Things for a Bank to Consider Before Lending Money to a Business - Essay Example

? A Case Study on Perry Rose Plc and A Case Study on Perry Rose Plc Introduction This is a case study of the Perry Rose Plc that is located in Bromsgrove Surrey. This report will involve answering of all the three studies that have been presented in the case study. Question One Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 ?000 ?000 ?000 ?000 ?000 ?000 Plant and Equipment Sales revenue (600) 450 470 470 470 0 470 Less Costs   Materials – 126 132 132 132 132   Labour – 90 94 94 94 94   Overheads – 30 30 30 30 30   Depreciation – 120 120 120 120 120 Working capital (180) – – – – – Interest on working capital – 27 27 27 27 27 Write-off of development costs – 30 30 30 – Total costs (780) 423 433 433 403 403 Operating profit/(loss) Add: Depreciation Net cash flows (780) 27 120 147 37 120 157 37 120 157 67 120 187 67 120 187 Note: The assistant did not include the initial cost of the new equipment in the year zero which amounted to 600,000 sterling pounds, adding this amount to the working capital of 180,000 pounds amounts to an initial cost of 780,000 pounds. The overheads have been adjusted from the previous 47,000 pounds to 30,000 pounds in a year. Question One b i) Pay back Year Cash flow ? (?000) Cum. CF ? (?000) 0 (600) (600) 1 147,000 (453) 2 157,000 (296) 3 157,000 (139) 4 187,000 48 5 187,000 23 3 years and (139/ 187) x 12 3 years and 8.9 months ii) Net Present Value Year Cash flow ? DF 12% PV ? 0 -600,000 1.000 -600,000 1 147,000 0.893 131,271 2 157,000 0.797 125,129 3 157,000 0.712 111,784 4 187,000 0.636 118,932 5 187,000 0.567 106,029 The net present value is -6,855 pounds. Question One C Using NPV to make decisions regarding the investment of a project is advantageous in that the NPV takes into consideration the time value of money and gives priority to the risks that will be involved as well as the profitability of the project. A negative NPV implies zero returns therefore I would advice the managers to reject the project. Question Two Whenever a bank is granting or making a loan facility to a client, a number of factors are considered by the authorizing persons. These are the factors that do determine whether the client is eligible to receive the loan or not. Factors sometimes do vary depending on whether the client is a person or a business. The bank looks at the credit history of the borrower. The history of the client’s credit situation is based on the score or the rating that is mostly done by agencies, for instance, Transition. The credit score that a client is awarded determines the eligibility to receive the loan facility. The bank acquires the commercial credit report from an agency on the company’s credit history. The reports normally comprise of the payment history information, past credit scores and information on the public filings done (Crawford 2013). Existence or occurrence of negative information from the report for instance late payments or tax liens outstanding degrades the company credit score. The most obvious response from thee bank is seeking an explanation from the company regarding the occurrence. The advice given to the company is to review a copy of the report, after requesting it from the agency responsible. This gives the company the opportunity to correct any discrepancies that exist. The business credit reports are bases on the tax allegiance (Crawford 2013). The bank also looks at the financial position of the company. The bank normally request to be provided with the latest statements that justify the working capital. Working capital ranges from the current assets to first hand cash to the availability of finances to pay the current debts without affecting the normal running of a business. Working capital defines what is left after deducting all the current liabilities. When the working capital is inadequate, the Implication of the assumptions to be made is that the firm or business is facing the risk of collapsing. The consequence of this is facing a rejection on the application. The financiers will be reluctant to give such a business loans (Crawford 2013). For the sake of comparison, the bank also requests for the statement from the previous years and interim or projected statements for adjacent months. Some of this statement s includes the statement of the financial position that shows the assets, liabilities and the equity for the period and the statement of income that shows the profitability of the firm. The statement of cash flows depicts the inflows and the outflows of cash for a given time period. The foundation of the firm is depicted or exposed in the financial statements (Crawford 2013). The statements reveal the strengths and the weakness of the company with reference to the financial position. The information allows the bank to determine how swiftly the company can service a loan. If the company for instance has been generating profits consistently for a given period of time, the response from the lender will mostly be positive. Incase the business has being lying on the break even point or making losses, the best way to get approval of loan from the lenders is through detailing information about the new opportunities that are available or the new contracts in waiting (Crawford 2013). The bank also pays keen interest on the available collateral or security for securing the loan. The collateral is a contingency plan by the lender incase the borrow falls short of paying the debt. The bank is given the opportunity or the chance to choose what they will find fit to be collateral. The company for instance may pledge the equipment if the loan is for securing one or any other asset requested by the bank. Collateral in a way is a proof of the ability of the borrower to pay the debt. The banks may probably demand for guarantees from the management. This involves engaging the owners of the company in filling forms that reflect the e financials of their persona as well as the companies’ positions. The bank reviews the statements and decides whether to approve the loan facility. If so, each owner of the company is faced with the obligation of executing his or her own guarantee. This acts as a collateral in that the guarantees from the owners acts as an assurance to the bank that they will be part of the company, at least until the loan is cleared (Crawford 2013). The bank relationship with the clients gives the client the credit to apply for the loan. The loan committees that give the final verdict on the approval process are mostly impressed by a client who has been banking with them for some time either through depositing money or investor in the bank. The bank also uses the relationship the client has had with thee bank to determine the character of the client. The experience of the client could also be depicted in the number of years the client has banked with the bank. Banks also do require the business loan applicants to have an adequate amount of equity used in the expansion of the business. If much of the capital is invested in equity, lenders are confident that the owner or at least shareholder will work hard to ensure the business will be a success. The credit period is a major factor also considered. The interests of the banks are to lend but retrieve the money within a short period to enable them to lend to other clients. The referees that introduce the clients also matter in informing the bank about the borrower. They also act as security incase the borrower is unable to pay the loan (Crawford 2013). Question 2b In my own opinion, the can offer the company an overdraft based on the historical relationship the bank has cultivated with the company. The loan that the company has taken has been secured by personal guarantees from the directors. This is one of the factors or requirement that a bank puts forth to instill confidence of repayment. The guaranteed from the directors imply their continuous existence in the company. This depicts that the company is in good management, hence credible for an overdraft. Examining the financial statements of the company shows that the company is making a profit and has inventory valued at 198,000 dollars. This profitability assures the bank of the ability to pay. Profitability ratios Return on assets ratio: Net Income/Total Assets = 23,000/275,000= 8.4% Net profit margin: Net Income/Net Sales=23,000/740,000= 3.1% Return on Equity: Net Income/Stockholder's Equity =23,000/41,000= 56.1% Liquidity ratios Current ratio= current assets/current liabilities= 201,000/194,000= 1.04 Acid test ratio= (current assets –stocks) / current liabilities =275000-198000=3000/194000= 1.55% Gearing ratios Debt to equity= total debt /total shareholder’s equity=40,000/41000= 97.6% Question Three For there to be an adequate working capital, the manager has to take considerations of the following ratios that help in managing inventory through monitoring and measuring the levels. Inventory turnover measures how fast a company sells the inventory and replaces it in a year or quarter as specified. It measure by dividing the cost of goods or the sales by the average inventory. Average inventory is acquired by summing the inventory value at the beginning and the end of a period and dividing the result by two. The cost of goods is obtained or captured from the statement of income while the inventory levels are obtained from the statement of financial position. To find the average number of days the inventory stays in the stock, the number of days in a year (365) are divided by the turnover ratio. Inventory turnover=cost of goods sold/ average inventory Average days in inventory=365 / Inventory Turnover Ratio Last year: The cost of goods sold is ?1800 while the average inventory is ? (250+200)/2=?225 The inventory turnover is 8 This year= 1920/225 = 8.5 The accounts receivable ratios depict how steady the receivables are collected. It relates to the management of the accounts receivables. There are two common account receivable ratios that are in practice, the accounts receivable turnover and the number in days the receivables take to be recovered (Average collection period or the Days Sales Outstanding) Accounts Receivable Turnover =Net receivable or Credit Sales / Average Receivable Balance. Last year = 375 / 427.5 = 0.9 This year= 480 / 427.5 = 1.1 Number of Days in Receivables = 365 Days in the Year / Turnover Ratio Question Three b There are four methods through which the management can control the inventory. One of the methods is through the use of the min-max system. This involves making a category of the inventory based on the inventory needs after carefully examining them. The system entails setting two lines, one on the top and the other on the bottom indicating the amount of product to keep on hand. Once the inventory reaches the bottom line, a reorder is done with much keenness to ensure ordering is not done above the top line. This method however could lead to ordering of too many or running out before the ordered inventory arrives (Lockard 2010). The second method is the use of the two-bin system where the second bin is a back up bin. Once the inventory has run out and reorder done, the backup inventory is used until the new products arrive. The third method is use of the ABC analysis. This entails categorizing the inventory into three groups, A, B and C. The expensive products go to group A, the less expensive products are placed in group B and the small and inexpensive ones are placed in category C. It is much easier to monitor the inventory this way. The last method is through the Order-cycling system. This involves checking on the inventory in set intervals, for instance in a month (Lockard 2010). The trade receivables are controlled through analyzing the customers to ensure they are potential credit worth customers. This helps in determining thee impact of selling products on credit. Trade receivables can be controlled through detailing the customer records and using the receivable aging schedule. These records are known as the accounts receivables subsidiary ledger. These help in collecting the cash and examining the clients interested in making reorders. The accounts receivable ratios can also be used to manage the transactions (Lockard 2010). The records reveal the five Cs that are used to analyze the credit worthiness. They include character, capacity, capital, collateral and conditions. Character involves analyzing the reputation of the borrower. This involves looking at his or her borrowing history and whether he pays the previous creditors. Capacity analyzes the ability of the borrowers to pay the loan in the stipulated time. This involves comparing the income of the borrower against the debts (Peavler 2013). Capital involves analyzing the investment of the borrower. This is a keen evaluation of the amount of capital the borrower is putting into an investment. A large contribution to the investment implies a reduced chance of defaulting. Collateral refers to the security that a borrower provides for the loan being borrowed. Property or assets with very high valuation increase the chances of being financed. Finally the conditions of the loan are a key factor o the lender. The lender looks at the gains to receive in lending the loan while taking into consideration the principal amount being lent. High interest rates influence the lender to lend the money (Peavler 2013). Conclusion As depicted in the analysis above, the Perry Rose Plc has a better basis for making decisions regarding the projects they are intending to invest in. This report has analyzed some of the important key issues facing the company and other companies too. The report has examined some of the factors considered when getting approval of a loan, as examined by banks. The report has also checked on some of the ways of controlling the inventory and accounts receivables. Bibliography Angelico A. Groppelli and Ehsan Nikbakht 2006. Finance. Barrons Education Series Inc.: New York. Accounts Receivable Turnover 2013. Retrieved from http://www.accounting- information.net/accounting_information/financial_ratios/account_receivable_turnover.sht ml Atrill, P. & McLaney E. 2011. Accounting and Finance for non-specialists. Harlow Financial Times Prentice Hall: London. Big Shoe 2007. Some Factors Bank Managers Consider before Granting Loans. Retrieved from http://fynance.blogspot.com/2007/06/some-factors-bank-managers-consider.html Charles Crawford 2013. Things for a Bank to Consider Before Lending Money to a Business. Retrieved from http://smallbusiness.chron.com/things-bank-consider-before-lending- money-business-57341.html Colin Lewis 2007. Demand Forecasting and Inventory Control. Woodhead publishing ltd: England. CI Staff 2012. Inventory Turnover. 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