Texas based Santa Fe Trading Company (“The Company”) is a small business venture trying to establish as a successful furniture and art jewelry shop. In July 2013, the owners of the company, Steven and Sue Mahon invested $350,000 of their own savings and received a loan of $150,000 from a family member. However, to start the business they need a building that costs $490,000 and inventory that costs $200,000. They also need additional $30,000 in cash reserves for running day to day operations. As a result, The Company found itself in need of $220,000 in financing to open the doors. Refer to Exhibit A for further detail.
This additional financing will need to come in the form of a loan from a local bank. As part of the loan process, The Company is required to prepare 5 years of forward looking financial statements, including a cash based income statement. Obtaining pro forma financial statements will help bank to gauge the financial strength and viability of the new business venture to process the loan request.
Pro forma income balance sheet and income statements are attached in the exhibit B. Santa Fe Company will have net loss of $44,000 during the first six months of its opening but will have positive net income for remaining five years. To keep the business running, in addition to the original loan of $220,000, Santa Fe Company will require more financing in the year 2014 for the amount of $69,000 and $58,000 in the year 2016.
Total cash on hand excluding loan amount in June, 2013 is $500,000. Owners of the company decided to spend $200,000 in cash on purchasing inventory to build the goodwill with local craftspeople. So, remaining cash on hand is $300,000 . To purchase the property & equipment (PP&E) and to run day to day operations company will require $520,000 . So, all of the loan proceeds worth of $220,000 will be used to purchase the property and remaining operational expenses will be handled using the cash on hand.
The primary source of repayment is from the income generated by the company over years. Loan repayment requires cash. With positive net income year after year starting from 2014 and positive cash flows will allow company to pay off loan in increments. Cash from operating activities is $50,000 in the first six months but in next year 2014 company is projected to have negative cash flow of $69,000 from operating activities. So, to sustain the business and to maintain minimum cash balance $30,000 an additional loan from the bank is required for the amount of $69,000 in the year 2014. This will increase the total outstanding debt to $289,000 in 2015. However increased revenues and positive net income at end of the year, allows The Company to pay $233,000 towards the loan, thereby reducing the loan amount to $56,000 in 2016. Payment of loan in 2015 of amount $233,000 will force Santa Fe Company to take additional loan of $58,000 to run its business in the year 2016. Additional $98,000 loan amount will be paid in the year 2017 leaving $16,000 as remaining loan amount balance in the beginning of the year 2018. With continuous trend of increasing revenue and positive net income and positive cash flow company will be able to payoff loan by end of year 2018.
A Cash based income statement provides information about realized revenue and adjusted net income. This information is crucial for any lender to gauge the real financial health of the company. Adjusted revenue is calculated by deducting the amounts that are collected by the year end. Calculating adjusted expenses are calculated by deducting expenses that have to be paid year end from expenses including cost for goods sold (COGS). We are assuming that taxes are paid in full each year except for the year with net loss. Please see Exhibit C for details.
A bank will look at the company’s history, business credit, revenues, equity contributions, balance sheet etc. to process the loan. Even with a good credit history banks may still require the collateral