Overview of Hokie Pool Sales (HPS)
HPS stands for Hokie Pool Sales, which was established in 1968. As can be seen from this company’s name, it is a pool construction firm. It is found out by Lynn that Hokie Pool Sales incorporation is a small business, but with rapid growth and high revenue. This finding is also explained by the firm’s place, which is surrounded by some of the wealthier counties in Indiana. Thus, demand for this service is certainly high and sources of customers are also abundant.
Eric Swank, the president of Hokie Pool Sales selected the seasonal sales pattern. It seems to be much suitable for a pool construction firm.Answers to questions
3.1 Importance of cash budget (solution for question 1)
If the Hokie Pool Sales (HPS) can estimate the profit for upcoming months, it is necessary for the firm also to estimate cash budget. There are some evidences and reasons which support this above statement. Firstly, a cash budget helps the company avoid having a shortage of cash during periods of numerous expenses. In contrary to cash budget, estimated profit certainly does not illustrate the current condition of cash. Secondly, a cash budget is very important, especially for the small companies because it allows a company to establish the amount of credit that it can extend to customers without having problems with liquidity. Thus, there are two things that make cash budget indispensable in this situation. One is that the company is a small business, as mentioned above. The second is that the amount of profit cannot show the amount of credit allowed to keep stable liquidity, which can be interpreted from a cash budget.
Finally, there are some differences between profit and cash flow.
Considering the sales of Hokie Pool Sales company in four month, from April to July, we have the following sales figure.
Source, Case study of Hokie Pool Sales
Table 2: Sales figures of Hokie Pool Sales for April through July (all values are made in thousand USD)
Based on case study, the cash inflow is measured as following:
Paid after 1m
Paid after 2 m
Paid after 3m
Source: Conducted by the author
Table 3: Cash inflow from April to September (all values are measured in thousand USD)
As noted from the two above tables, sales revenues do not necessarily equal cash inflow. It results in the fact that while the revenue may be healthy, there is still a delay between making the sale and receiving the cash.
It is better to attempt to analyze the cash budget on a monthly basis. Typically, almost companies choose to calculate monthly cash budget. And as a general rule, the law to select the most suitable frequency to build the cash budget is that it should be long enough to show the effect of company’s policies in running the business and then short enough so that estimates can be made with reasonable accuracy. Based on this rule, I prefer monthly cash budget to other basis.
Firstly, because the Hokie Pool Sales firm is a small business, thus an hourly basis or daily one cannot support it to describe the effect of this company’s policies. Secondly, daily basis or hourly basis is too short and useless to provide reasonable accuracy. Moreover, transactions involving in revenue and expenditures are normally conducted in several days, not only one day or even one hour. So if cash budget is made on daily basis, it is redundant and confused to see clearly.
Based on information of case study from analysis of Julie Lynn, I makes a cash budget for April through September as following.
April through September, 1992
|Cash balance beginning||80,000||47,745||-7,475||-67,200||-113,510||-5,270|
|Cost of goods sold||36,000||60,000||60,000||36,000||15,000||12,000|
|Wages and salaries||6,000||8,000||11,000||11,000||8,000||6,000|
|Total cash outflow||47,000||83,000||101,000||104,000||28,000||38,000|
|Cash balance end of month||47,745||-7,475||-67,200||-113,510||-5,270||39,330|
Source: Conducted by the author
Table 4: Cash budget for April through September
If the cash inflows and outflows are not constant during each month, the analysis may be affected. This can be explained by the fact that the cash balance in beginning depends on the cash balance on this of previous month. Therefore, if there is any lack of cash inflow or cash outflow, it will lead to change in cash balance at the end, which may make the cash on hand for the next month confused to measure accurately.
However, this situation may happen due to the high seasonal sales pattern of this company. It is very easy to see from the actual sales and cash expenditure of the cash budget. As can be seen that from May to August, sale reaches its peak and the highest one is 100,000 USD in both June and July. In complying with the rate of sale, in these four months, the expenditures are also higher than other months, more than 100,000 USD in June and July. The remained months seem to be reported at both low revenue and low expense. Thus, the problem of lack of data in cash budget in some months may occur.
The fundamental concept of a cash budget is estimating all future cash receipts and cash expenditures that will take place during the time period. However, the most important estimate required in making this analysis is estimate of sale.
The first reason to the above conclusion is that sales are not actual cash on hand that the company will gain. It is also divided into two groups, including cash paid immediately and credit. This credit is also comprised of four different types, which are cash paid after 30 days, cash paid after 60 days, cash paid after 90 days and cash as bad debts. Finding out which group the proportion of sales will fall into is very important to make analysis of cash budget. As can be seen from the above table, I must analyze the cash inflow in the separated area with its owned table in order to see the change in cash flow easily and clearly. It is noted that sales does not come into money completely because about 3% of credit is bad debt, which cannot be collected from customers.
The second reason is that the estimate of expense is pointed out typically and particularly, it cannot be changed easily. Because the expense is necessary to be implemented in order to operate business activities. To reduce the expenditure is not easy. In addition, the cost of goods sold in this company is tied to expected sales in the next month. Therefore, estimate of sale is essential to measure the cost of goods sold required. If an increase in sales of, for example, 10 percents, is desired and expected, various other accounts must be adjusted in the budget. Not only costs of goods sold are affected, but the wage, salaries and capital expenditure are also changed to comply with the increase of sale.
In my opinion, trade discount is not as bad as Swank’s feeling. For many businesses, especially small businesses, trade discount can be considered as the big solution for solving the cash flow problem. It means that this discount will help speed up cash flow as the bookkeeper, Bellich recommended.
Firstly, this idea actually makes sense, not be bad as Swank thought. Because trade discount will lower the time period in which customers pay money for previous sales. It certainly improves cash budget significantly. Secondly, trade discount is one of the best methods to increase purchasing power of customers. This additional benefit can be used for improvements to production facilities, additional employees for increasing output or other purchases for improving business operations. Therefore, I can comment that the trade discount solution does not cost money and become useless as Swank’s opinion.
Finally, Swank said that trade discount was the way they bribe customers. But I think that why this company does not take this method while it can bring mutual benefits for both customers and HPS. Customers pay lower money and HPS also lower its average collection period.
Cash strategies Lynn should recommend to Swank as described as following:
- Allowing customers a suitable trade discount in the peak season, from April to September: if they can make payment during this period, they will get an attractive trade discount. This solution helps solve the cash deficit in the peak season, it means the cash on hand in this situation can meet obligation to pay all incurred cost and expenditure. The most suitable trade discount is equal the 3% of bad debt. Because if the company does not offer its customer this discount, 3% of credit still disappears. So, Swank can take advantage of this number to help improve the cash flow, lower the average collection period.
- It is vital for Swank to check to see how well your customer terms and supplier terms are balanced. For example, if his average payable is 24 days and his average receivable is 47 days, that’s 23 days that he has to float, which means he has to go out and get working capital. It is advised to balance the time period the company must pay to its supplier and the period the customers must repay to it.
- In order to shorten its receivables period, Swank will need to have a good collection system in place. Prefect system is not only a way to improve how quickly the company can be paid but also improve customer service as well.
- If improving cash flow is a priority, make sure all of the employees in Hokie Pool Sales understand that.
To conclude, it is necessary to address the role of cash budget in any company in the world and if there is any trouble with this, solve it promptly. Hokie Pool Sales had problems of cash flow due to its highly seasonal sales patterns, which causes in some peak period, cash balance may be cash deficit. To overcome this difficulty, Swank, president of this company had invited Lynn, a professional consultant to help him improve cash budget. The paper makes analysis on cash budget of HPS, prepares it and shares some recommendations.
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