Question

TABLE 3.3 Pro Forma Financial Statements for R&E Supplies, Inc., December 31, 2018 ($ thousands)

Income Statement
	2018	Comments
Net sales	$25,766	25% increase
Cost of goods sold	22,159	86% of sales
Gross profit	3,607
Expenses:
General, selling, and administrative expenses	3,092	12% of sales
Net interest expense	90	Initially constant
Earnings before tax	425
Tax	191	45% tax rate
Earnings after tax	$    234
Balance Sheet
Assets
Current assets:
Cash and securities	$  1,271	18 days sales
Accounts receivable	3,600	51-day collection period
Inventories	2,462	9 times turnover
Prepaid expenses	20	Rough estimate
Total current assets	7,353
Net fixed assets	280	See text discussion
Total assets	$  7,633
Liabilities and Owners’ Equity
Current liabilities:
Bank loan	$        0
Accounts payable	3,582	59-day payables period
Current portion of long-term debt	100	See text discussion
Accrued wages	22	Rough estimate
Total current liabilities	3,704
Long-term debt	660
Common stock	150
Retained earnings	1,697	See text discussion
Total liabilities and owners’ equity	$  6,211
External funding required	$  1,422

Table 3.3 shows the December 31, 2018 pro forma balance sheet and income statements for R&E Supplies, Inc. The pro-forma balance sheet shows that R&E Supplies will need external funding from the bank of $1.4 million. However, they show almost $1.3 million in cash and short-term securities. Why are they talking to the bank for such a large amount when they have most of this sum in their cash account?

Answer 1

The firm is probably trying to be too conservative so that they
can maintain a comfortable cash position.
Some of the ratios of liquidity that are relevant are:
Current ratio = 7353/3704 =	1.99
Quick ratio = (1271+3600)/3704 =	1.32
The above ratios indicate a comfortable liquidity position.
The cash cycle of the firm is reasonable at 51+365/9-59 =	33 days
But, the Days sales outstanding is high at 51, as also the days
payables outstanding of 59 days.
The firm can consider lowering the DSO and DSI and use a
part of the cash & marketable sexurities for financing the
fixed capital and working capital needs.
From the solvency angle, the firm's debt/equity ratio before taking the additional funding = (3704+660)/(150+1697) =	236%
This is very high and with the additional funding by bank, the
ratio will become (3704+660+1422)/(150+1697) =	313%
The bank may insist of enhancing the equity component of the
additional funding.