Musical Instruments Business
A group of musicians have established a company selling medievalperiod musical instruments by mail order and appointed themselvescompany directors. The musicians have raised £750,000 of thecapital required themselves and borrowed a further £500,000 in theform of a long-term bank loan. In order to establish the business,they have undertaken the following transactions.
- Bought premises for £850,000 (paid by cheque).
- Bought furniture and fittings for £100,000 (paid bycheque).
- Bought (on credit) stock of instruments for resale for£300,000.
- Bought a motor van for £20,000 (paid by cheque).
The remaining £280,000 of the total initial funds provided isdeposited in the business’s bank account.
During the first year of trading, the following transactionsoccurred:
- instruments costing £1,400,000 were sold on credit terms for£2,000,000
- more instruments were purchased on credit terms for£1,500,000
- wages and other expenses of £300,000 were paid in cash
- cash totalling £1,250,000 was received from debtors
- cash totalling £1,400,000 was paid to creditors
- interest (paid cash) on the long-term loan was 10%.
At the end of the year, the directors decided to make aprovision for bad debts of 5% of the year end debtors’ figure.
Closing stock (valued at cost) was £400,000.
An allowance for depreciation is to be made as follows:
- buildings, 2% of cost = £17,000
- furniture and fittings, 10% of cost = £10,000
- motor van, 20% of cost = £4,000.
Task
Construct a cash flow statement and use the information providedby it. The purpose is to highlight the factors that determine anorganisation’s liquidity.
Refer to figures above for the Musical Instruments Business. Youwill need this information to prepare a cash flow statement for thebusiness.
During the first year of trading, the directors of MusicalInstruments Business have frequently experienced serious cashshortages – even though the enterprise has made a profit.
Advise them how to improve the business’s liquidity. To do this.use Table 2 to record your output. You will need, firstly, toprepare a cash flow statement for the business, for the first yearof trading, and use the information this provides to make yourrecommendations.
Not all of the different categories of cash flow given in thetext example – Terrestrial Trading Company – will appear in thefirst year of trading for Musical Instruments Business. Thetemplate below (Table 1) provides you with the structure andcontent of the cash flow statement: all you have to do is fill inthe numbers.
Table 1 Cash flow statement for Musical InstrumentsBusiness first year of trading
| £ |
Cash received from customers | - |
Cash paid to suppliers- | |
Cash expenses | — |
Cash flows from operations- | |
Bank interest paid | — |
Net cash flow- | |
Table 2 Advice on improving liquidity for MusicalInstruments Business
Problem identification- | |
Analysis (investigation)- | |
Conclusion to the analysis (results of the investigation)- | |
The solution, listed as a set of SMART recommendations- | |
Strengths and weaknesses of the recommendations- | |
The implications of the solution, if implemented- | |
This should illustrate that profit does not equal cash (theprofitability of an organisation does not automatically result inits liquidity). The cash flow statement you have prepared shouldindicate the main source of this organisation’s lack of liquidity.Such information should enable management to take appropriateremedial action, as well as enable other stakeholders (such as theproviders of funds) to form an opinion about the financialmanagement of the organisation. You may have noticed, in preparingthe cash flow statement, that the net cash outflow for the yearexceeded the business’s cash/bank balances at the beginning of theyear; how do you think it financed this deficit?
