The Business Situation

weats Galore, Inc.

Developed by Jessica Johnson Frazier, Eastern Kentucky University,and PatriciaH.Mounce, University of Central Arkansas

The Business Situation

After graduating with a degree in business from Eastern University in Campus Town, USA, Michael Woods realized that he wanted to remain in Campus Town. After a number of unsuccessful attempts at getting a job in his discipline, Michael decided to go into business for himself. In thinking about his business venture, Michael determined that he had four criteria for the new business:

  1. He wanted to do something that he would enjoy.
  2. He wanted a business that would give back to the community
  3. He wanted a business that would grow and be more successful every year.
  4. Realizing that he was going to have to work very hard, Michael wanted a busi- ness that would generate a minimum net income of $25,000 annually.

While reflecting on the criteria he had outlined, Michael, who had been presi- dent of his fraternity and served as an officer in several other student organiza- tions, realized that there was no place in Campus Town to have custom sweatshirts made using a silk-screen process. When student organizations wanted sweatshirts for their members or to market on campus, the officers had to make a trip to a city

100 miles away to visit “Shirts and More.”
Michael had worked as a part-time employee at Shirts and More while he

was in high school and had envisioned owning such a shop. He realized that a sweatshirt shop in Campus Town had the potential to meet all four of his cri- teria. Michael set up an appointment with Jayne Stoll, the owner of Shirts and More, to obtain information useful in getting his shop started. Because Jayne liked Michael and was intrigued by his entrepreneurial spirit, she answered many of Michael’s questions.

In addition, Jayne provided information concerning the type of equipment Michael would need for his business and its average useful life. Jayne knows a competitor who is retiring and would like to sell his equipment. Michael can pur- chase the equipment at the beginning of 2013, and the owner is willing to give him terms of 50% due upon purchase and 50% due the quarter following the purchase. Michael decided to purchase the following equipment as of January 1, 2013.

Used cash register

4 yrs. 10 yrs. 5 yrs.

case6Cases for Management Decision-Making

Hand-operated press that applies ink to the shirt Light-exposure table
Dryer conveyer belt that makes ink dry on the shirts Computer with graphics software and color printer Display furniture

$7,500 1,350 2,500 3,500 2,000 500

5 yrs. 10 yrs. 10 yrs.

Michael has decided to use the sweatshirt supplier recommended by Jayne. He learned that a gross of good-quality sweatshirts to be silk-screened would cost $1,440. Jayne has encouraged Michael to ask the sweatshirt supplier for terms of 40% of a quarter’s purchases to be paid in the quarter of purchase, with the remaining 60% of the quarter’s purchases to be paid in the quarter following the purchase.

Michael also learned from talking with Jayne that the ink used in the silk- screen process costs approximately $0.75 per shirt.

Knowing that the silk-screen process is somewhat labor-intensive, Michael plans to hire six college students to help with the process. Each one will work an average of 20 hours per week for 50 weeks during the year. Michael estimates total annual wages for the workers to be $72,000.

In addition, Michael will need one person to take orders, bill customers, and operate the cash register. Cary Sue Smith, who is currently Director of Student Development at Eastern University, has approached Michael about a job in sales. Cary Sue knows the officers of all of the student organizations on campus. In addition, she is very active in the community. Michael thinks Cary Sue can bring in a lot of business. In addition she also has the clerical skills needed for the position. Because of her contacts, Michael is willing to pay Cary Sue $1,200 per month plus a commission of 10% of sales. Michael estimates Cary Sue will spend 50% of the workday focusing on sales, and the remaining50%will be spent on clerical and administrative duties.

Michael realizes that he will have difficulty finding a person skilled in com- puter graphics to generate the designs to be printed on the shirts. Jayne recently hired a graphics designer in that position for Shirts and More at a rate of $500 per month plus $0.10 for each shirt printed. Michael believes he can find a university graphics design student to work for the same rate Jayne is paying her designer.

Michael was fortunate to find a commercial building for rent near the uni- versity and the downtown area. The landlord requires a one-year lease. Although the monthly rent of $1,000 is more than Michael had anticipated paying, the building is nice, has adequate parking, and there is room for expansion. Michael anticipates that 75% of the building will be used in the silk-screen process and25%will be used for sales.

Michael’s fraternity brothers have encouraged him to advertise weekly in the Eastern University student newspaper. Upon inquiring, Michael found that a 3″ x 3″ ad would cost $25 per week. Michael also plans to run a weekly ad in the local newspaper that will cost him $75 per week.

Michael wants to sell a large number of quality shirts at a reasonable price. He estimates the selling price of each customized shirt to be $16. Jayne has suggested that he should ask customers to pay for 70% of their purchases in the quarter purchased and pay the additional 30% in the quarter following the purchases.

After talking with the insurance agent and the property valuation administra- tor in his municipality, Michael estimates that the property taxes and insurance on the machinery will cost $2,240 annually; property tax and insurance on dis- play furniture and cash register will total $380 annually.

Cost

Useful Life

SWEATS GALORE

case6Cases for Management Decision-Making

Jayne reminded Michael that maintenance of the machines is required for the silk-screen process. In addition, Michael realizes that he must consider the cost of utilities. The building Michael wants to rent is roughly the same size as the building occupied by Shirts and More. In addition, Shirts and More sells ap- proximately the same number of shirts Michael plans to sell in his store. There- fore, Michael is confident that the maintenance and utility costs for his shop will be comparable to the maintenance and utility costs for Shirts and More, which are as follows within the relevant range of zero to 8,000 shirts.

January February March April
May
June
July August September October November December

$1,716 1,720 1,740 1,740 1,758 1,818 1,825 1,780 1,914 1,860 1,855

Shirts Sold

2,000
2,110
2,630
3,150
5,000
5,300
3,920
2,080
8,000
6,810
6,000
3,000 1,749

Maintenance

Costs

Utility Costs

$1,100 1,158 1,171 1,198 1,268 1,274 1,205 1,117 1,400 1,362 1,347 1,193

Michael estimates the number of shirts to be sold in the first five quarters, beginning January 2013, to be:

First quarter, year 1 Second quarter, year I Third quarter, year 1 Fourth quarter, year 1 First quarter, year 2

8,000 10,000 20,000 12,000 18,000

Michael decides to establish his company as a corporation. He will invest $10,000 of his personal savings in the company.

Seeing how determined his son was to become an entrepreneur, Michael’s father offered to co-sign a note for an amount up to $20,000 to help Michael open his sweatshirt shop, Sweats Galore, Inc. However, when Michael and his father approached the loan officer at First Guarantee Bank, the loan officer asked Michael to produce the following budgets for 2013.

Sales budget
Schedule of expected collections from customers Shirt purchases budget
Schedule of expected payments for purchases Silk-screen labor budget
Selling and administrative expenses budget Silk-screen overhead expenses budget
Budgeted income statement
Cash budget
Budgeted balance sheet

The loan officer advised Michael that the interest rate on a 12-month loan would be 8%. Michael expects the loan to be taken out as of January I, 2013.

Michael has estimated that his income tax rate will be 20%. He expects to pay the total tax due when his returns are filed in 2014.

Instructions

Answerthe following questions.
1.Do you think it was important for Michael to stipulate his four criteria for the business

(sec page CA-20), includingthe goal of generating a net income of at least$25,000 an-nually? Why or why not?

2.

3.

4.

If the company has sales of $12,000 during January of the first year of business, de- termine the amount of variable and fixed costs associated with utilities and mainte- nance using the high-low method for each. (Round unit variable costs to three decimal places where necessary.)

Using the format below, prepare a sales budget for the year ending 2013.

Sweats Galore, Inc.
Sales Budget
For the Year Ended December 31, 2013

Quarter
1 2 34Year

Expected unit sales Unit selling price Budgeted sales revenue

Prepare a schedule of expected collections from customers.

Sweats Galore, Inc.
Schedule of Expected Collections from Customers For the Year Ending December31, 2013

Quarter 1234

Accounts receivable 1/1/13 -0- First quarter
Second quarter
Third quarter

Fourth quarter Total collections

Michael learned from talking with Jayne that the supplier is so focused on making quality sweatshirts that many times the shirts arc not available for severaldays.She encouraged Michael to maintain an ending inventory of shirts equal to 25% of the next quarter’s sales.

Prepare a shirt purchases budget for shirts using the format provided.

Sweats Galore, Inc.
Shirt PurchasesBudget
For the Year Ended December 31, 2013

Quarter
1 2 3 4 Year

Shirts tobe silk-screened Plus: Desired ending inventory Total shirts required
Less: Beginning inventory Total shirts needed
Cost per shirt
Total cost of shirt purchases

Prepare a schedule of expected payments for purchases.

Sweats Galore, Inc.
Schedule of Expected Payments for Purchases For the Year Ended December 31, 2013

Quarter1234

Accounts payable 1/1/13-0-First quarter
Second quarter
Third quarter

Fourth quarter Total payments

5.

6.

case6Cases for Management Decision-Making

.s.pSWEATSA.•4GALORE

CA-23

CA-24SWEATS GALORE

case6Cases for Management Decision-Making

7.

Prepare a silk-screen labor budget.

8.

Prepare a selling and administrative expenses budget for Sweats Galore, Inc. for the year ending December 31, 2013.

9.

Prepare a silk-screen overhead expenses budget for Sweats Galore, Inc. for the year ending December 31, 2013.

Units to be produced
Silk-screen labor hours per unit Total required silk-screen labor hours Silk-screen labor cost per hour
Total silk-screen labor cost

Variable expenses: Sales commissions

Total variable expenses Fixed expenses:

Advertising
Rent
Sales salaries
Office salaries
Depreciation
Property taxes and insurance

Total fixed expenses Total selling and

administrative expenses

Variable expenses: Ink

Maintenance Utilities Graphics design

Total variable expenses Fixed expenses:

Rent
Maintenance
Utilities
Graphics design
Property taxes and insurance Depreciation

Total fixed expenses
Total silk-screen overhead
Direct silk-screen hours
Overhead rate per silk-screen hour

Sweats Galore, Inc. Silk-Screen Labor Budget
For the Year Ended December 31, 2013

Sweats Galore, Inc.
Selling and Administrative Expenses Budget For the Year Ended December 31, 2013

Sweats Galore, Inc. Silk-Screen Overhead Expenses Budget For the Year Ended December 31, 2013

Quarter
1 2 3 4 Year

Quarter
1 2 3 4 Year

Quarter
1 2 3 4 Year

Sales
Cost of goods sold
Gross profit
Selling and administrative expenses Income from operations
Interest expense
Income before income taxes Income tax expense
Net income

Beginning cash balance Add: Receipts
Collections from customers Total available cash

Less: Disbursements
Payments for shirt purchases Silk-screen labor
Silk-screen overhead
Selling and administrative expenses Payment for equipment purchase Total disbursements
Excess (deficiency) of available cash over disbursements

Financing

Borrowings
Ending cash balance

case6Cases for Management Decision-Making

  1. Using the information found in the case and the previous budgets, prepare a budgeted income statement for Sweats Galore, Inc. for the year ended December 31, 2013.

Sweats Galore, Inc.
Budgeted Income Statement
For the Year Ended December 31, 2013

  1. Using the information found in the case and the previous budgets, prepare a cash budget for Sweats Galore, Inc. for the year ended December 31, 2013.

Sweats Galore, Inc.
Cash Budget
For the Year EndedDecember31, 2013

12.Using the information contained in the case and the previous budgets, prepare a bud- geted balance sheet for Sweats Galore, Inc. for the year ended December 31, 2013.

Cash
Accounts receivable
Sweatshirt inventory Equipment
Less: Accumulated depreciation Total assets

Sweats Galore, Inc. Budgeted Balance Sheet December 31, 2013

Assets

Quarter 1234

CA-26SWEATScase 6Cases for Management Decision-MakingGALORE

Liabilities andStockholders’ Equity

Accounts payable
Notes payable
Interest payable
Taxes payable
Total liabilities
Common stock
Retained earnings
Total stockholders equity
Total liabilities and stockholders’ equity

  1. (a) Using the information contained in the case and the previous budgets, calculate the estimated contribution margin per unit for 2013.(Hint:Silk-screened labor and the taxes are both fixed costs.)

(b) Calculate the total estimated fixed costs for 2013 (including interest and taxes). (c) Compute the break-even point in units and dollars for 2013.

  1. (a) Michael is very disappointed that the company did not have an income of $25,000 for its first year of budgeted operations as he had wanted. How many shirts would the company have had to sell in order to have had a profit of $25,000? (Ignore changes in income tax expense.)

(b) Why dots the company’s net income differ from its ending cash balance?

  1. Do you think it was a good idea to offer Cary Sue a salary plus10%of sales? Why or why not?

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