Question

Scandi Home Funishings, Inc.

     Kaj Rasmussen founded Scandi Home Furnishings as a corporation during mid-2016. Sales during the first full year (2017) of operation reached $1.3 million. Sales increased by 15 percent in 2018 and another 20 percent in 2019. However, after increasing in 2018 over 2017, profits fell sharply in 2019, causing Kaj to wonder what was happening to his “pride and joy” business venture. After all, Kaj worked as closely as possible to a 24/7 pace, beginning with the startup of Scandi and continuing through the first three full years of operation.

     Scandi Home Furnishings, located in eastern North Carolina, designs manufacturers, and sells Scandinavian-designed furniture and accessories to home furnishings retailers. The modern Scandinavian design has a streamlined and uncovered look. While this furniture style is primarily associated with Denmark, both Norwegian and Swedish designers have contributed to the allure of Scandinavian home furnishings. Some say that the inspiration for the Scandinavian design can be traced to the elegant curves of art nouveau from which designers were able to produce aesthetically pleasing, structurally strong modern furniture. Danish furnishings and the home furnishings produced by other Scandinavian countries—Sweden Norway, and Finland—are made using wood (primarily oak, maple, and ash), aluminum, steel, and high-grade plastics.

     Kaj grew up in Copenhagen, Denmark, and received an undergraduate degree from a technical university in Sweden. As is typical in Europe, Kaj began his business career as an apprentice at a major home furnishings manufacturer in Copenhagen. After learning the trade, he quickly moved into a management position in the firm. However, after a few years, Kaj realized that what he really wanted to do was to start and operate his own Scandinavian home furnishings business. At the same time, after travelling throughout the world, he was sure that he wanted to be an entrepreneur in the United States. Kaj moved to the United States in early 2016. With $140,000 of his personal assets and $210,000 from venture investors, he began operations in mid-2016. Kaj, with a 40 percent ownership interest and industry-related management expertise, was allowed to operate the venture in a way that he thought was best for Scandi. Four years later, Kaj is sure he did the right thing.

     Following are the three years of income statements and balance sheets for Scandi Home Furnishings. Kaj felt that he would need to continue to expand sales to maintain a competitive advantage. After first concentrating on selling Scandinavian home furnishings in the Northeast in 2017 and 2018, he decided to enter the West Coast market. An increase in expenses occurred associated with identifying, contacting, and selling to home furnishings retailers in California, Oregon, and Washington. Kaj Rasmussen hopes that you can help him better understand what has been happening to Scandi Home Furnishings from both operating and financial standpoints.

SCANDI HOME FURNISHINGS, INC. IN COME STATEMENTS 2017 2018 2019 Net Sales Cost of goods sold Gross profit Marketing General and administrative Depreciation EBIT Interest Earnings before taxes Income taxes (40%) Net income (loss) Cash Dividends $1,300,000 780,000 520,000 130,000 150.000 40.000 200.000 45,000 155,000 62,000 $99.000 SO $1,500,000 900,000 600,000 150,000 150,000 53,000 247.000 57.000 190,000 76,000 $114,000 $74,000 $1,800,000 1.260.000 540,000 200,000 200.000 60.000 80,000 70,000 10.000 4.000 S8.000 SO SCANDI HOME FURNISHINGS, INC. BALANCE SHEETS 2017 2018 2019 Cash Accounts receivable Inventories Total current assets Fixed assets, net Total assets Accounts payable Accruals Bank loan Total current liabilities Long-term debt Common stock Retained earnings Total liabilities and equity $50.000 200.000 450.000 700,000 300,000 $1,000,000 130.000 50.000 90.000 270.000 $300,000 $350,000 80,000 $1,000,000 S40,000 260,000 500,000 800,000 400,000 $ 1.200.000 170,000 70,000 90,000 330,000 $400,000 $350,000 120,000 $ 1.200.000 $10.000 360,000 600,000 970,000 500,000 $1,470.000 180,000 80,000 184,000 444,000 S550,000 $350,000 126,000 $1,470,000 *350.000 shares of commonstock were issued to Kaj Rasmussen and the venture investors when Scandi Home Furnishings was incorporated in mid-2016.

Your first challenge is to advise Kaj on what has been happening with Scandi Home Furnishings from a liquidity perspective.

1. Kaj was particularly concerned by the drop in cash from $50,000 in 2017 to $10,000 in 2019. Calculate the average current ratio, the quick ratio, and the NWC-to-total assets ratio from 2017-2018 and 2018-2019. What has happened to Scandi’s liquidity position?
2. Kaj should be interested in knowing whether Scandi has been building or burning cash. Compare the cash build, cash burn, and the net cash build/burn positions for 2018 and 2019. What, if any, changes have occurred?

Answer 1

Solution

Part A

Summary of Liquidity Ratio

Particulars	2018	2019	Change*
Current Ratio	2.50	2.29	Worse
Quick Ratio	0.92	0.87	Worse
NWC-Total Assets Ratio	0.41	0.37	Worse

Note* that change should show one of the following Better or Worse

Calculation for 2017-18

Current Ratio = Avg Current Assets / Avg Current Liabilites

  = (700,000+800,000)/2 /(270,000 + 330,000) / 2

= 750,000 / 300,000 = 2.50

Quick Ratio = Avg CA - Avg Inventories / Avg Current Liabilities

=(1500000/2 - 950000/2) / 300,000

= 275,000 / 300000 = 0.92

NWC-Total Assets Ratio = Avg CA - Avg CL / Avg Total Assets

= 750,000 - 300,000 /(1000000+1200000)/2

= 0.41

Calculation for 2018-19

Current Ratio = Avg Current Assets / Avg Current Liabilites

  = 800000+970000/2 = 885000 / 330000 +440000/2 = 387000

= 2.29

Quick Ratio = Avg CA - Avg Inventories / Avg Current Liabilities

= 885000 - 550000 / 387000

= 0.87

NWC-Total Assets Ratio = Avg CA - Avg CL / Avg Total Assets

= $ 498,000 / $ 1335,000

= 0.37

Part B

Cash Build (Source of Cash ) =

	2018	2019
Net Sales	$ 1,500,000	1,800,000
Less Increase in receivables	(60,000)	100,000
Cash Build	$ 1,440,000	$ 1,700,000

Cash Burn (Use of Cash) =

Operating Expenses	$ 1,200,000	$1,660,000
Interest	57,000	70,000
Income Taxes	76,000	4,000
Total cash burn from Income Statement	1,333,000	1,734,000
Change in Inventories	50,000	100,000
Change in Payables	(40000)	(10,000)
Change in Accrued Liabilities	(20,000)	(10,000)
Change in Gross Fixed Assets	100,000	100,000
Add Back Depreciation Expense	53,000	60,000
Cash Burn	$ 1,476,000	$ 1,974,000

Notes

1) The Increase in receivables represents a use of cash since is extended and no cash is collected.

2) The increase in Inventories and gross fixed assets reflect a use of cash for inventory purchases and capital expenditures.

3) The increase in payables and accrued liabilities represent a source of cash since purchases were made on account (without cash).

Net Cash Burn =

	2018	2019
Cash Burn	$ 1,476,000	$ 1,974,000
Less Cash Build	1,440,000	1,700,000
Net cash Build/ (Burn)	$ (36,000)	$ (274,000)

B. If your answer in Part A resulted in a net cash burn position , calculate the net cash burn monthly rate and indicate the numbers of months remaining until out of cash. If your ans in PartA resulted in a net cash build position , calculate cash build monthly rate and indicate the expected cash balance at the end of 2018.

	2018	2019
Monthly Cash Burn	$ 3,000.00	$ 22,833.00
Cash Balance at end of period	$ 40,000	$ 10,000
Months Remaining	13.33	0.44