Bank Lending - Lettera Pty Ltd - Essay Example

CASE STUDY: LETTERA (PTY) LTD I. BACKGROUND As a business banker of XYZ Bank involved with business1 applications, having reviewed all of the information presented to me I cannot, in good conscience, recommend Lettera Pty Ltd for a loan.2 In my expert opinion, after having compiled information for the regional credit department of XYZ bank for Lettera Pty Ltd—in order to purchase a building of $400,000 close to the existing premises that the company3 is operating from at present—I am of the mind where I do not recommend this company to receive the loan. Although Lettera Pty Ltd intends to relocate to the new building--which would save the company an amount of more than $9,000 per month on the rental of premises where they operate from at present—at this time it is not recommended that Lettera Pty Ltd be allowed to have a loan. If the company is afforded a loan, it should be loaned the money with special restrictions. The business for which the loan is being applied is a family printing business. Old Mr Lewis is the director, and he is assisted by the two co-directors of his sons. This business was started five years ago by Mr Lewis, after having a twenty-year stint as a technical supervisor at a competitor printing company. That being said, his technical4 knowledge with regard to printing is superior. He emphasizes quality, and as such all of the machines used by Lettera must be imported from Germany as per Mr Lewis’s predilection. To quote Mr Lewis: “The locally manufactured machinery always breaks. Only two of my machines broke during the past five years, and although I had to order the spare parts from Germany I received it in both instances within three weeks. I also order the printing ink that we use directly from Germany as I do not believe that the locally manufactured ink is good enough to ensure high quality printing. I am also going to replace all the existing printing machines with the latest German developed machines during next year when the existing machines will have been paid for in full. This will enable us to improve the quality of our printing even further.” Both of Mr Lewis’s sons became involved with the business’s management5 straightaway after they finished with school. It is Mr Lewis’s hope that the company be inherited by hs sons. The older son was involved with the business since its inception whilst his second son has been involved for the past two years. Actual printing activities are not the business of either of the sons. Rather, they deal with the financial management and general administration ends of the business. In addition, they also take care of marketing6 of Lettera’s services. This division of responsibility does well according to Mr Lewis: “I have worked with printing machines my whole life and enjoys it. I hate paper work. My sons, however, know nothing about machines. As a result we form a good team by not infringing on each others areas of responsibility.” The business provides printing for: wedding cards; visitors’ cards; letterheads; invoice books and other accounting books and forms; calendars; pamphlets; yearbooks; brochures; and newsletters. II. FINANCIAL POSITION OF CLIENT According to balance sheets, the business did not do remarkably well in the past, however the company’s position did improve quite a bit within the past year. This can be attributed to the fact that Lettera is the only printing business in the neighborhood where it does business. This is because a major print franchise which was located nearby closed down. Mr Lewis sees the local business as the principal source of business for Lettera’s services. This is seeing as how Lettera has gotten very few requests for the printing of certain items since the inception of the company five years ago. Mr Lewis thinks that the local businesses would do well to have more business done at his company, and believes that this could be a possibility for the future. He made a point of mentioning this in his estimation that only 15% of the businesses in his neighborhood have printing done at his company. Mr Lewis attributes this fact due to the sly way in which the people representing other printers in different areas lure businesses with low prices for printing, saying, “They should - like ourselves - concentrate on the community in which they are located and leave the markets of other printers alone.” Lettera, in order to stay competitive, would have to cut its prices. The Lewises are open to the fact that they might have to do this but they have not been getting the desired reactions from the ads being placed in the newspaper. III. FINANCIAL NEEDS OF CLIENT Mr Lewis has requested that the existing overdraft facility of Lettera Pty Ltd be increased from $60,000 to $140,000 to enable them to put down a deposit of $60,000 on the building and pay the transfer fees of $20,000. This would mean he would have an overdraft facility of $80,000. The total loan consisting of the additional overdraft facility and the loan on the building would amount to $400,000. Mr Lewis has indicated that he wishes the property loan to be only $320,000. The overdraft would ideally be repaid quite quickly from the cash flow in the next twelve months. In addition to all the aspects that have already been included in the loan proposal here, the budget information provided by Lettera was used to determine the repayment ability of the company by drawing up a cash flow budget on a spreadsheet. All cash flow items were included, including the loan repayments, in the cash flow section. For all practical purposes, the expenditure that the mortgage and overdraft would have on the cash flow were included, utilizing the following information: Overdraft interest rate 13% for existing and new overdraft Repayment period of mortgage loan - monthly over 25 years Mortgage loan interest rate – 8% per annum compounded monthly If transaction is approved, the additional overdraft facility will be utilized in May 200X and first mortgage payment will have to be made in May 200X. IV. COLLATERAL Basically, Lettera has no collateral. After analyzing the cash flow forecast for Lettera (PTY) Ltd, it is obvious that the company is in debt by at least $150K every month and cannot make its overhead, according to the calculations. Not only this, but besides that fact, it is rumoured that a large competitor is going to be opening a store in the same neigbhorhood as Lettera. This chain is a well-established company with major branches throughout the country. Obviously, this poses a large problem for Lettera because much of their business will be drained. In a recent article regarding the printing industry which was printed in the “Finance Week” the following was said: a) The demand for printing services and products will on average increase with fifteen percent per year during the next five years. b) Profit margins will be small and effective cost management will be imperative for success due to the high fixed cost structure of the industry. The key words are that profit margins will be small. As a smaller business, Lettera is already fighting a losing battle in this business sector in the printing industry. IV. DESIRABILITY According to the bank account information on file for Lettera, Lettera has banked for five years with XYZ Bank. The secured loan/s in the balance sheet of Lettera as well as the existing overdraft facility is with XYZ Bank. The loan/s have been paid back satisfactorily. Lettera has, however, sometimes exceeded the approved overdraft facility of $60,000. The reason that Mr Lewis provided for the excesses were that delays in the payments by Lettera’s debtors resulted in a shortage of cash flow when stock had to be purchased or expenses had to be paid. The maximum excess on the facility amounted to $20,000. Mr Lewis, however, indicates that the delayed payments by debtors have now been resolved and that Lettera will not experience such problems again in future. This is not a credible statement and Lettera (Pty) Ltd should not be allowed to have this loan. According to bank statements the turnover on the cheque account of Lettera was $3,250,000 during the past twelve months. VI. PROFITABILITY OF TRANSACTION This transaction would be primarily profitable for the business owner, but not necessarily the wisest decision. This is based on the fact that this business owner, Mr Lewis, seems to be rather in debt every month. This is according to the calculations performed on the spreadsheet. Mr Lewis simply does not have the collateral to justify being given a loan. To this end, Mr Lewis’s company is in a somber state of affairs. He can choose to either stay in business at the risk of continuing to incur monthly losses, or perhaps chuck the company in favor of starting over doing something else or becoming employed with a printing company where he could work for someone else. It is not recommended that Mr Lewis stay in business, seeing as how many of his assets are eaten up by liabilities. This does not bode well for Lettera (Pty) Ltd as a company. His balance worksheet shows the cash flow into the company is not sufficient to relegate more money to his cash flow since the cash flow out of the company is not comparable but rather supercedes the amount of cash he is receiving. This transaction would not be profitable for the bank; thus, the loan is denied. REFERENCES Dictionary.Com Web Site. [Online Dictionary Entry]. Retrieved 11 Oct 2009. http://dictionary.reference.com/browse/business. Dictionary.Com Web Site. [Online Dictionary Entry]. Retrieved 11 Oct 2009. http://dictionary.reference.com/browse/company. Dictionary.Com Web Site. [Online Dictionary Entry]. Retrieved 11 Oct 2009. http://dictionary.reference.com/browse/loan. Dictionary.Com Web Site. [Online Dictionary Entry]. Retrieved 11 Oct 2009. http://dictionary.reference.com/browse/management. Dictionary.Com Web Site. [Online Dictionary Entry]. Retrieved 11 Oct 2009. http://dictionary.reference.com/browse/marketing. Dictionary.Com Web Site. [Online Dictionary Entry]. Retrieved 11 Oct 2009. http://dictionary.reference.com/browse/technical. Read More