Marlowe Kitchens Ltd: a profitable quarter with a growing overdraft
Marlowe Kitchens Ltd is preparing its cash budget for the first quarter. Sales are budgeted at £120,000 in January, £150,000 in February and £180,000 in March, up from £110,000 in December. Customers pay 40% in the month of sale and 55% in the following month; 5% is never collected. Purchases are 60% of the following month's sales and are paid in the month after purchase, so December purchases of £72,000 are paid in January. Wages are £22,000 a month, paid in the month incurred, and cash overheads are £22,000 a month. Depreciation of £8,000 a month is also charged in the accounts. A new oven costing £45,000 is to be paid for in February and £12,000 of corporation tax falls due in March. The opening cash balance on 1 January is £18,000 and there is currently no overdraft facility.
1. Prepare the cash budget for January to March and identify the month and size of the peak funding requirement.
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Receipts:
- Jan: (40% × 120,000) + (55% × 110,000) = 48,000 + 60,500 = £108,500
- Feb: (40% × 150,000) + (55% × 120,000) = 60,000 + 66,000 = £126,000
- Mar: (40% × 180,000) + (55% × 150,000) = 72,000 + 82,500 = £154,500
Payments: purchases are 60% of the following month's sales, paid one month later: Jan £72,000, Feb £90,000, Mar £108,000.
| Jan £ | Feb £ | Mar £ | |
|---|---|---|---|
| Receipts | 108,500 | 126,000 | 154,500 |
| Purchases | (72,000) | (90,000) | (108,000) |
| Wages | (22,000) | (22,000) | (22,000) |
| Cash overheads | (22,000) | (22,000) | (22,000) |
| Oven | – | (45,000) | – |
| Tax | – | – | (12,000) |
| Net | (7,500) | (53,000) | (9,500) |
| Opening | 18,000 | 10,500 | (42,500) |
| Closing | 10,500 | (42,500) | (52,000) |
Peak requirement: £52,000 overdrawn at the end of March. The facility must also cover February's £42,500, so a facility of £60,000–£65,000 is needed to leave a buffer for timing slippage.
2. The managing director points out that the quarter is budgeted to make a profit of £24,000 yet the bank balance falls by £70,000. Reconcile the two and explain the main causes.
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Budgeted profit: sales 450,000 − materials 270,000 (60%) − wages 66,000 − cash overheads 66,000 − depreciation 24,000 = £24,000.
Why cash is £70,000 worse (18,000 → −52,000):
- Depreciation £24,000 is a cost but not a payment, so cash is higher than profit by this amount.
- Oven £45,000 is a payment but not a cost in this period (it becomes depreciation over its life). This is the single biggest cause of the gap.
- Corporation tax £12,000 relates to earlier profits; it is a payment with no charge this quarter.
- Receivables growth: December's £110,000 of sales is still being collected and sales are rising month on month, so debtors absorb cash continuously.
- The 5% never collected - £22,500 of the quarter's £450,000 of sales - is a real outflow that profit already bears but cash never receives.
Check: 24,000 − 45,000 − 12,000 − 24,000 + (working capital movement) ≈ −70,000 movement. Profit and cash answer different questions; a growing, investing business can be both profitable and overdrawn.
3. Advise the directors on how to manage the peak. Quantify at least two options and state which you would recommend.
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Option 1 – arrange the facility properly. The peak is £52,000 in March. A facility of £65,000 gives a £13,000 buffer. Cost is modest (say 2% over base on the drawn balance, roughly £600 for the quarter) and it removes the risk of bounced payments, which would damage supplier relationships far more than the interest.
Option 2 – attack the 5% collection failure. 5% × £450,000 = £22,500 a quarter, £90,000 a year. If this is bad debt, it is larger than the budgeted profit of £24,000 and dwarfs the overdraft interest. Tightening credit checks and prompt follow-up is the highest-value action available.
Option 3 – pull receipts forward. A 10% deposit on order would bring forward 10% of sales - around £45,000 over the quarter - and would largely eliminate the overdraft. It also filters out customers who never intended to pay.
Option 4 – lease rather than buy the oven. Avoids the £45,000 outflow, replacing it with, say, £1,300 a month, cutting the March peak to around £20,000.
Recommendation: secure the £65,000 facility now as insurance, but treat the 5% collection loss as the real problem. Deferring the oven would delay capacity the sales growth needs, so leasing or facility finance is better than cancellation.