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Sweats Galore – The Business Situation

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    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 business that would generate a minimum net income of $25,000 annually. While reflecting on the criteria he had outlined, Michael, who had been president of his fraternity and served as an officer in several other student organizations, realized that there was no place in Campus Town to have custom sweatshirts made using a silk-screen process. When student organizations wanted sweatshirts to give to 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 envisioned owning such a shop. He realized that a sweatshirt shop in Campus Town had the potential to meet all four of his criteria. 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 purchase the equipment at the beginning of 2008, 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 equipment as of January 1, 2008.

    Cost
    Useful Life
    Hand-operated press that applies ink to the shirt
    $7,500
    5 yrs
    Light-exposure table
    $1,350
    10 yrs
    Dryer conveyer belt that makes ink dry on the shirts
    $2,500
    10 yrs
    Computer with graphics software and color printer
    $3,500
    4 yrs
    Display furniture
    $2,000
    10 yrs
    Used cash register
    $500
    5 yrs

    Michael has decided to use the sweatshirt supplier recommended by Jayne. He learned that a gross (144 units in 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 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 remaining 50% will be spent on clerical and administrative duties.

    Michael realizes that he will have difficulty finding a person skilled in computer 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 university 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 and 25% 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 administrator for his municipality, Michael estimates that the property taxes and insurance on the machinery will cost $2,240 annually; property tax and insurance on the display furniture and cash register will total $380 annually.

    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 approximately the same number of shirts Michael plans to sell in his store. Therefore, 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 rage of zero to 8,000 shirts.

    Shirts Printed
    Maintenance Costs
    Utility Costs
    January
    2,000
    $1,716
    $1,100
    February
    2,110
    1,720
    1,158
    March
    2,630
    1,740
    1,171
    April
    3,150
    1,740
    1,198
    May
    5,000
    1,758
    1,268
    June
    5,300
    1,818
    1,274
    July
    3,920
    1,825
    1,205
    August
    2,080
    1,780
    1,117
    September
    8,000
    1,914
    1,400
    October
    6,810
    1,860
    1,362
    November
    6,000
    1,855
    1,347
    December
    3,000
    1,749
    1,193

    Michael estimates the number of shirts to be sold in the first five quarters, beginning January 2008, to be:
    First quarter, year 18,000
    Second quarter, year 110,000
    Third quarter, year 120,000
    Fourth quarter, year 112,000
    First quarter, year 218,000

    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. 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 2008. 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 1, 2008.
    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 2009. Please use the following information when working the case.

    1. IMPORTANT: Sweats Galore makes custom silk screened shirts, which means
    all of their activities are budgeted based on expected sales.

    2. Time required per shirt for screening
    a. 6 people x 20 hours = 120 per week x 50 weeks = 6000 hours per year b. 6000 hrs / 50000 shirts = .12 hours per shirt

    3. For advertising expense – use 52 weeks

    4. Assume that no payments of interest or principal are made during the current year

    You will be graded on your knowledge, logic and organization, language, spelling, and grammar. The case grading rubric will be posted on Moodle for your review.

    Your completed packet should include:
    A. Cover page with Case Name, Your Name and Submission Date
    B. Memo to Michael Woods explaining your findings (see questions below) and recommendations. This memo should be no longer than 3 typed, double spaced, pages and should address the issues presented in a concise manner.

    1. Do you think it was important for Michael to stipulate his four criteria for the business, including the goal of generating a net income of at least $25,000 annually? Why or why not?

    2. If Michael has sales of $12,000 during January of his first year of business, determine the amount of variable and fixed costs associated with utilities and maintenance using the high-low method for each.

    3. Using the format below, prepare a sales budget for the year ending 2008. SWEATS GALORE
    Sales Budget
    For the Year Ending December 31, 2008

    Quarter
    1 2 3 4 Year Expected unit sales
    Unit selling price x Budgeted sales revenue $

    4. Prepare a schedule of expected collections from customers. SWEATS GALORE
    Schedule of Expected Collections from Customers
    For the Year Ending December 31, 2008

    Quarter
    1 2 3 4__ Accounts receivable 1/1/08 -0-
    First quarter
    Second quarter
    Third quarter
    Fourth quarter
    Total collections

    5. Michael learned from talking with Jayne that the supplier is so focused on making quality sweatshirts that many times the shirts are not available for several days. She encouraged Michael to maintain an ending inventory of shirts equal to 25% of the next quarter’s sales. The desired ending direct materials in Quarter 4 are 4,500 shirts. Prepare a shirt purchases budget for shirts using the format provided.

    SWEATS GALORE
    Shirt Purchases Budget
    For the Year Ending December 31, 2008
    Quarter
    1 2 3 4 Year Shirts to be silk-screened
    Direct materials per unit
    Total shirts needed for production
    Plus: Desired ending direct materials (shirts)
    Total shirts required
    Less: Beginning direct materials (shirts)
    Direct materials purchases
    Cost per shirt
    Total cost of shirt purchases

    6. Prepare a schedule of expected payments for purchases.
    SWEATS GALORE
    Schedule of Expected Payments for Purchases
    For the Year Ending December 31, 2008
    Quarter
    1 2 3 4__ Accounts payable 1/1/08 -0-
    First quarter
    Second quarter
    Third quarter
    Fourth quarter
    Total collections

    7. Prepare a silk-screen labor budget.
    SWEATS GALORE
    Silk-Screen Labor Budget
    For the Year Ending December 31, 2008
    Quarter
    1 2 3 4 Year 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

    8. Prepare a selling and administrative expenses budget for Sweats Galore for the year ending December 31, 2008. SWEATS GALORE
    Selling and Administrative Expenses Budget
    For the Year Ending December 31, 2008
    Quarter
    1 2 3 4 Year 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

    9. Prepare a silk-screen overhead expenses budget (use production budget) for Sweats Galore for the year ending December 31, 2008.

    SWEATS GALORE
    Silk-Screen Overhead Expenses Budget
    For the Year Ending December 31, 2008

    Quarter
    1 2 3 4 Year 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

    10. Using the information found in the case and the previous budgets, prepare a budgeted income statement for Sweats Galore for the year ended December 31, 2008.

    SWEATS GALORE
    Budgeted Income Statement
    For the Year Ending December 31, 2008
    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

    11. Using the information found in the case and the previous budgets, prepare a cash budget for Sweats Galore for the year ended December 31, 2008. SWEATS GALORE
    Cash Budget
    For the Year Ending December 31, 2008
    Quarter
    1 2 3 4__ Beginning cash balance $0
    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 (assume $20,000 loan approved in Q1)
    Ending cash balance

    12. Using the information contained in the case and the previous budgets, prepare a budgeted balance sheet for Sweats Galore for the year ended December 31, 2008. SWEATS GALORE
    Budgeted Balance Sheet
    December 31, 2008
    Assets Cash
    Accounts receivable
    Sweatshirt Inventory
    Equipment
    Less: Accumulated depreciation
    Total Assets
    Liabilities and Owner’s Equity
    Accounts payable
    Notes payable
    Interest payable
    Taxes payable
    Total liabilities
    Michael Woods, Capital
    Total liabilities and owner’s equity

    13. Do you think it was good idea to offer Cary Sue a salary plus 10% of sales? Why or why not?

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