Sensitivity Analysis Ashley’s CFO is concerned about the impacts of changes in the rates of interest for borrowing and invest-

ing money. To study the impacts, prepare a one-variable input table to show how changes in the annual interest rate for borrowing would affect the end-of-year short-term investment and the net interest earned as a result of borrowing and lending activity. Analyze variations from 6 to 12 percent for the rate of interest for borrowing in increments of 2 percent. Assume that the spread between the rates for borrowing and lending is 2 percent—that is, assume that the annual rate for investing will be 2 percent less than the rate for borrowing—and that the rates will persist throughout the entire year. Plot the results.

Solution: Figure 8-10 shows the results. To link the rate of interest for investing to that for the rate for borrowing, change the entry in Cell F60 from a data value to the expression =F59-0.02. To create the table of values shown in Cells Q5:U8 in Figure 8-10, begin by entering the values for the annual rates of interest for borrowing in Cells Q5:Q8. Then make the following entries in Cells Q4:T4:

Q4:฀=F59 This฀transfers฀the฀values฀from฀Cells฀Q5:Q8฀to฀Cell฀F58. R4:฀=N53

This฀transfers฀the฀calculated฀values฀in฀Cell฀N53฀to฀R5:R8. S4:฀=O49

This฀transfers฀the฀calculated฀values฀in฀Cell฀O49฀to฀S5:S8. T4:฀=O51

This฀transfers฀the฀calculated฀values฀in฀Cell฀O51฀to฀T5:T8.

As these entries are made, Cells Q4:T4 will show the values in Cells F59, N53, O49, and O51. To hide these values, we have formatted the cells with the following custom formats:

Q4: “for Borrowing” R4: “Invested” S4: “Investing” T4: “Borrowing” The next step is to drag the mouse to select the Range Q4:T8. With this range highlighted, click on

Table on the Data menu to access the dialog box shown in Figure 8-11. Enter F59 as the column input cell and click OK or press Enter. This results in the values shown in Cells Q5:T8.

For the entries in Cells U5:U8, enter =S5+T5 in Cell U5 and copy the entry to U6:U8.

Cash Budgeting ❧ 271 Figure฀8-10

Effect of Annual Interest Rate for Borrowing on Amounts of Interest Earned, Paid, and Net for the Year

1 ASHLEY MANUFACTURING: SENSITIVITY ANALYSIS FOR RATE OF BORROWING

2 Annual Rate

Interest Earned and Paid for the Year 3 of Interest

End-of-Year

Amount

Income from

Payments for

4 for Borrowing

9 Note: Annual rate of interest for borrowing is 2% more than rate for investing.

16 Income from 17 Investing 18 $100,000

Net Interest

25 INTEREST EARNED OR P

Payments for Borrowing 26

29 ANNUAL RATE FOR BORROWING

(Cell entries in Row 4 have been hidden by custom formatting as text.)

Figure฀8-11

Table Dialog Box with Entry for Column Input Cell

272 ❧ Corporate Financial Analysis with Microsoft Excel ®

Case Study: Ashley Manufacturing (continued)

Strategy 2: Reduced Annual Capacity

To avoid the high inventory holding costs of the first strategy, Ashley might choose to reduce its annual capacity to somewhat less than the annual demand. If customers are not satisfied unless their demands are met promptly, the results of such a strategy will be lost sales. This is shown in Figures 8-12, 8-13, and 8-14. (Figures 8-12 and 8-13 show only the first 10 rows of the complete spreadsheets. Note that Rows 9 and 10 have been inserted in a copy of the worksheet for Strategy 1 in order to account for lost sales. The preparation of the complete spreadsheet for this strategy is left to the reader.)

Figure฀8-12

First Six Months of Sales Results with Annual Capacity Reduced to 30,000 Units

1 ASHLEY MANUFACTURING: Strategy #2

Apr-97 May-97 Jun-97

3 SALES

4 Percent of annual

14% 12% 5 Forecast demand, units

3,520 4,480 3,840 6 Sales completed, units

3,520 4,480 3,803 7 Unit selling price

$920.00 $920.00 $960.00 8 Sales completed, dollars

1,104,000 $ 1,472,000 $ 2,060,800 $ 2,649,600 $ 3,238,400 $ 4,121,600 $ 3,650,833 9 Lost sales, units

0 0 0 0 0 37 10 Lost sales, dollars

- $ - $ 35,567

Figure฀8-13

Second Six Months of Sales Results with Annual Capacity Reduced to 30,000 Units

1 ASHLEY MANUFACTURING: Strategy #2

Dec-97 All 1997

3 SALES

4 Percent of annual

4% 5 Forecast demand, units

1,280 32,000 6 Sales completed, units

1,280 30,850 7 Unit selling price

$960.00 8 Sales completed, dollars

$ 2,596,721 $ 2,478,689 $ 2,150,400 $ 1,843,200 $ 1,536,000 $ 1,228,800 $ 29,027,043 9 Lost sales, units

0 0 0 0 1,150 10 Lost sales, dollars

Figures 8-9 and 8-14 provide some interesting comparisons between Strategies 1 and 2. Even though the reduced capacity results in losing some sales, Strategy 2 provides a larger net cash flow from operations and a larger value for short-term investing at the end of the year. If this seems strange, note that the labor and material costs and other operating expenses are less, as is also the value of the year-end inventory and the annual holding costs of inventory. Liquidity has improved, as shown by the increase in the end-of-year short-term investments and the reduction in the value of the inventory.

Losing sales, however, is not a good strategy. We therefore move on to other strategies that avoid losing sales and provide better profits.

(Continued)

Cash Budgeting ❧ 273

Figure฀8-14

Cash Flow Reconciliation and Other Information with Annual Capacity Reduced to 30,000 Units

63 ASHLEY MANUFACTURING: Strategy #2 64 Cash Inflow-Outflow Reconciliation for the Year

65 Inflows

Outflows

66 Starting cash balance

Manufacturing labor and material $ 18,446,730 67 Sales receipts

$ 7,253,994 68 Interest earned on short-term investing

Other operating expenses

Interest paid on short-term borrowing $ 17,830

69 Total

End-of-year short-term investments $ 3,313,805 70

Ending cash balance

Total $ 29,082,359

72 Other Information for Comparison of Strategies

73 Inventory holding cost for the year

End-of-year numbers

74 Net cash flow from operations for the year

2,550 75 Lost sales, units

Inventory, units

$ 1,591,844 76 Lost sales, dollars

Inventory, value at cost

Inventory + short-term investments $ 4,905,649

Case Study: Ashley Manufacturing (continued) Strategy 3: Overtime Used with Annual Capacity Less Than Annual Demand

The first strategy for Ashley Manufacturing was based on an annual production capacity equal to the annual demand. This strategy required stockpiling large inventories in months when demand was less than the units available and using the inventory to satisfy demand in months when demand was greater than the units available. Although this satisfied all demands and avoided losing any sales, it resulted in large inventory holding costs. For example, note the large costs for holding inventories in January to May.

Companies use different strategies to avoid large inventory holding costs. The first of the alternate strategies we evaluate is to set the workforce at a level somewhat below that needed to satisfy the average monthly demand and use overtime during months when demand is high. This minimizes the cost to hold inventory but adds the premium cost of working overtime.

Let us begin by considering what would happen if Ashley’s normal production capacity was reduced to 30,000 units/year while the forecast demand remained at 32,000 units/year. Overtime needs to be worked in any month when demand exceeds the sum of what is available from the inventory at the beginning of the month and the units produced on regular time during the month.

The company also recognizes that the actual demands of customers will not be the same as the forecast demands. Demands will be less than forecast some months, and other months will be more. To guard against losing sales when actual demand is greater than forecast demand, the company will use overtime production whenever it is necessary to provide a safety stock as well as to satisfy forecast demand. The amount of the safety stock will depend on the company’s policies for satisfying customers and on the accuracy of its forecasts. For the purpose of illustration, assume that the planned safety stock left in inventory at the end of a month should not be less than 10 percent of the forecast demand for the month.

Figures 8-15 to 8-17 give the results. To perform the analysis, copy the spreadsheet for Figures 8-7 and 8-8 to a new worksheet and change the value for the annual production capacity in Cell O11 of the copy to 30,000. (Row 11 of the copy becomes Row 12 in Figures 8-15 and 8-16 after further editing, as described below.)

Because all forecast demands are met, the entry in Cell C6 can be changed to =C5, and the entry can be copied to D6:N6. (Alternatively, after the changes in the next two paragraphs have been made, the entry in Cell C6 can be edited to =IF(C23+C14>C5,C5,C23+C14) and copied to D6:N6.)

Insert a new row after Row 10 of the copied spreadsheet. The new row is Row 11 in Figure 8-15. Enter the label “Safety stock, percent of forecast demand” in Cell A11 and the value 10% in Cell B11.

(Continued)

274 ❧ ® Corporate Financial Analysis with Microsoft Excel

Figure฀8-15

First Six Months with Overtime to Provide 10% Safety Stock (Strategy #3)

1 ASHLEY MANUFACTURING: Strategy #3

Apr-97 May-97 Jun-97

3 SALES

14% 12% 5 Forecast demand, units

4 Percent of annual

4,480 3,840 6 Sales completed, units

4,480 3,840 7 Unit selling price

$920.00 $920.00 $960.00 8 Sales completed, dollars

10 Workdays 19 19 21 22 21 21 11 Safety stock, percent of forecast demand

2,582 2,582 13 Units produced on overtime

12 Units produced on regular time

0 0 0 0 0 421 14 Total units produced

2,582 3,003 15 Direct labor cost, $/unit increase in July

$145.00 $145.00 $145.00 16 Material cost, $/unit

$463.46 $464.62 $465.78 17 Direct labor cost, regular time

annual increase

392,213 $ 374,385 $ 374,385 18 Direct labor cost, overtime

- $ 91,578 19 Direct labor cost, total

392,213 $ 374,385 $ 465,963 20 Material cost, total

21 Total manufacturing cost

1,645,831 $ 1,574,012 $ 1,864,705 22 INVENTORY LEVEL

23 Start of month, units

3,119 1,221 24 End of month, units

1,221 384 25 Average, units

26 INVENTORY VALUE, AT COST

27 Start of month

1,645,831 $ 1,574,012 $ 1,864,705 29 Total before sales

4,024,418 $ 3,464,688 $ 2,606,739 30 Average unit cost of those sold

$606.18 $607.74 $617.13 31 End of month (total after sales)

1,890,676 $ 742,035 $ 236,976 32 Average value of inventory

33 CASH INFLOWS FROM SALES

1,766,400 $ 2,158,933 $ 2,747,733 35 Cash from sales this month

34 Cash from sales last month

2,845,867 $ 3,532,800 $ 3,976,533 37 MISCELLANEOUS EXPENSES

36 Total sales receipts (cash inflow)

80,000 $ 80,000 39 Advertising pct of preceding sales

increase in August

129,536 $ 164,864 $ 147,456 41 Fringe benefits pct of wages and salaries

pct of sales

193,607 $ 186,298 $ 186,298 42 Interest on long-term notes

12,000 $ 12,000 43 Inventory holding cost pct of avg inventory

26,327 $ 9,790 44 Long-term leases

85,000 $ 85,000 45 Income tax

$ 120,000 46 Dividends to shareholders

47 Total miscellaneous expenses

48 Cost of manufacturing labor and materials

2,304,907 $ 2,209,461 $ 2,608,289 50 NET CASH FLOW FROM OPERATIONS

49 CASH OUTFLOW FROM OPERATIONS

540,960 $ 1,323,339 $ 1,368,244 51 CASH FLOWS FOR FINANCIAL ACTIVITIES

52 Opening cash balance $ 45,000 $ 30,000 $ 30,000 $ 30,000 $ 30,000 $ 50,000 53 Return of previous invested principal

- $ 877,333 54 Interest inflow from previous investing

- $ 3,656 55 Payoff of previous borrowed principal

(958,902) $ (423,535) $ - 56 Interest outflow for previous borrowing

Cash balance before new short-term 57 investing or borrowing

58 New short-term investing

- $ 877,333 $ 2,249,233 59 New short-term borrowing

60 Ending cash balance

61 Cash balance policy

62 Minimum month-end balance

63 Maximum month-end balance

64 Annual interest rate for borrowing

65 Annual interest rate for investing

(Continued)

Cash Budgeting ❧ 275

Figure฀8-16

Last Six Months with Overtime to Provide 10% Safety Stock

1 ASHLEY MANUFACTURING: Strategy #3

Dec-97 All 1997

3 SALES

4% 5 Forecast demand, units

4 Percent of annual

1,280 32,000 6 Sales completed, units

1,280 32,000 7 Unit selling price

$960.00 8 Sales completed, dollars

10 Workdays 22 21 21 23 19 15 244 11 Safety stock, percent of forecast demand 12 Units produced on regular time

1,844 30,000 13 Units produced on overtime

0 0 0 0 1,438 14 Total units produced

1,844 31,438 15 Direct labor cost, $/unit increase in July

$152.25 16 Material cost, $/unit

$472.81 17 Direct labor cost, regular time

annual increase

280,789 $ 4,457,859 18 Direct labor cost, overtime

- $ 323,862 19 Direct labor cost, total

280,789 $ 4,781,720 20 Material cost, total

$ 1,152,773 $ 19,441,915 22 INVENTORY LEVEL

21 Total manufacturing cost

23 Start of month, units

2,274 24 End of month, units

2,838 25 Average, units

26 INVENTORY VALUE, AT COST

27 Start of month

$ 1,152,773 29 Total before sales

$ 2,570,260 30 Average unit cost of those sold

$624.13 31 End of month (total after sales)

$ 1,771,377 32 Average value of inventory

33 CASH INFLOWS FROM SALES

$ 1,024,000 $ 20,004,267 35 Cash from sales this month

34 Cash from sales last month

$ 1,433,600 $ 30,048,000 37 MISCELLANEOUS EXPENSES

36 Total sales receipts (cash inflow)

38 Salaries increase in August

pct of preceding sales

49,152 $ 1,205,248 41 Fringe benefits

pct of sales

149,563 $ 2,229,522 42 Interest on long-term notes

pct of wages and salaries

12,000 $ 144,000 43 Inventory holding cost

31,889 $ 307,213 44 Long-term leases

pct of avg inventory

100,000 $ 1,065,000 45 Income tax

130,000 $ 470,000 46 Dividends to shareholders

47 Total miscellaneous expenses

48 Cost of manufacturing labor and materials

$ 1,747,777 $ 26,793,058 50 NET CASH FLOW FROM OPERATIONS

49 CASH OUTFLOW FROM OPERATIONS

(314,177) $ 3,254,942 51 CASH FLOWS FOR FINANCIAL ACTIVITIES

52 Opening cash balance $ 50,000 $ 50,000 $ 50,000 $ 50,000 $ 50,000 $ 50,000 53 Return of previous invested principal

$ 3,620,662 54 Interest inflow from previous investing

15,086 $ 89,459 55 Payoff of previous borrowed principal

- 56 Interest outflow for previous borrowing

Cash balance before new short-term 57 investing or borrowing

58 New short-term investing

$ 3,321,571 59 New short-term borrowing

60 Ending cash balance

(Continued)

276 ❧ ® Corporate Financial Analysis with Microsoft Excel

Figure฀8-17

Cash Flow Reconciliation and Other Information for Ashley Manufacturing

66 ASHLEY MANUFACTURING: Strategy #3 67 Cash Inflow-Outflow Reconciliation for the Year

68 Inflows

Outflows

69 Starting cash balance

Manufacturing labor and material $ 19,441,915 70 Sales receipts

Other operating expenses $ 7,351,143 71 Interest earned on short-term investing

Interest paid on short-term borrowing $ 17,830

72 Total

End-of-year short-term investments $ 3,321,571 73

Ending cash balance

Total $ 30,182,459

75 Other Information for Comparison of Strategies

76 Inventory holding cost for the year

End-of-year numbers

77 Net cash flow from operations for the year

Inventory, units

Inventory, value at cost

Inventory + short-term investments $ 5,092,948

(Annual capacity is 30,000 units and overtime is worked to satisfy demand and provide 10% safety stock.)

Change the label for Row 12 to “Units produced on regular time.” Insert new rows for Rows 13 and 14, and label them “Units produced on overtime” and “Total units produced.” The units produced on overtime must make up for any shortfall between the forecast demand plus the safety stock (i.e., 110 percent of forecast demand) and the units available before working any overtime (i.e., the units from inventory at the beginning of the month and the units produced on regular time). To calculate the number of units produced on overtime, use an IF statement that first checks on whether or not there is a shortfall and then either calculates the number of units if there is a shortfall or enters zero if there is no shortfall. To do this, enter =IF(C23+C12<(1+ $B$11)*C5,(1+$B$11)*C5-C23-C12,0) in Cell C13 and copy to D13:N13. For the total units produced, enter =C12+C13 in Cell C14 and copy to D14:N14.

Change the label for the entries in Row 17 to “Direct labor cost, regular time” and insert two new rows between Rows 17 and 18. Label the entries in the new Row 18 “Direct labor cost, overtime,” and label the entries in the new Row 19 “Direct labor cost, total.” Enter =1.5*C13*C15 in Cell C18 and copy to D18:N18. The multiplier 1.5 is used because there is a 50 percent premium for working overtime. For the total cost of direct labor, enter =C17+C18 in Cell C19 and copy to D19:N19.

Edit the total material cost values by entering =C14*C16 in Cell C20 and copying to D20:N20. Change the entry in Cell C21 for the total manufacturing cost to =C19+C20 and copy to D21:N21. For the month-end units in inventory, change the entry in Cell C24 to =C23+C14-C6 and copy to D24:N14. If this is done correctly, the number of units in inventory at the ends of June, July, and August will equal 10 percent of the forecast demands for those three months. (Note that these were the three months for which there were lost sales for Strategy 2.)

Edit the average unit cost of those sold by entering =C29/(C14+C23) in Cell C30 and copying to D30:N320. Note that the entries below Row 30 remain unchanged. This includes the entry for fringe benefits, which

is linked to the salaries and direct labor cost on regular time but does not include direct labor cost for overtime. Workers do not get extra days of vacation and other benefits for working overtime; their reward is the 50 percent overtime premium pay.

Figure 8-17 is a reconciliation of the cash inflow and outflow and other information. Compare the results in this figure with those in Figure 8-9. Note the improvements by working overtime when necessary to satisfy demand. The net operating income for the year is the highest, and all customer demands are satisfied. The end- of-year short term investments is higher than for either of the other two situations, the number of units held in

(Continued)

Cash Budgeting ❧ 277

inventory is less than when capacity equals demand, and the total value of inventory and short-term investments is higher. Working overtime provides flexibility for meeting peak seasonal demands without having too much capacity at other times. But it has its limits. Asking workers to work too much overtime ultimately causes their efficiency to drop and invites quality problems. It may also delay maintenance of equipment, cause excessive wear, and hasten breakdowns. Spreadsheets can, of course, be modified to include a limit on the amount of overtime allowed in any period.

Sensitivity Analysis

Figure 8-18 is a one-variable input table that shows the sensitivity of selected results to the policy for setting safety stock.

Figure฀8-18

Sensitivity of Selected Results to the Policy for Setting Safety Stock (Strategy #3)

80 SENSITIVITY OF SELECTED RESULTS TO SIZE OF END-OF-MONTH SAFETY STOCK

Average Monthly Values Safety Stock,

81 Results for 12-Month Period

Average Maximum percent of

Average

Inventory Inventory forecast

Value, at Value, at 82 demand

Operating

Holding

on Overtime,

cost cost

TING INCOME 102

12-MONTH NET OPERA $3,000,000 0%

SAFETY STOCK, PERCENT OF FORECAST DEMAND

(Continued)

278 ❧ Corporate Financial Analysis with Microsoft Excel ®

Row 83, which has been hidden in Figure 8-18, carries the following entries for transferring values from the main body of the spreadsheet:

Cell฀B83฀=B11

Cell฀G83฀=AVERAGE(C25:N25) Cell฀C83฀=O50

Cell฀E83฀=O13

Cell฀H83฀=AVERAGE(C32:N32) Cell฀D83฀=O43

Cell฀F83฀=O18/3

Cell฀I83:฀=MAX(C32:N32)

To complete the table, drag the mouse cursor over the range B83:I94, open the Table dialog box from the Data drop-down menu, and enter B11 for the column input cell, as shown in Figure 8-19.

Figure฀8-19

Table Dialog Box with Entry for Completing the Sensitivity Analysis

Reducing the size of the safety stock, and reaping the benefits from doing so, depends on how accurately future demands can be forecast. The more accurate the forecasts, the less safety stock is needed to ensure being able to satisfy customers’ demands promptly, and the higher is the net operating income.

Case Study: Ashley Manufacturing (continued)

Strategy 4: Overtime, Reduced Capacity, and Backordering

When a product cannot be delivered immediately upon receipt of a customer’s order, the customer is often willing to wait several weeks. The order is placed on “backorder” and delivered as soon as the product is available. This reduces the manufacturer’s need to carry a safety stock and its attendant carrying costs. At the same time, backordering eliminates the penalty of losing a sale.

We now analyze the situation of Ashley Manufacturing if, instead of providing a safety stock (as in the second strategy), the company adds any unfilled orders one month to the forecast demand for the following month and then fills the orders on backorder first, before satisfying any new demand. That is, the total demand for any month is the sum of the demand forecast for the month plus any backorders carried over from the preceding month.

As before, the company’s annual capacity is 30,000 units on regular time and the number of units on hand at the end of December 1996 is 3,400 units. The company expects that its new strategy of using backordering will reduce its year-end inventory for 1997.

Assume also that the company’s policy is not to use overtime in a given month unless the number of units of unsatisfied demand at the end of a month would otherwise exceed 20 percent of the forecast demand for the month. As a result of this policy, enough overtime must be worked so that the number of units on backorder at the end of any month does not exceed 20 percent of the forecast demand for the month.

Figures 8-20, 8-21, and 8-22 show the results for the fourth strategy. To perform the analysis, copy the spreadsheet for the third strategy to a new spreadsheet and insert rows and labels as indicated in Figure 8-20 and discussed below.

(Continued)

Cash Budgeting ❧ 279

Figure฀8-20

First Six Months of Cash Budget with Overtime and Backordering (Strategy #4)

1 ASHLEY MANUFACTURING: Strategy #4

May-97 Jun-97

3 SALES

4 Percent of annual

14% 12% 5 Forecast demand, units

4,480 3,840 6 Backorders from preceding month, units

0 0 0 0 0 0 7 Total demand, units

4,480 3,840 8 Sales completed, units

4,480 3,803 9 Backorders to following month, units

0 0 0 0 0 37 10 Unit selling price

$920.00 $960.00 11 Sales completed, dollars

13 Workdays 19 19 21 22 21 21 14 Maximum backorders, pct of forecast demand

2,582 2,582 16 Units produced on overtime

15 Units produced on regular time

0 0 0 0 0 0 17 Total units produced

2,582 2,582 18 Direct labor cost, $/unit increase in July

$145.00 $145.00 19 Material cost, $/unit

$464.62 $465.78 20 Direct labor cost, regular time

annual increase

374,385 $ 374,385 21 Direct labor cost, overtime

- $ - 22 Direct labor cost, total

374,385 $ 374,385 23 Material cost, total

1,574,012 $ 1,577,011 25 INVENTORY LEVEL

24 Total manufacturing cost

26 Start of month, units

3,119 1,221 27 End of month, units

1,221 28 Average, units

29 INVENTORY VALUE, AT COST

30 Start of month

1,574,012 $ 1,577,011 32 Total before sales

3,464,688 $ 2,319,045 33 Average unit cost of those sold

$607.74 $609.80 34 End of month (total after sales)

742,035 $ - 35 Average value of inventory

36 CASH INFLOWS FROM SALES

2,158,933 $ 2,747,733 38 Cash from sales this month

37 Cash from sales last month

39 Total sales receipts (cash inflow)

3,532,800 $ 3,964,678 40 MISCELLANEOUS EXPENSES

80,000 $ 80,000 42 Advertising pct of preceding sales

41 Salaries

increase in August

164,864 $ 146,033 44 Fringe benefits pct of wages and salaries

pct of sales

186,298 $ 186,298 45 Interest on long-term notes

12,000 $ 12,000 46 Inventory holding cost pct of avg inventory

26,327 $ 7,420 47 Long-term leases

85,000 $ 85,000 48 Income tax

$ 120,000 49 Dividends to shareholders

50 Total miscellaneous expenses

51 Cost of manufacturing labor and materials

2,209,461 $ 2,316,803 53 NET CASH FLOW FROM OPERATIONS

52 CASH OUTFLOW FROM OPERATIONS

1,323,339 $ 1,647,875 54 CASH FLOWS FOR FINANCIAL ACTIVITIES

55 Opening cash balance $ 45,000 $ 30,000 $ 30,000 $ 30,000 $ 30,000 $ 50,000 56 Return of previous invested principal

- $ 877,333 57 Interest inflow from previous investing

- $ 3,656 58 Payoff of previous borrowed principal

(958,902) $ (423,535) $ - 59 Interest outflow for previous borrowing

Cash balance before new short-term 60 investing or borrowing

61 New short-term investing

877,333 $ 2,528,864 62 New short-term borrowing

63 Ending cash balance

64 Cash balance policy

65 Minimum month-end balance

66 Maximum month-end balance

67 Annual interest rate for borrowing

68 Annual interest rate for investing

(Continued)

280 ❧ ® Corporate Financial Analysis with Microsoft Excel

Figure฀8-21

Last Six Months of Cash Budget with Overtime and Backordering (Strategy #4)

1 ASHLEY MANUFACTURING: Strategy #4

Dec-97 All 1997

3 SALES

4% 5 Forecast demand, units

4 Percent of annual

1,280 32,000 6 Backorders from preceding month, units

0 0 7 Total demand, units

1,280 8 Sales completed, units

1,280 32,000 9 Backorders to following month, units

0 0 0 10 Unit selling price

$960.00 11 Sales completed, dollars

13 Workdays 22 21 21 23 19 15 244 14 Maximum backorders, pct of forecast demand 15 Units produced on regular time

1,844 30,000 16 Units produced on overtime

0 0 0 0 574 17 Total units produced

1,844 30,574 18 Direct labor cost, $/unit increase in July

$152.25 19 Material cost, $/unit

$472.81 20 Direct labor cost, regular time

annual increase

355,666 $ 280,789 $ 4,457,859 21 Direct labor cost, overtime

- $ 131,125 22 Direct labor cost, total

355,666 $ 280,789 $ 4,588,983 23 Material cost, total

24 Total manufacturing cost

$ 1,457,425 $ 1,152,773 $ 18,846,454 25 INVENTORY LEVEL

1,410 27 End of month, units

26 Start of month, units

1,974 28 Average, units

29 INVENTORY VALUE, AT COST

30 Start of month

419,600 $ 879,239 31 Added

$ 1,457,425 $ 1,152,773 32 Total before sales

$ 1,877,026 $ 2,032,012 33 Average unit cost of those sold

$624.43 34 End of month (total after sales)

879,239 $ 1,232,736 35 Average value of inventory

36 CASH INFLOWS FROM SALES

$ 1,378,581 $ 1,024,000 $ 20,004,267 38 Cash from sales this month

37 Cash from sales last month

39 Total sales receipts (cash inflow)

$ 2,341,750 $ 1,890,581 $ 1,433,600 $ 30,048,000 40 MISCELLANEOUS EXPENSES

increase in August

pct of preceding sales

49,152 $ 1,205,248 44 Fringe benefits

pct of sales

180,263 $ 149,563 $ 2,229,522 45 Interest on long-term notes

pct of wages and salaries $

12,000 $ 144,000 46 Inventory holding cost

21,120 $ 259,646 47 Long-term leases

pct of avg inventory

100,000 $ 100,000 $ 1,065,000 48 Income tax

$ 130,000 $ 470,000 49 Dividends to shareholders

50 Total miscellaneous expenses

51 Cost of manufacturing labor and materials

52 CASH OUTFLOW FROM OPERATIONS

$ 2,366,766 $ 1,959,813 $ 1,737,009 $ 26,150,029 53 NET CASH FLOW FROM OPERATIONS

(69,232) $ (303,409) $ 3,897,971 54 CASH FLOWS FOR FINANCIAL ACTIVITIES

55 Opening cash balance $ 50,000 $ 50,000 $ 50,000 $ 50,000 $ 50,000 $ 50,000 56 Return of previous invested principal

4,310,387 $ 4,259,115 57 Interest inflow from previous investing

17,746 $ 98,312 58 Payoff of previous borrowed principal

- 59 Interest outflow for previous borrowing

Cash balance before new short-term 60 investing or borrowing

$ 4,310,387 $ 4,259,115 $ 3,973,452 62 New short-term borrowing

61 New short-term investing

63 Ending cash balance

(Continued)

Cash Budgeting ❧ 281

Figure฀8-22

Cash Flow Reconciliation for Overtime and Backordering (Strategy #4)

69 ASHLEY MANUFACTURING: Strategy #4 70 Cash Inflow-Outflow Reconciliation for the Year

71 Inflows

Outflows

72 Starting cash balance

Manufacturing labor and material $ 18,846,454 73 Sales receipts

$ 7,303,576 74 Interest earned on short-term investing

Other operating expenses

Interest paid on short-term borrowing $ 17,830

75 Total $ 30,191,312

End-of-year short-term investments $ 3,973,452 76

Ending cash balance

Total $ 30,191,312

78 Other Information for Comparison of Strategies

79 Inventory holding cost for the year

End-of-year numbers

80 Net cash flow from operations for the year

Inventory, units

Inventory, value at cost

Inventory + short-term investments $ 5,206,188

Sales section: Ashley’s sales organization will want to keep track of how well their customers’ demands are satisfied. To do this, add two new rows after Row 5 of the “Sales” section to keep track of the backorders from the preceding month and the total demand (i.e., the sum of the forecast demand plus backorders from the preceding month). Label new Row 6 “Backorders from preceding month, units” and label new Row 7 “Forecast demand plus backorders, units” or “Total demand, units.” Then make the following entries in the new rows:

•฀ For฀the฀backorders฀from฀the฀preceding฀month:฀Enter฀=B9฀in฀Cell฀C6฀and฀copy฀to฀Cells฀D6:N6. •฀ For฀the฀total฀demand฀(i.e.,฀the฀forecast฀demand฀plus฀backorders฀from฀preceding฀month):฀Enter฀

=C5+C6 in Cell C7 and copy to Cells D7:N7. •฀ For฀the฀sales฀completed:฀Change฀the฀entry฀in฀Cell฀C8฀to฀=IF(C17+C26>C7,C7,C17+C26)฀and฀copy฀

to Cells D8:N8. •฀ For฀the฀backorders฀to฀the฀following฀month:฀Add฀another฀row฀after฀Row฀8฀to฀create฀a฀new฀Row฀9฀and฀

label the new row “Backorders to following month, units.” Then enter =IF(C7>C8,C7-C8,0) in Cell C9 and copy the entry to Cells D9:N9.

•฀ For฀the฀dollar฀value฀of฀the฀sales฀completed:฀Change฀the฀entry฀in฀Cell฀C11฀to฀=C6*B10+(C8-C6)*C10฀ and copy to D11:N11. This entry is the sum of the backorders completed at the selling price in effect the preceding month (i.e., when the backorders were placed) plus new orders completed at the current price. (Actually, omitting this change does not affect the results for the conditions of this particular problem because the first month in which backorders occur (i.e., June) is the first month for the price increase to $960/unit from $920/unit.)

Manufacturing: Manufacturing needs to respond to the new rules for overtime. Change the label in Cell A14 to “Maximum backorders, percent of forecast demand,” and change the value in Cell B14 to 20%.

If the difference (or “shortfall”) between the total demand and what is available from regular time production and beginning inventory is greater than 20 percent of the forecast demand, overtime must be worked. The number of units produced on overtime must then equal the shortfall minus 20 percent of the forecast demand. Otherwise, no overtime is needed. To calculate the number of units produced on overtime, change the entry in Cell C16 to =IF(C7-(C26+C15)>$B$14*C5,C7-(C26+C15)-$B$14*C5,0) and copy to Cells D16:N16. (Study this entry carefully and note how it corresponds to the statements of the first three sentences of this paragraph.)

(Continued)

282 ❧ Corporate Financial Analysis with Microsoft Excel ®

Because of the linkages already established for the second strategy, no further editing should be required to produce the results shown in Figures 8-20, 8-21, and 8-22.

Sensitivity Analysis

We will use a one-variable input table to show the impact of the maximum percentage of forecast monthly demand permitted on backorder on (1) the net cash flow from operations for the year, (2) the average number of units in inventory during the year, (3) the average value of inventory during the year, (4) the inventory holding cost for the year, (5) the number of units produced on overtime during the year, and (6) the labor cost for working overtime during the year. Figure 8-23 shows the results in tabular format, and Figure 8-24 plots the result from the first two columns to show the impact of the backorder policy on the net cash flow from operations for the year.

Figure฀8-23

Sensitivity of Net Operating Cash Flow and Other Variables to the Backordering Policy, Expressed as the Maximum Percent of Monthly Demand Allowed on Backorder

SENSITIVITY TO BACKORDER POLICY, AS EXPRESSED BY THE MAXIMUM PERCENT OF

89 FORECAST DEMAND PERMITTED ON BACKORDER

Maximum Labor Cost for Percent of

Number of Working Forecast

Net Cash Flow

Average

Units Produced Overtime Demand on

from

Number of

Average

Inventory

on Overtime during the 90 Backorder

Operations for

Units in

Value of

Holding Cost

for the Year during the Year Year 92 0%

the Year

Key Cell Entries in Row 85 for Transferring Values

B91: =B14 C91: =O53 D91: =AVERAGE(C28:N28)

E91: =AVERAGE(C35:N35)

F91: =O46

G91: =O16 H91: =O21

(Row 91 has been hidden.)

(Continued)

Cash Budgeting ❧ 283

Figure฀8-24

Sensitivity of Net Operating Cash Flow and Other Variables to the Backordering Policy, Expressed as the Maximum Percent of Monthly Demand Allowed on Backorder

SENSITIVITY ANALYSIS Net Cash Flow from Operations vs. Backorder Policy

TIONS $4,200,000 $4,100,000

$4,000,000 OM OPERA $3,900,000

W FR $3,800,000 $3,700,000

NET CASH FLO $3,400,000

90% 100% MAXIMUM PERCENT OF FORECAST MONTHLY DEMAND ALLOWED ON

The preparation of the table and chart follows the same procedure as for the earlier sensitivity analyses. Be sure that the results are not plotted as a smooth curve but as a pair of straight-line segments that meet at the common point, as in Figure 8-24. (To do this, delete the check in the “Smoothed line” box on the “Patterns” tab of the “Format Data Series” dialog box.)

Sensitivity Analysis Ashley’s CFO is concerned about the impacts of changes in the rates of interest for borrowing and invest-