note on the remaining $90,000 at an interest rate of 15 percent a
year. Ms. Carmen is relatively “untested” as an independent business person, but the sellers have
confidence in her potential. Joan will pay them simple interest on the $90,000 note each month
because of this confidence. And the principle will be due in one payment at the end of the five
years.

Background
A graduate of Northwestern University with honors, Ms. Carmen worked for 11 years with the
Gap. Her experience there included:

   Selling clothing in a Gap store.
   Managing the store’s sales people.
   Serving as the store manager.

All along, her ambition was to have her own clothing store. The Gap, she believed, would be a
good place to learn every aspect of store operations. After all, the Gap was one of the nation's
more successful clothing retailers.

Ms. Carmen worked for ten years to learn the business. Then she started to search for a clothing
store in a small city. A year went by before she learned from a banker that a clothing store was
for sale in New Philadelphia, a city of 16,000 people. Three months later, she and the sellers
agreed on a purchase price of $120,000.

Cash Budget
One week after she took over, Ms. Carmen and her accountant are sitting down to prepare a
preliminary cash budget. It is early August. Ms. Carmen knows that she will need short-term
financing to build up her inventory in anticipation of high consumer demand in September, when
schools start, and again in December, when Christmas buying is in full swing.

A sales estimate and a preliminary cash budget will help her to negotiate with her banker for
terms on the short-term borrowing. After the financing terms are settled with the banker, she can
compose a final cash budget to help her decide how much to borrow and when to borrow.

After analyzing past records, she came up with these estimates:

        Sales Revenue Forecast                          Monthly Expenses
        June (actual)            $24,000                Rent                       $3,000
        July (actual)             20,000                Depreciation                  500
        August                    28,000                Other expenses                900
        September                 52,000                Wages and salaries
        October                   44,000                   August                   2,800
        November                  76,000                   September                3,200
        December                  96,000                   October                  3,200
        January                   22,000                   November                 3,600
        February                  32,000                   December                 3,600
                                                           January                  2,800




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MGMT 437, Entrepreneurship and Innovation, Cash Flow Exercise




   Sales are 30 percent cash, 70 percent credit.
   Of the credit sales, 80 percent are paid within one month of purchase, 20 percent are paid
    within two months.
   Credit sales outstanding on August 1 consisted of $14,000 from July and $3,360 from June.

Ms. Carmen talked with her banker regarding the short-term financing needed to get her through
the early phases of Ludey Clothing’s operations. The banker checked Joan’s personal credit
rating report, looked at the sales projections, and settled on a monthly bridge loan arrangement
with a $70,000 credit limit. With this agreement, Joan can borrow up to $70,000 once per
month, she must pay the principle and interest each month, and she will pay 1 percent per month
simple interest on the principle.

                                               Exhibit A
                            Ludey Clothing Store, Inc.: Cash Budget Worksheet

                              August       September       October     November      December         January

Cash inflow                  __________     __________    __________    __________   __________       __________
 Sales revenues              __________     __________    __________    __________   __________       __________
 Credit sales                __________     __________    __________    __________   __________       __________
 Collections from:           __________     __________    __________    __________   __________       __________
   One month before          __________     __________    __________    __________   __________       __________
   Two months before         __________     __________    __________    __________   __________       __________
   Subtotal                  __________     __________    __________    __________   __________       __________
 Cash sales                  __________     __________    __________    __________   __________       __________
 Total cash inflow           __________     __________    __________    __________   __________       __________
Cash outflow
 Inventory purchases         __________     __________    __________    __________   __________       __________
 Wages and salaries          __________     __________    __________    __________   __________       __________
 Rent                        __________     __________    __________    __________   __________       __________
 Other expenses              __________     __________    __________    __________   __________       __________
 Interest, 90-day Note       __________     __________    __________    __________   __________       __________
 Principal, Bridge Loan      __________     __________    __________    __________   __________       __________
 Interest, Bridge Loan       __________     __________    __________    __________   __________       __________
 Total cash outflow          __________     __________    __________    __________   __________       __________
Cash gain or loss            __________     __________    __________    __________   __________       __________
Borrowings
 Opening cash balance        __________     __________    __________    __________   __________       __________
 Balance before borrowing    __________     __________    __________    __________   __________       __________
 Borrowing, Bridge Loan      __________     __________    __________    __________   __________       __________
 Ending cash balance         __________     __________    __________    __________   __________       __________
 Cumulative borrowing        __________     __________    __________    __________   __________       __________




   Gross profit on sales is 25 percent, which are sales less cost of goods sold.
   Inventory will be purchased monthly to cover the next month's budgeted sales.
   All inventory purchases will be paid for in the same month they are made.
   A minimum cash balance of $8,000 will be maintained.
   The cash balance was $19,000 on August 1.
   All bridge loan borrowing will be in multiples of $1,000 and will be made or repaid on the
    first of the month.
   Interest at 1 percent a month will be paid when bridge loan borrowing is repaid.



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MGMT 437, Entrepreneurship and Innovation, Cash Flow Exercise


   The $900 of “Other Expenses” will recur each month.

Questions
1. How much will Joan Carmen borrow, cumulatively, to meet seasonal demand? Prepare a
   cash budget on a separate piece of paper using the worksheet in Exhibit A as a guide.
2. How profitable does Ms. Carmen expect the store to be during the six months covered by her
   estimates? Prepare a six-month income statement.
3. Why is the final cash budget useful to Ms. Carmen?
4. Why are sales estimates (projections) and the preliminary cash budget useful to Ms.
   Carmen’s banker?




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