Question

You are a loan officer for National Bank. You have a loan application submitted by a company for $50,000. This company just got a prior loan for $45,000 and has not made the first payment. This gives you an uneasy feeling as you examine a loan application from ABC, Co. The application included the following financial statements.

ABC, Co.

Income

Statement

For the Year Ended December 31, 2018

Sales revenue                                 $100,000

Cost of goods sold                         (50,000)

Depreciation expense                    (5,000)

Remaining expenses                     (25,000)

Net income                                      $20,000

ABC, Co.

Balance Sheet

December 31, 2018

Cash                                                $5,000

Accounts receivable                       25,000

Inventory                                          20,000

Depreciable asset                          $55,000

Accumulated depreciation             (5,000)

Total $100,000

Accounts payable                           $10,000

Interest payable                                5,000

Note payable                                   45,000

Common stock                                20,000

Retained earnings                          20,000

Total                                                 $100,000

It is not ABC’s profitability that worries you. The income statement submitted with the application shows net income of $20,000 in the first year of operations. By referring to the balance sheet, you see that this net income represents a 20.00% rate of return on assets of $100,000. Your concern stems from the recollection that the note payable reported on ABC, Co’s. balance sheet is a two-year loan you approved earlier in the year.

You also recall another promising new company that, just last year, defaulted on another of your bank's loans when it failed due to its inability to generate sufficient cash flows to meet its obligations. Before requesting additional information from ABC, Co. you decide to prepare a statement of cash flows from the information available in the loan application.

Required:

1. Write a Memo to the President of ABC, Co. of 250 - 300 words.

2. Prepare the statement of cash flows using the indirect method. All beginning balance sheet accounts are .00

3. Explain the bank’s position on the loan.

4. Would you approve the loan or deny the loan?

5. What aspects of the financial statements would deny or merit the new loan?

6. Give both financial statement analysis and any lending comments in your memo.

Answer 1

From

National Bank


To

The President

Memorandum regarding Your loan application

Dear Sir,

We received your loan application dated --- from your company for sanctioning of $50,000 loan. The Bank have observed the following with respect to your account and on the information submitted with the loan application.

• The bank has already sanctioned and disbursed $45,000 short term loan.
• No payment has been made so far towards this loan.
• The cash flow emanating from operating activities is negative (-$5,000). Inadequate cash flow to meet your obligations.
• Short term loan was used to finance fixed assets.
• Accounts receivables are 1/4th of sales means debts collection mechanism of the company may not be effective. (25000/100000)
• The company's financial leverage ratio is on higher side and going for additional loan may impact Company's solvency. (45,000/40000) = 1.13 times. If the additional loan is sanctioned, this would be (95,000/40000) = 2.38.
• Though Company's profit margin is 20%,, its assets turnover ratio is 1 only. This may indicate that the company is not operating efficiently. (100,000/100,000)
• Current ratio of more than 3 indicates not using its funds wisely. (50,000/15000) = 3.33
• Your business is still young and may not be prepared to take more risks at this stage.
• Primary criteria for any bank in lending is to evaluate the repayment capacity of the borrower.

Based on the above observations, we request you to provide further information which helps the bank in taking decision on your loan application.

1. Your plan of repayment schedule against existing loan.

2. Complete business plan regarding utilisation of new loan and projected income and cash flow statements for next five years.

Loan Officer

National Bank

Dated

2)

ABC,CO.
Cash Flow Statement
	2018
Operating Cash Flow
Net Earnings	20,000
Plus: Depreciation & Amortization	5,000
Less: Changes in Working Capital	30,000
Cash from Operations	(5,000)
Investing Cash Flow
Investments in Property & Equipment	( 55,000)
Cash from Investing	(55,000)
Financing Cash Flow
Issuance (repayment) of debt	45,000
Issuance (repayment) of equity	20,000
Cash from Financing	65,000
Net Increase (decrease) in Cash	5,000
Opening Cash Balance	-
Closing Cash Balance	5,000

Net Working Capital Calculation
Current Assets:
Accounts Receivable		$     25,000.00
Inventories		20,000.00
		45,000.00
Current Liabilities:
Accounts Payable		$     10,000.00
Short-term borrowings		-
Accrued liabilities		5,000.00
		15,000.00
Net Working Capital		$     30,000.00

3. Bank can not sanction the loan

• unless and until the reliable assurance and expectation on the prior loan could be cleared on schedule and
• convinced that new loan could increase the profitability and cash flows of the company and new loan could be repaid from improved performance.

4. Based on the information available at present, Bank should deny the loan.

5. Merits for new loan:

only profit margin

Demerits for New Loan:

• Negative operating cash flows
• Lower Assets turnover
• Higher level of accounts receivables
• Idle working capital
• Non payment of any instalment towards loan
• High trading on equity ratio