7.51a.The following table provides Gary’s income statement for October through December. In this statement, notice that the cost of purchases = 80% of sales. (Gary marks up $1 of cost to $1.25 in sales. So, $1 in sales = $1/1.25 = $0.80 in cost.)OctoberNovemberDecemberRevenues $475,000$525,000 $562,500 Purchases cost 380,000420,000 450,000 Contribution Margin $95,000$105,000 $112,500 Cash fixed costs 85,00085,000 85,000 Non cash fixed costs 10,00010,000 10,000 Profit before taxes $0 $10,000 $17,500 Overall, Gary appears to be running a profitable business, with breakeven sales of$475,000. (Check: $475,000 × CMR of 20% - $95,000 = 0). Thus, while Gary is at breakeven in October, he is well past the required volume in November and December.b.The following table provides Gary’s cash budget for October – December. In this statement, Collections – 1 month are the collections from prior month sales (e.g., October = 0.30 of September sales) and Collections – 2 months arethe collections from sales 2 months ago (October = 0.70 × August sales). Likewise, purchases – current month = 50% of current month purchases and purchases – 1 month are 50% of the prior months purchases.OctoberNovemberDecemberCollections – 1 month $140,625$142,500 $157,500 Collections – 2 months 328,125 328,125 332,500 Total cash available $468,750$470,625 $490,000 Purchase – current month 190,000 210,000 225,000 Purchase month ago 187,5001190,0002210,000 Cash fixed costs 85,000 85,000 85,000 Net cash from operations $6,250 ($14,375)($30,000)+opening balance 5,000 11,250 (3,125) = Ending balance$11,250 ($3,125) ($33,125) 1$187,500 = (468,750/1.25) × 0.50.2$190,000 = (475,000/1.25) × 0.50.Overall, Gary appears to be facing a cash crunch. Available cash dips from $11,250 in October to an anticipated shortfall of ($33,125) in December. This occurs even though sales have increased in this time period.
c.Gary’s problem is common among firms which experience growth. In essence,Gary is pumping money into working capital because he is financing his customers’ purchases. He is paying his suppliers faster than his customers are paying him. Thus, when his business grows, he has to put more money into the business. We can see this by calculating that the accounts receivable at the start of October is $796,875 (= 70% of August sales + September sales), whereas it is $930,000 (= 70% of November sales + December sales) at the start of January next year.Gary needs to find ways to manage this imbalance. One avenue is to borrow, but he has to consider interest costs. The other avenue is to accelerate collections or defer payments, but then customers might cut back on orders and suppliers might raise prices. Both actions are costly to Gary. Gary would need to estimate his expected profit to evaluate each option.7.52We know that the COGM is the outflow from the WIP inventory account. Direct materials, direct labor, and overhead are the inflows into this account. Applying the inventory equation then helps us fill in the required data.Likewise, we know that the COGS is the cost of the items removed from finished goods inventory. Thus, we can compute COGS by applying the inventory equation to the FG inventory account.