Analysis Statement of Cashflows

Fountain of Youth – Mock Report

Analysis: Statement of Cashflows

Net Income is a source of cash; after adding depreciation. Lender’s would normally prefer to see more cash from net income. For a new business these are acceptable figures. An examination of growth patterns and profitability is necessary to predict how this business will develop.

Operating income is a use of cash for their second year of business which although not ideal is commonplace for new businesses. THE operations changing to selling on account commercially has tied up a lot of cash in A/R. This is necessary to generate larger sales with larger clients. I don’t predict A/R to be such a large consumption of cash next year wish will improve cashflow.

Hannah is using long term bank loans and past cash reserves to fund the purchase of new assets to grow to meet the new commercial customers. Debt levels need to be examined, however long term debts are paired with long term assets and is an appropriate financing decision. It will be important to confirm Hannah is getting a good return on her asset acquisitions, however seeing someone transfer cash reserves to an active investment is a positive sign for their business.

Hannah has large amount of cash on hand to spend as the company grows. This decreased the chance of a cashflow issue making her more secure to lend to.

Analysis: Ratios

Profitability – Their COGS expense is stable and likely to continue being 27 – 31% unless changes to the recipe are made, meaning reliable profits. The large Gross profit margin gives more contribution towards operating costs and interest making them more attractive to lenders.

Most of the costs for this business are fixed meaning that more sales will allow for strong scaling towards profitability. In her first year she did not have the sales to cover these costs but now is beginning to reach scale. The growth potential of profit is very attractive to lenders.

Hannah has ROE for the first time because she achieved positive net income. Though the returns are modest they are a sign of things for a young firm. These improvements are attractive because it indicates future cashflow from profit to put towards loan payments and interest.

Overall this business has positive trends of profit based on reliable underlying reasons, so they will like have strong profitability and be very capable of making payments regarding their debts.

Efficiency – Hannah’s inexperience as a manager is showing as she carries large volumes of inventory and allows accounts with customers to remain uncollected for extended times. The massive flux in inventory is a bit concern as variability increases risk to lenders, but the trend has been positive demonstrating she’s learning. With a planned expansion, which would grow her sales exponentially, the risk of these accounts fluctuating will remain, decreasing the attractiveness to a lender. Overall, her efficiency is improving but may still fluctuate, a lender might consider putting some constraints in regarding inventory levels or collections.

Liquidity – Hannah is vastly liquid and an extremely low risk of insolvency, drastically improving her appeal to lenders. However, current ratios of 5:1-ish indicated probably too much liquid assets. Hannah is asking for a loan however if the lowered her working accounts like inventory she would likely have much of the cash she needs. As a lender I know she will not be in a cash desperate position any time soon making her very attractive to lend to.

Stability – Hannah’s stability has steadily been declining as she brings on more debt to finance her first expansion. However, she still has a strong equity in the business as of 2016 with the majority of assets still funded through equity. Though there is room for debt given equity levels, a lack of profits to this point shows a potential to struggle making interest payments as show in the interest coverage being below 1x. Lenders will not want to lend to anyone who cannot make interest payments. The profitability analysis predicts that this will change, however a proven track record would be much safer. Overall, she has room for debt in terms of debt to equity balance, but it might be early in her business’ development to take on such large interest payments. As a lender I would still consider her but realise the risk is increased.

Growth – stems offering A/R to commercial clients. Her sales trend is slowing but still strong. The major leap in 2015 is likely to occur from a major change like expansion. Profits have been impressively out growing sales in 2016, this was anticipated as the profitability ratios showed strong growth potential. The asset growths seem aggressive compared to sales or profits and this trend is not sustainable but maybe reflective of the early years requiring larger investments.

Analysis: Projected statements

Next year they are very successful making between $400k – $800k, see exhibit 1. These new profit levels easily justify the cost of borrowing and I would support a loan based on this.

The plug indicates a need of between 500k – $1 million from a line of credit with a limit of $75k. This is after the application of the $500k loan and deeply concerning. Hannah would need to borrow double to triple the original loan amount to have enough cash. This is primarily driven by work capital accounts. As sales take a massive leap so does A/R an inventory which causes a larger need for cash than for new equipment. Hannah’s in experience has her believing the only cost to expand is equipment and not operating accounts. Given her record of slow collection and poor inventory management on larger scale this will be hundreds of thousands of dollars.

A sensitivity analysis in exhibit two further demonstrates if Hannah allows her collections to slip by less than 10 days, she will need $100k to cover slow collections. This makes the account very volatile and increases my risk as lender. However, if she can collect in a more standard amount of time like 90 days, the plug will be within her line of credit. This reveals how important inventory and account receivable management will be to Hannah. As a lender I would want to attach a constraint requiring her to collect more promptly.

3 C’s of Credit

The beauty industry is a multi billion dollar market with major dominant players. Hannah will struggle to compete against so many other competitors. The key focus of the industry will be on brand building because of this. Without the same resources as the major firms she will likely be an unknown name and struggle to get shelf space or consumers mind space. However, niche product that are local often feel safer and businesses like this may not be industry leaders but can provide reasonable incomes to local people.

Hannah’s formula is passed down for generations and trustworthy due to its nature which makes them appealing to lend to. However, without much formal business training she will continue to make questionable decisions and have less reliability in key things like efficiency ratios. Given the impact that sensitivity reveals about these accounts her lack of expertise is worry some.

The table in exhibit 3 reveals that in all scenarios the risk of running low on cash and risking insolvency are extremely low. This table gives me confidence that cash constraints will not disrupt them which makes it more attractive to lend to them as I face less risk. The interest coverage re-affirms that this idea is profitable and can easily afford the cost of borrowing making them a strong loan candidate. The similarity in result between high and low confirms to a lender these will be the outcome regardless of a high or low sales volume.


As a lender I would approve a $500k loan with the condition that new contract stipulates payment within 30 days and that delinquent accounts are identified within 60 days. The primary reason I’m granting the loan is for the growth potential. The drawbacks are a temporary natural learning curve. Finally, the guaranteed sales from the contract and expansion are comforting.

Predicted growth – The vertical analysis revealed that the majority of the costs were fixed and this business would see profit grow faster with each new sale. This contract leaps them forward to a whole new sales level. The projected statement confirms this as every new scenario will makes hundreds of thousands of dollars. Concerns about affording interest in the past are unwarranted. This growth will make the loan extremely low risk.

Learning curve – Hannah is learning as a manager. Her inventory numbers start with way too much inventory but quickly learns makes this a priority. She has learned the importance of controlling working capital accounts. By setting conditions in on collection this will guide her even further. Her business has not faced a cash constraint so I don’t believe she collecting A/R was a priority because her healthy cash reserve shielded her from the impact of delayed collection. Natural improvement and guidance makes any concerns easily mitigated.

Guaranteed sales– Most business loans are about buying assets in hopes that sales follow. However, sales almost guaranteed. The low and high are both amazing scenarios.

Overall, I feel a loan with conditions collections is the correct decision. Working with a client on account collection is much easier than working on a lack of sales.

Exhibit 1 : Projected : Statement of Earnings
in (000s) of Dollars
For year ending Dec 31 Assumptions
High Low
Traditional (16’Sales*30%) *1.10 72.6 72.6
Vision of Perfection Given 4000 2500
B/I $37 $37
Purchases COGAFS – B/I $1,991 $1,244
COGAFS COGS – E/I 2028.1852 1281.17
E/I 100 days given = (COGS/365)* 100dayys 436.16887 275.521
COGS (Assumed percent + 10%) 1592.0164 1005.65
Gross Profit   2480.5836 1566.95
Operating Expenses
Website Admin Same $ $20 $20
Rent $1 per sq ft (14000+26000 feet) 40 40
General and Admin given 8% 325.808 205.808
Old Depreciation same $ $64 $64
New Depreciation 500,000 / 10 years 50 50
Jessica’s Salary 48 48 48
Vision’s fee 20% 800 500
Total operating expenses   $1,348 $928
Interest Expense same $ + new (500,000*.08) 48 48
Net Profit before tax $1,085 $591
Tax   same tax % $271.19 $147.78
Net Profit after tax   $813.58 $443.35

Projected Statement of Financial position

As at Dec 31st 2017

In (000s) of Dollars

Assumption High Low
Current assets:
Cash same $ $58 $58
Accounts Receivable Pattern , 165 days = (sales/365)*165 days $1,841 $1,163
Prepaid Expenses same $ $2 $2
Inventory PSOE $436 $276
total current assets: $2,337 $1,498
Long Lived Assets:
Computers same $ $55 $55
Fixtures same $ $200 $125
New Computers same $ $45
Net long lived assets old net – new depreciation $72 $72
New Assets given $500 $500
new A/D new assets $500 cost /10 useful life $50 $50
net $450 $450
total net long lived assets $522 $522
Total Assets   $2,859 $2,020
Assumptions High Low
Current Liabilities:
Working Capital Loan Plug $906 $574
Accounts Payable 30 days given $164 $102
Other Payables same $ $19 $19
Vision Payable 90 days 200 125
Current portion 500/20yrs 25 25
Wages Payable 48k/12 4 4
Total current liabilities $412 $275
Old bank loan same $ $112 $112
New Loan 500-25-25 $450 $450
Common stock $190 $190
Retained Earnings No dividends $790 $419
Total Equity & Liabilities $2,859 $2,020

Exhibit 2: A/R Sensitivity

In (000s) of Dollars

# of Days A/R Account amount Days * ( Sales / 365) Change from Base Absolute : (Original – New) New Plug
165 $1,841 $0 $906
174 $1,941 $100 $1,006
90 $1,004 $837 $69

Exhibit 3

Capacity to repay

Ratio High Low
Current ratio 5.67:1 5.44:1
Acid Test 4.61:1 4.44:1
Interest coverage 23.6x 13.3x
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