Question

Lydia’s sale grew by 30% in 2018 and 25% in 2019.  She excepts similar growth in 2020, but this is straining her cash reserves.  Her bank is concerned about her loan amount exceeding $100,000.

Because the fishing season effectively ends in late fall, Lydia’s accountant has completed the financials for 2019.  There may be some small changes, but the current 2019 numbers are sufficiently accurate for 2020 planning purposes.

Use the actual financial statements for 2019 and the assumptions below to construct pro forma financial statements for 2020 for The Dry Fly.   Submit your pro forma statements and refer to the pro forma statements to answer the following questions.  The form on the next page should be used for your pro forma.

1. Develop pro forma financial statements for 2020.
2. What will the 2020 year-end bank loan balance be?
3. Create a Sources and Uses statement to show the items driving Lydia’s loan need?
4. In a few sentences comment on the change in the loan amount compared to the large increase in Sales.  If Sales growth begins to level off what will happen to the loan amount in the future?

Assumptions

• Sales will increase 25% in 2020

• COGS will remain 72% of Sales in 2020.

• GA&S will increase by $22,000 in 2020.

• In 2020, depreciation expense will be $8,000, no assets will be sold and $10,000 of new assets will be purchased.

• The bank loan has an interest rate of 8%.  Base your Interest Expense for 2020 on the year-end bank loan balance

• The tax rate is 30%.

• Cash, A/Receivable, Inventory and A/Payable will be the same % of sales in 2020 as they were in 2019.  The minimum cash balance is 1% of Sales.

• All earnings are retained to finance growth (No dividends are paid).

• Assume Cash is kept at its minimum level as long as there is a loan outstanding.
• Common Stock is unchanged at $40,000 in 2020.

The Dry Fly Financial Statements

2019 Actual and 2020 Pro Forma

Income Statement	2019	2020 Pro Forma
Sales	550,000.00
COGS	396,000.00
Gross Margin	154,000.00
GA&S Expense	110,000.00
Interest Expense	15,050.00
Depreciation Expense	6,000.00
Taxable Income	22,950.00
Taxes (30%)	6,885.00
Net Income	16,065.00
Balance Sheet
Assets	2019	2020 Pro Forma
Cash	5,500.00
A/Receivables	22,000.00
Inventory	137,500.00
Total Current Assets	165,000.00
Net Fixed Assets	80,000.00
Total Assets	245,000.00
Liabilities & Equity	2019	2020 Pro Forma
A/Payable	39,600.00
Bank Loan (8%)	80,000.00
Total Current Liabilities	119,600.00
Common Stock	40,000.00
Retained Earnings	85,400.00
Total Liabilities & Equity	245,000.00

Answer 1

a.)

The Dry Fly Financial Statements Income Statement Sales COGS Gross Margin GA&S Expense Interest Expense Depreciation Expense Taxable income Taxes (30%) Net Income 2019 550000.00 396000.00 154000.00 110000.00 15050.00 6000.00 22950.00 6885.00 16065.00 2020 Pro Forma 687500 =550000*125% 495000|=687500*72% 192500 =687500-495000 132000 6492 8000 46008 13802 32206 6,87,500 4,95,000 1,92,500 1,32,000 .08x 8,000 52500 -0.08x 15750 -0.024x 36750 - .056x Suppose Bank Loan amounts to "x" Interest Expense = .08x So Taxable income = 192500 - 132000 - 8000 -.08x = 52500 -0.08x Taxes = 30% of (52500 -0.08x) Net Income = 70% of (52500-.08x) or, 36750 - .056x This is addition to retained earnings So Retained Earnings = 85400 + 36750 -0.056x or, 122150 - 0.056x Now, As Liabilities and Equity = Total Assets So, (49500 + x) + (122150 - 0.056x) + 40000 = 288250 Balance Sheet Assets Cash A/Receivables Inventory Total Current Assets Net Fixed Assets Total Assets 2019 5500.00 22000.00 137500.00 165000.00 80000.00 245000.00 2020 Pro Forma 6875 1.00% 27500 4.00% 171875 25.00% 206250 82000 =80000+10000-8000 288250 6,875 27,500 1,71,875 2,06,250 82,000 2,88,250 Solving above equation forx 211650 +X- .056x = 288250 or, x = 81144 Inserting which gives interest @ *8% as 6492 Putting this Interest Expense in Income Statement gives Taxable income as 46008 and addition to retained Earnings come as 32206 Which ultimately goives same Balance Sheet Total for Liabilities and Equity as it came for Assets as per information given. 7.20% 49,500 Liabilities & Equity A/Payable Bank Loan (8%) Total Current Liabilities Common Stock Retained Earnings Total Liabilities & Equity 2019 39600.00 80000.00 119600.00 40000.00 85400.00 245000.00 2020 Pro Forma 49500 81144 130644 40000 117606 288250 49500 + x 40,000 122150 - .056x 2,88,250

b.) Bank Loan would amount to 81144 at year end 2020

c.) Sources and Uses Statement

Balance Sheet Assets Cash A/Receivables Inventory Total Current Assets Net Fixed Assets Total Assets Source Use 2019 2020 Pro Forma 5500.000 6875 1375 22000.00 27500 5500 137500.000 171875 34375 165000.00 206250 80000.00 82000 2000 245000.00 288250 43250 9900 1144 Liabilities & Equity JA/Payable Bank Loan (8%) Total Current Liabilities Common Stock Retained Earnings ITotal Liabilities & Equity 2019 2020 Pro Forma 39600.000 49500 80000.00 81144 119600.00 130644 40000.00 40000 85400.00 117606 245000.00 288250

As Assets are increasing so funds are being used towards them, and as liabilities are increasing so they are a source of funds. If any asset would have decrease it would have been a source of funds and vice versa holds true for liabilities.

d.) As the sources of funds have increased only marginally but the uses of funds have increased drastically, this shows that the business is a profit making entity and should be able to recover and be able to repay loan, as its not dependent upon loan funds only to finance its uses. And is generating funds to finance uses on its own as well.