CASE STUDY

CREDIT ANALYSIS FOR MANGO FACTORY LOAN APPLICATION

Overview
The MANGO Garment Factory case involves an industrial company that requests a short-
term loan from a commercial bank to cover short-term operating needs. It is a new loan
request that must be analyzed by the bank's credit staff.
After reading the case study, you will be asked to perform a company financial analysis as
a practice exercise. The first step in the exercise is to examine the financial statements
submitted by the client, taking into consideration any additional verbal information. Then,
make any necessary adjustments to the client's numbers before including them within the
spreadsheet model. These adjustments, if any, pertain to the proper presentation of the
financial statements and those adjustments that are necessary for calculating ratios. To do
this, you must draw on basic accounting definitions.
Once the adjustments have been made, you should compute the vertical analysis and
financial ratios included in the spreadsheet. To do this, you will draw on knowledge of
ratios and inter-account relationships.
When the numbers have been laid out and the ratios computed, you will interpret the figures
to formulate financial conclusions and answer certain questions.
Keep these steps in mind as you read the case study.

Setting
Yesterday, January 20, 20X4, the financial analyst of the Friendly Bank received the
financial statements of the MANGO Garment Factory for the fiscal years ending
September 30, 20X1, 20X2, and 20X3. The numbers submitted by the client are attached.
The manager of the bank has asked his trusted analyst to immediately perform the financial
analysis, since the credit request is to be considered in today's afternoon session of the
credit committee.
The company, which is not yet a client of the bank, requested a loan for US Dollars 300,000
(exchange rate = US Dollars 2/US$) for 180 days. The analyst has heard of the company,
but has never been directly involved with them in business transactions. The reason for the
expedited treatment of this credit is that the factory's owners are friendly with one of the
bank's directors.
The company has been established in the market for many years. It manufactures general
clothing (men's, women's, and children's) for the domestic market (growth rate of about
5% annually), aimed at the middle and upper middle classes. The MANGO Garment
Factory has principally dealt with the COCONUT Bank and a specialised public sector
bank for long-term financing. It is owned by a respected and socially prominent local
family with a reputation for being very conservative and traditional in business dealings.

Finding information: General Manager

Upon examining the financial statements, the analyst noted that the external auditor, the
firm of REALITY, was unfamiliar to him. The analyst had questions about some of the
numbers and called the general manager of MANGO for some clarifications. The general
manager has been with the company for fourteen years and was promoted to his present
position three years ago. Concerning the purpose of the loan, he said it was "for working
capital purposes."
Concerning sales, he indicated that “Sales are growing — following the same trends as last
year” and that “Our policy is to raise prices along with inflation,” now estimated at 15%
per year by the analyst. “We've never had problems with raising our prices due to the high
quality of our brand names and our entrenched market position,” said the manager. “We
sell 85% of our production at 90-days to strong distributors. The other 15% is sold on a
cash basis through our own store, which is well located in the downtown shopping district.
The July - August - September quarter constitutes about 25% of annual sales and
production.”
The analyst also asked why inventories were higher and payables lower in the past year.
The gIn inventories, the general manager said wish to increase our stocks as a hedge on
inflation.” Regarding payables, he said that “Our policy is to buy some raw materials on a
cash basis to take advantage of discounts offered by some suppliers.”

Credit References
Before writing up his analysis, the analyst called an acquaintance at the COCONUT
Bank—a friend since university years. The COCONUT banker indicated that the MANGO
Factory had been a client of COCONUT for eight years. The present owners were the
second generation of the family to direct the company; they took over three years ago and
installed the present general manager.
The banker mentioned that, when the company was taken over with long-term notes by the
present generation of owners, a certain amount of goodwill was put on the company's
books. Also, about six months ago, the MANGO Factory sold an old warehouse for US
Dollars 210,000. Terms of the sale were three years, including 18 months grace.
The COCONUT Bank, because of traditional relationships, mainly dealt with the owners
rather than the management; obligations were paid satisfactorily, although rollovers
(renewals) were frequent on the short-term loan. Six months ago, COCONUT Bank
approved a new credit facility, with full recourse to MANGO, of US Dollars 400,000 for
the discount of receivables.
(A “discount facility” is one where the bank "buys" certain of the customer's trade
receivables at a specified price, for example, at a 10% discount. This means the customer
receives $90 for every $100 receivables. The bank collects the receivables when they are
due for payment of the amount advanced to the customer, plus interest.
Structuring with “full recourse” to MANGO means that MANGO guarantees payment of
the transaction in case the trade receivables are not paid when they are due.) The credit
facility was fully taken down almost immediately, and outstanding have not changed since
then. The COCONUT Bank also has financed equipment purchases for MANGO over the
years, generally with good results. COCONUT is now near its legal lending limit with
MANGO.

Financial Statements
The financial statements presented by the general manager of the MANGO Company
follow.

MANGO FACTORY
Income statements for the Years Ending 9/30/X1, 9/30/X2, 9/30/X3
Figure in Thousands of US Dollars

YEAR 9/30/X1 9/30/X2 9/30/X3

Net Sales 3,501.50 3,934.00 4,358.90

Cost of Goods Sold 2,667.00 3,059.00 3,438.80

Gross Profit 834.50 875.00 920.10

Selling, General, Admin. Expenses 395.60 435.50 492.40

EBITDA 438.90 439.50 427.70

Depreciation 73.80 75.70 90.80

EBIT 365.10 363.80 336.90

Interest Expense 116.40 151.10 279.20

EBT 248.70 212.70 57.70

Income Taxes 94.51 80.83 21.93

Net Income 154.19 131.87 35.77

Dividends Paid 40.00 40.00 20.00

 MANGO FACTORY
Balance sheet for the Years Ending 9/30/X1, 9/30/X2, 9/30/X3
Figure in Thousands of US Dollars

9/30/X1 9/30/X2 9/30/X3

Cash 85.70 102.70 121.60
Account Receivable 1,012.20 1,267.60 993.70
Inventory
Finished Goods 369.40 623.20 1,056.20
Work in Process 34.00 44.60 49.00
Raw Material 648.20 658.20 702.40
1,051.60 1,326.00 1,807.60

Prepaid Expenses 42.50 46.00 52.40

Other current assets 33.80 28.40 245.60
Current Assets 2,225.80 2,770.70 3,220.90
Fixed Assets
Land 176.40 176.40 168.00
Building 442.00 442.00 316.40
Machinery&Equipment 800.60 832.60 955.10
Total Fixed assets 1,419.00 1,451.00 1,439.50
Less Accumulated Depreciation 862.00 937.70 1,028.50
Subtotal 557.00 513.30 411.00
Net fixed assets 557.00 513.30 411.00
Good will 148.80 148.80 148.80
Noncurrent assets 705.80 662.10 559.80

TOTAL ASSETS 2,931.60 3,432.80 3,780.70

Sort-term loan 625.20 928.80 1,417.00

Account payable 548.60 689.10 461.50
Accruals 40.20 46.20 54.70
Other current liabilities 36.40 42.00 30.30
Current liabilities 1,250.40 1,706.10 1,963.50
Long-term debt 260.00 220.00 280.00
TOTAL LIABILITIES 1,510.40 1,926.10 2,243.50
Common stock 200.00 200.00 200.00
Retained earnings 1,221.20 1,306.70 1,337.20
OWNERS' EQUITY 1,421.20 1,506.70 1,537.20

LIABLITIES AND OWNERS ' EQUITY 2,931.60 3,432.80 3,780.70

REQUIRED:

Directions: You are the financial analyst for Friendly Bank and you have been asked to
perform the financial analysis of the MANGO Garment Factory. This includes:
- Analyzing the figures submitted by the potential client for conformity to accounting
conventions
- Computing the ratios
- Interpreting the figures

PART I
Step 1: For purposes of analysis, make any necessary adjustments to the client's financial
statements — either to achieve conformity to accounting conventions or for purposes of
financial analysis. There are three adjustments to be made; they pertain to the correct levels
for trade receivables, other current assets, and tangible net worth.

Step 2: Using the adjusted figures, prepare financial statements for your analysis. Ignore
adjustments to the numbers for inflation.

PART II
Based on the numbers from part I, compute the all financial ratios that you have learned
for 20X1, 20X2, and 20X3. Note that to compute the days receivable number, you should
remember that not all sales are made on a credit basis.

PART III
Interpret the results, focusing first on the income statement and then on the balance
sheet. In so doing, consider the percentage to sales as well as the ratios.

INCOME STATEMENT
Question 1: How do sales increases compare to inflation? What does this mean?
Question 2: Based on the numbers in the case, what do you think MANGO's pricing
policy situation might be?
Question 3: What do the numbers reveal about MANGO's operational efficiency?
Question 4: What effect are interest expenses having on profits?

BALANCE SHEET
Question 5: What is the situation with receivables? What does it mean?
◼ Remember that you adjusted the receivables amount.
◼ Compare days receivable to credit terms offered.
Question 6: What is the inventory situation? What does it mean?
◼ Calculate days of finished goods inventory.
◼ Calculate days of raw materials inventory.
◼ Contrast these numbers to the information provided by MANGO's
general manager.

Question 7: What is the situation with fixed assets? What does it mean?
◼ Focus on accumulated depreciation.
◼ What does this mean on the income statement?

Question 8: What is the situation with days payable?

◼ Why decrease payables when the company has high working capital needs?
◼ Is MANGO really getting discounts for cash payment, or are trade creditors cutting
back?

Question 9: What can be said about the relationship between retained earnings and
capital of the firm?

PART IV
Please answer the following five questions.

Question 1: Are the following conclusions about MANGO's present financial situation
probably (T) true or (F) false?
____ a) The company is losing market position.
____ b) Pricing policies are adequate.
____ c) Operations are becoming less efficient.
____ d) Current asset management is adequate.

Question 2: Select three reasons why the MANGO cash generation capacity is highly
suspect.
____ a) Very low profitability
____ b) Illiquid current assets
____ c) Low taxes
____ d) Improving margins
____ e) Declining trends

Question 3: The manager's stated purpose for requesting a loan is to increase “working
capital.” The more precise purpose of the loan probably is to:
____ a) finance fixed assets.
____ b) finance a new product line.
____ c) pay creditors.
____ d) hedge long-term liabilities.
Question 4: Select three "clues" that indicate why the loan should not be granted.
____ a) Numbers sometimes contradict verbal information.
____ b) Owners are good friends of one of the bank directors.
____ c) There is a build up in potentially unrealizable current assets.
____ d) The company is a long-established business.
____ e) There are doubts regarding the manager's character and/or capacity to do his job.

Question 5: What lessons can be learned from this exercise? Check the statements that
apply.
____ a) Numbers analysis, alone, is sufficient to make credit decisions.
____ b) Ratios are extremely useful, but there must be some discrimination of the
numbers that determine results before the ratios are computed.
____ c) Financial analysis should consider qualitative factors which permit more
meaning to be derived from otherwise sterile numbers.
____ d) Ratios never lie. Together, with the financial statements, they provide absolute
determinations about the condition of a company.
____ e) The analyst should develop abilities to "read between the lines" to frame incisive
questions that look for causes, not symptoms, and draw appropriate conclusions.
____ f) It does not matter who the external auditor is because client financial statements
always comply with Generally Accepted Accounting Principles.