Hanson Ski Product
Why cant you rely on the pro forma financial statements as at March 31, 1987 to tell you whether the plans on which the budgets are based are feasible?To comment on the way of relying on annual pro forma financial statement to make decision, the main goal of the budget plan need to be stated at the first place. It’s a good thing for Hanson Ski Product to receive a rising of their credit line up to $4.2 million from its bankers due to its steady upward growth of the business and reliable reputation. With more funds available, Hanson Ski Product can pursue further expanding on its scale by producing more goods and increasing their capacity when needed. When they plan their 1987 financial year, they not only need to take into account their increased operation expense due to expansion, but also need to plan ahead the $0.841million loan repayment to shareholders, which is a significant and unavoidable expense during a year. One of the main issues they interest in from the budgeting is to see whether the credit line is sufficient for the cash needs of the company to make sure they could pay their shareholder’s loan on time. Then here comes to the question, when preparing the projected financial statements, does the year end position sufficient to explain or cover the main risks and distresses that the company would face in entire year? What are the risks if company makes decisions solely based on their projected year-end position?
From the projected balance sheet, the line of credit at 31 March 1987 is $1.65 million, increased only $0.103 million compared with last year and there is still a considerably large room to reach the $4.2 million limit. With the information above, it seems like Hanson will not face any financial problem in consideration of all feasible expenses and will have no problem to pay the loan to the shareholders. However, if breaks the budget down into monthly basis, things will looks different. Since the major $0.841million payment happens in November, the cash budget of November will be the most relevant piece of information to be checked. Since in November, there will accumulating a large size of account receivable, which supposed to be collected until December, thus there are less cash to be received. The opening balance of the credit line in November is $3.68 million, which is pretty close to the $4.2 million limit, with a decreasing of cash inflow plus an increasing of cash outflow, the credit line at the end of November will be lifted to $4.65 million to exceed the limit. As a consequence, Hanson will face financial distress at that time and have difficulty to pay the loan. Because from December, accounting receivables start to become to cash, and variable costs due to sales starts to become slow, then the financial pressure will be released at that time causing the credit line goes down to a safe level, thus, if looks at company’s financial situation on 31 March 1987, the credit line have already gone to a relatively low level with no other risks reflected.