Chapter 3- Activity 4 – Ropa Dulce Case Study

Rudsan G. Turqueza Business

Finance
Activity 4: Ropa Dulce Case Study
Ropa Dulce Company is currently the most talked about clothing shop in town. Not only was the shop
filled with customers every day, but they have been a major supplier of clothing to other shops. Ms.
PaÑo, the owner of the shop has remained confident that the operations will go smoothly until one
early morning when there had been problems with the delivery that was supposed to leave the shop.
The clothes which were scheduled to be delivered were already packed and waiting on the loading bay.
It was past 30 minutes of the scheduled delivery and no delivery truck was in sight. Ms. PaÑo decided to
call the delivery contractor to find out what was taking the trucks so long.

“You’ve been one month late from your scheduled payment for our delivery service,” the frustrated
delivery contractor said. “We’ve been sending you notice every day for the past week and your company
doesn’t seem to be responding. Unless you will be able to pay the amount due by this morning, we will
not send any truck to deliver your goods.

Ms. PaÑo was astounded to hear of the unpaid fee. To clear up the mishap, Ms. PaÑo hurriedly
approached the company’s accountant, Mr. Vestir in hopes of drawing cash from the company. Mr.
Vestir regrettably reported that the company does not have cash to pay the delivery contractor. In fact,
the company has been consistently borrowing short term funds for three months from the start of the
year. The company has yet to pay any of these borrowings and Mr. Vestir informed Ms. PaÑo that the
short term lenders have been reluctant to lend money at this point.

As a result, the shipments will not be delivered to the customers until the company figures out how to
pay their delinquency with the delivery contractors. The outside customers have understood enough to
acknowledge that there will be a delay on the deliveries for this day. However, too much delay may
frustrate these customers and may cause bad reputation to the company. Ms. PaÑo is looking into
taking a loan from Fresco Rural Bank to pay for the delinquent fees. The bank manager of Fresco Rural
Bank has requested a meeting with Ms. PaÑo to discuss the financial condition of Ropa Dulce Co. and
plans for restoring its liquidity.

Outraged, Ms. PaÑo told Mr. Vestir, “Why don’t we have any balance in our cash account? Our company
has been very profitable but we seem to be depending on loans to finance our operations. We need to
figure out what is going wrong. Otherwise, we may lose our customers.”

Company Background

Ropa Dulce Co. was founded in 2010 as a manufacturer of summer clothes. The first shop was located
near a calm beach with sky blue waters and powdery sands. Families and tourist would usually flock to
the beach on summer weekends which gave the clothing shop foot traffic and gained the market’s
attention. Due to its high quality products, the clothing store became a popular stop shop for vacation
goers. In 2011, a known blogger fancied the clothing line displayed in Ropa Dulce and published an
article promoting the shop. This earned the company nationwide publicity which led to other clothing
stores offering shelf space for Ropa Dulce’s brand. In 2013 it expanded its garment productions due to
the increasing demand of their products. To this day, the company maintained its position as summer
clothing store since this line has brought its brand equity.

Clothing Market

The demand for clothing was characterized by a stable year-to-year growth. Unit demand increased with
both population and individual income. However, the seasonal character of the company’s product has
resulted to cyclical sales. Competition among other clothing shops in the town is unlikely to clash with
the company’s sales growth. The company believes it will maintain its average growth rate for sales for
the succeeding years.

Sales Forecast

Ropa Dulce Co. had been consistently profitable. Moreover, sales had grown at an annual rate of 18
percent in 2019. Gross sales were projected to grow at 20% of the sales on the first quarter, 30% of sales
on the second quarter and 25% of sales on the third and 4th quarter. This growth rate is expected to be
constant until 2021.

Financial Information

To prepare a forecast on a business-as-usual basis, Ms. PaÑo and Mr. Vestir agreed on various
parameters. Cost of goods sold would run at 73.7% of gross sales—a figure that was up from recent
years because of increasing price competition. Operating expenses would be about 6% of sales —also up
from recent years to include the addition of a quality-control department and two new sales agents.
Depreciation is at 10% of cost of property, plant and equipment (PPE). Additions during 2020 are
expected to amount to ₱1,200,000 which will be paid on January 2021. The Company’s policy is to
expense full year’s depreciation on the date of purchase. The Company expects inventory level for 2020
to be the same as 2019.

The company’s income tax rate was 30% paid for each quarter in May, August, November, and April of
the following year, respectively. The company opts to use optional standard deduction of 40% from the
company’s gross profit to arrive at the taxable income for the quarter.

The delivery contractor’s fee (at 3% of sales) was collected at the loading gate as trucks left to make
deliveries to customers. Ms. PaÑo proposed to pay dividends of ₱450,000 per quarter. For years Ropa
Dulce had paid high dividends.

Mr. Vestir observed that sales collections in any given month had been running steadily at the rate of
40% of the last month’s sales plus 60% of the sales from the month before last. The value of raw
materials paid in any month represented on average 55% of the value of sales expected to be made two
months later. Wages and other expenses in a given month were equivalent to about 34% of purchases in
the previous month. As a matter of policy, Ms. PaÑo wanted to see a cash balance of no less than
₱640,000.

Ropa Dulce Co. had a line of credit from Fresco Rural Bank, where it also maintained its cash
balances. Fresco Rural Bank’s short-term interest rate was currently 16%. Return on investment for
short term investments is at 12%.
 Ropa Dulce Company Ropa Dulce Company
Monthly Sales 2019 Historical Income Statement
First Quarter 6,404,640 2018 2019
Second 11,237,050 Gross Sales 55,546,936 66,306,050
Quarter Cost of Goods Sold 38,327,385 46,398,029
Third Quarter 19,819,670 Gross profits 17,219,551 19,908,021
Fourth 30,260,390 Delivery Fees 1,666,408 1,989,182
Quarter Operating Expense 3,012,444 4,159,275
Depreciation 869,600 869,600
Operating Profit 11,671,099 12,889,965
Interest Expense 910,000 1,240,000
Pretax Profit 10,761,099 11,649,965
Income Tax 3,095,519 3,583,444
Net Profit 7,661,580 8,066,521
Ropa Dolce Co.
Balance Sheet
December 31, 2019
Cash 641,123.00 Accounts Payable 654,234.00
Accounts Receivable 3,379,958.00 Short-term Borrowings 587,575.00
Inventories 1,076,000.00 Payable to PPE Supplier 0
Short-term 0 Accrued Taxes 396,893.15
Investments
Total Current Assets 5,097,081.00 Total Current Liabilities 1,638,702.15
Gross PPE 8,696,000.00
Accumulated 1,278,500.00 Owner’s Equity 10,875,878.85
Depreciation
Net PPE 7,417,500.00

Total Assets 12,514,581.00 Total Liabilities and 12,514,581.00

Equity

Problem

Ms. PaÑo needs to prove that the company will be liquid enough to pay for its loans with Fresco Rural
 Bank so that it will be allowed to ask for another loan to meet the delivery contactor’s fee. How should
Ms. PaÑo explain to First Rural Bank that the company is in a good financial position? Moreover, should
the company prove to have financial liquidity problems, what can to company do to cope with their
need for cash?

Learner’s Guide

1. Assume that you are Ms. PaÑo and you will be presenting to the Fresh Rural Bank. Convince the
bank that you are in a good financial position evidenced by your cash budget and projected financial
statements.
2. Prepare a monthly cash budget for Ropa Dulce Co. for the year ending December 2020. Start with
the monthly sales forecast (Tip: Forecast sales up to Feb 2021).
3. The following table format may be used for the cash budget:

First Quarter Second Quarter Third Quarter Fourth Quarter

Cash Receipts from Collections 5,990,275 6,687,505 10,252,871 18,648,190
Less: Purchase of Raw Materials 14,005,605 21,636,179 25,784,811 22,512,134
Less: Payment for Salaries and 2,637,414 4,761,905 7,356,300 8,766,835
Wages
Less: Payment to Delivery 230,657 423,114 763,942 1,180,155
Contractors
Less: Dividends Paid 450,000 450,000 450,000 450,000
Less: Income Tax Paid - 1,321,900 1,685,735 1,685,735
Net Cash Flow - 11,333,313 - 21,905,594 - 25,787,918 - 15,946,670
Add: Beginning Cash 1,921,123 1,920,000 1,920,000 1,920,000
Less: Required Ending Balance - 1,920,000 - 1,920,000 - 1,920,000 - 1,920,000
Add: Return on Investment (12%) - - - -
Less: Interest on Borrowing (16%) - 76,021 - 228,131 - 523,247 - 874,062
Less: Repayment of Principal - - - - 1,735,195
Add: Liquidation of Investment - - - -
Excess Cash (Required Financing) - 11,408,211 - 22,133,725 - 26,311,165 - 18,555,928

First Quarter Second Quarter Third Quarter Fourth Quarter

Loan Balance - Beginning - 5,701,571 - 17,109,782 - 39,243,506 - 65,554,671
 Add: Required Financing - 11,408,211 - 22,133,725 - 26,311,165 - 18,555,928
Less: Repayments 1,735,195
Loan Balance - End - 17,109,782 - 39,243,506 - 65,554,671 - 82,375,403

Investment Balance - Beginning - - - -

Add: Excess Cash - - - -
Less: Liquidations - - - -
Investment Balance – End - - - -

4. Forecast Financial Statements - Income Statement.

Gross Sales Total of monthly forecasted sales
Cost of goods 73.7% of Sales
Gross profit
Delivery Fees 3% of sales
Operating expenses 6% of sales
Depreciation 10% of Total PPE cost
Interest expense Total of Interest from borrowings and ROI from cash budget
Pretax profit
Income tax Gross profit x (1 – 40%) x 30%
Net profit
Ropa Dulce Company
Projected Income Statements for the year 2020
Gross Sales 84,075,350
Cost of goods 61,963,533
Gross profit 22,111,817
Delivery Fees 2,522,261
Operating Expense 5,044,521
Depreciation 989,600
Interest Expense 1,485,865
Pretax profit 12,069,571
Income Tax 3,980,127
Net Profit 8,089,443

5. Forecast Financial Statements – Balance Sheet

Cash Required cash balance
 Accounts receivable Accounts receivable beginning + Sales - Collections from Customers
Inventories Same as last year
Short term investments Resulting balance from cash budget
Total current assets
Gross PPE Beginning balance + current year additions
Accumulated depreciation Beginning balance + depreciation expense
Net PPE
Total Assets
Accounts payable Accounts payable 2019 + Purchases* + Operating Expense –
Cash payment for raw materials - Cash Payment for Salaries and Wages
*Purchases = Cost of goods sold + Inventory 2020 – Inventory 2019
Short term borrowings resulting balance from cash budget
Payable to PPE supplier Additions to PPE payable on January 2020
Accrued taxes Tax payable for the last quarter
Total current liabilities

Owners’ equity Owners’ Equity 2019 + Net Income – Dividends paid

Total liabilities and equity
Ropa Dulce Company
Projected Balance Statements for the year 2020
Format of Paper/Presentation
Prepare a Assets - paper containing the
following: Current Assets -
1. Letter Cash ₱ 640,000 to Fresh Rural Bank
Accounts Receivable ₱ 4,224,948 explaining that the
Inventories ₱ 1,076,000 company is in a healthy
Short-term Investments ₱ 9,495,393 financial position and has
Total Current Assets capacity to pay loans
when Non-Current Assets ₱ 15,436,341 they come due.
2. Cash Gross Property, Plant and Equipment ₱ 9,896,000 Budget for 2020 in good
form. Accumulated Depreciation ₱ 2,268,100
3. Net PPE ₱ 7,627,900 Projected Financial
Total Assets ₱ 23,064,241 Statements for 2020 in
good form.
4. Liabilities and Owners Equity Supporting computations.
Liabilities
Paper Accounts Payable ₱ 5,189,351 outline
• Case Payable to PPE Supplier ₱ 1,200,000 Background: Brief
Accrued Taxes ₱ 434,575 explanation of the
Total Current Liabilities problem of the Company.
• Equity ₱ 6,823,926 Methodology: Explain why
the Owners' Equity ₱ 16,240,315 cash budget and
Total Liabilities and Equity ₱ 23,064,241 projected financial
statements was made in order to help the company in their dilemma.
• Budgets and Projections: Present the resulting budgets and implications of the figures that were
derived. Explain in class how you were able to derive your figures.
Conclusion: Was the company performing well based on the budgets and projections and will it be
able to sustain its operations?