FINANCIAL PLANNING: AN EXERCISE

Bradford Co. forecasts the following financial position and performance for the next fiscal period
(2022):

Balance Sheet as of December 31 (€/000)

2022* 2021 2022* 2021
Non current intangible assets 800 800 Contributed capital 5,000 5,000
Non current tangible assets 7,000 8,000 Retained earnings 3,600 3,700
Financial investments 0 500 Net income -510 100

Inventory 12,000 13,000 Loans payable 11,000 10,000

Accts. Receivable 9,000 6,000
Other receivables 500 750 Accts. Payable 2,060 2,200
Bank and cash 200 550 Short term borrowings 6,000 5,000
Other payables 2,350 3,600
TOTAL 29,500 29,600 TOTAL 29,500 29,600
*Budgeted

2022 Income statement (forecast)

Revenues from sale 18,200
Cost of goods sold -7,800
Gross margin from sales 10,400
Service expenses -3,600
Cost of labor -4,700
Depreciation -1,450
Operating income 650
- Interest expenses -960
Earnings before tax -310
- Income tax -200
Net income -510

According to the plan, in 2022 the operating income is not going to cover interest expenses: thus,
the CFO (chief financial officer) decides to start a program for the improvement of the cash flow.
The program consists of the following improvements:

a) the inventory has to be reduced: the CFO wants to achieve a stock turnover ratio
(sales/inventory) equal to 3;
b) reducing the cash collection period from clients to only 3 months (receivables = ¼ sales
revenues); this would produce, according to the sales manager, a decrease in budgeted sales
by 200, while the cost of goods sold would decrease by 100;
c) increasing the average settlement period to creditors up to 4 months (accounts payable =1/3
of cost of goods sold and service expenses).
Answer the following questions:

1) What is the effect of the proposed improvements on the operating cash flow? Compare the
operating cash flow in the original budget with the operating cash flow resulting from the
new program.

2) What is the effect of this program on the interest expenses, considering that the company
pays a 6% interest on its average balance of loans and borrowings?