ADMN 2167

BUSINESS DECISION MAKING

ASSIGNMENT #1
BY: HAMID KARIM
STUDENT ID: 0649214
Requirements of Mountainarious Sporting Co:

 Loan request $150,000

 $100,000 line of credit

Who they are:

Started in 1994 in Barron, Ontario Canada by Steven Donnie. They offered a variety of sporting

goods and outdoor products, which was the main driving force for all their sales revenue.

However, the business suffered greatly in 2002 when a fire caused major damage to the

location. Later, Steven Donnie decided to open up shop again offering exclusive specialty sports

equipment and apparel. Steven Donnie wants to expand his business and add another

extension to the existing store called Deviltech Outfitters. This extension would cost $150,000

for the business.

Changes to consider:

 He believed new layout would result in 15 % increase in overall sales for both stores

 15% for 2008, and for 2009 a 30% increase above projected 2008 sales

 For both years Donnie also expects the cost of goods sold to decrease by 65% of sales

 Advertising will remain the same with slight change by adding “Visit Deviltech Outfitters

next to the Mountainarious Sporting Co.”

 Donnie is requesting a $20,000 increase to his existing $80,000 line of credit.

 He also estimated the renovation along with capital improvements will cost a $150,000

 If loan is approved annual principle will be $15,000 and annual interest will be $8,500

 Donnie would also resume payment on his mortgage in 2009 for $3,600 each year
  He also expected the accounts payable to increase by $74,608 in 2008 but reduced to

$58,617 in 2009

 The “other assets” account on balance sheet be cleared in 2009

 Other items on statement of earnings would remain the same percentage of sales as

was experienced in 2007

 Because clothing is high-margin, inventory may move slowly causing an additions 20

days of inventory

 Being in Business for 13 years, Donnie considering selling part of the business to relieve

some stress

Competition:

 Big-box retailers like Wal-Mart, Canadian Tire, and Sport Chek had opened stores with

3,500 square meters to 15,000 sq, offering lower prices and providing a larger variety of

sporting goods across all mainstream sporting categories

 3 big-box retailers currently operating in Barron, with a 4th one opening in the following

months

 Other specialty stores offering similar product like Circuit Sports as a direct competitor.

 Online selling had been growing and has become a source of competition. Even stores

like Circuit Sports have websites with online ordering.

 Mountainarious Sporting Co. has a website but only for informational purposes.

Soft Goods:

 2005 Donnie incorporated selling soft goods like sports footwear and apparel.
  Donnie has no previous experience selling “soft goods”

 Donnie wants to add an extension called Deviltech Outfitters for his “soft goods”

apparel.

 Donnie wants to appoint his wife to manage the new store although she has no prior

experience managing a store before.

Answers:

Answer 1:

Profitability:

Mountainarious’s net income (2.6%) in 2007 is a lot lower than the industry average of 12.59%.

Based on my analysis, it seems that the company pays more for its inventory (68.1%) compared

to its competitors (60%) Or there is a possibility of shrinkage which could have been caused by

inventory becoming obsolete or stolen by employees and customers.

The other area of concern is the bank and interest charges. The company spends about 3.4% of

its proceeds of sale on interest and bank charges, which is a lot higher than the industry

average of 0.8%. Based on the information provided on the balance sheet, it seems that the

company has borrowed money from family and friends where it pays a lot higher interest than

traditional lenders. In addition, borrowing from private individuals could jeopardize the

company’s sustainability, and operation, should these lenders demand their funds in the near

future.

Liquidity:
Current ratio: The company’s current ratio has increased in 2007 compared to prior years. The

company has $1.30 for every $1 it owes; however, it is still below the industry average of 1.9.

The majority of current asset ($199,062) has been invested in Inventory ($189,000); from the

bank’s perspective, it is a very high risk as the inventory is not always immediately cashable.

Specially in Mountainarious’s case, where the inventory is seasonal. Should the company

become insolvent, it may not be able to sell the inventory at its full price and pay-off the line of

credit and other current liabilities.

Acid Test: The company’s acid test is 0.07 compared to the industry average of 1.2, which

means the company has 7 cents for every $1 it owes. As it was explained in the current ratio

analysis, the majority of the company’s current assets have been invested in inventory and all

these inventories may not be sellable should the bank recall its line of credit or loan payable.

Efficiency:

Age of receivable: The age of accounts receivable indicates that the average collection of the

sales proceeds are 5 days, which is a short period compared to many industries. However,

Mountainarious is a retail store where customers pay for their purchases COD or instantly as

the purchase takes place. The accounts receivable balance is an area of concern where it might

be bad debt or an error in the financial statements.

Age of Inventory: The age of inventory is about 140 days, which is a very long period for any

business to hold inventory. Either the company has inventory that is obsolete and unsellable, or

they might be trying to take advantage of larger discounts for early purchasing.
Age of Accounts payable: The age of accounts payable (47.2 days) is much higher than the

credit term that the company has, which is 30 days. This shows that the company is in default

of paying its supplier on time. In addition, this shows that the company is not taking advantage

of early payment discounts on all its purchases.

Stability:

Net worth to total assets: is 32.3% which is a lot lower than the industry average of 45%.

Additionally, the quality of the asset is questionable. For example, the AR balance may not be

accurate or the inventory may be obsolete, which in case of default, the company may not be

able to pay back the borrowed money.

Additionally, the interest coverage ratio has been deteriorating year over year. With additional

borrowing and increased costs due to the expansion of the new store, the company may not be

able to generate enough income to pay the interest on the borrowed money.

Growth:

Sales: Sales have been growing year over year from 2004 to 2006 however, the growth has

been in an average range of about 4% (12.3%+9.9%-10.1%) over the past 3 years.

Net income: has been experiencing negative growth, which means the company’s margin has

been jeopardized by increased cost of sale and high borrowing costs.

Total Assets: has had an unstable growth over the years of 11.4% in 2007, 4.7% in 2006 and -

17.2% in 2005. Additionally, the quality of assets could be in question as the high inventory

indicates some problems with this account.

Overall:

Overall, Mountainarious has experienced some growth over the years; however, the growth

has not been stable, and consistent. There are many areas of high-risk accounts in its financials

that indicate potential problems, such as the accounts receivable and most importantly,

inventory. Additionally, money owed to individual investors or family members could be

recalled at anytime where it could jeopardize the sustainability of the company.

Statement of Cash flow:

Cash flow from Operations: The company’s cashflow from operating activities has been

deteriorating year over year, where it has declined from $87,208 in 2005 to only $941 in 2007.

The cashflow from operations is alarming because the company has used a much larger portion

of the cash towards purchasing the inventory and increased its Accounts payable liability by

$28,820.

Financing activities: The company’s cash flow from the financing activities has been improving

year over year. The company has paid off some of its line of credit in the amount of $15,619;

however, the company has obtained an additional loan of $26,167, which could be loans from

private individuals with high interest costs. Additionally, the owner has withdrawn $12,330

from shareholder loan accounts; this is an area of risk which raises the question of why the

owner withdraws its own funds from the company while trying to borrow money from other

lenders. It is also worth noticing that the company has not paid its mortgage for the year 2007.

Either it has defaulted on the mortgage payment or may have arranged to pay later. In any

case, mortgage payments will add additional pressure to cashflow in the coming years.
Investing activity: The company did not have investing activity in 2007. This would have been an

area of concern for businesses in many other industries, however, in Mountainarious’s case it

might be fine as it’s a retail store and probably does not need much machinery, equipment or

assets.

Answer 3:

Mountainarious’s future financial requirements:

The company is requesting $150,000 loan for the expansion of the new business and an

increase of $20,000 for the purchase of additional inventory, most likely for the new business.

The $150,000 will likely be spent on leasehold improvements, fixtures, and furniture.

However, from a practical stand point, the company may require a lot more funds to fund the

new operation. The company will have to hire new employees and management for the new

business, which will add additional cost to the business. Steven Dinnie is being very optimistic

forecasting the expenses to be the same percentage of sales as in 2007. Adding an extension to

the current business will come with its own overhead costs, variable costs, rent obligations, and

salaries and wages. Another future requirement will be increasing advertisement spending;

Donnie needs to invest some money in advertising in order to ensure success of the business; it

is very difficult to attract new customers without spreading awareness about the new location.

Additionally, Mountainarious already had debt obligations in the 2007 year, such as accounts

payable, mortgage, and debt from lenders; which means that additional loans will require more

payment obligations in the future years. From the information provided, we know that

mortgage payments will also resume in 2009. Without the current debt payment obligations,
acquiring additional $150,000 loan along with $20,000 increase of line of credit will require the

business to pay $15,000 in principle and $8,500 in interest payments. It can also be assumed

that the extra line of credit will not be enough for inventory costs for the new extension;

therefore, the business will require additional funds to complete the necessary inventory needs

of Deviltech outfitters.

Answer 4:

Sensitivity Analysis:

The company has projected that there will a revenue growth of 15% in 2008 and 30% in 2009

however, this growth has not been backed by reputable evidence or supporting documents. It is

highly likely that the growth of the coming years could be a lot less than projected based on

historical data provided.

Based on historical data, we would consider a growth of 11% per year (Average of 2006 & 2007

growth) to be a more achievable target for the business. With a 11% annual growth the

company’s net income would decrease to $24,732 and $30,520 after taxes in 2008 and 2009

respectively.

With the residual net income from operation, the company would have a net cash inflow of

$9732 in 2008 and negative -$4071 in 2009.

Additionally, the company’s increase in labour cost may not be reliable. Since the new store will

be a separate operation, it will require its own employee and management which will increase

the cost of labour substantially. (See sensitivity analysis calculation in excel).

Answer 5:

Perform 4 C’s risk assessment:

Capacity to pay back the loan: The company will have a challenging time paying back the loan if

the loan is acquired. Firstly, their cost of goods is higher than the industry average and it will

likely continue to grow, the reason being the addition of the extension. We can see that in 2007

the cost of goods sold was at 68.1% compared to the industry average of 65%; keeping in mind

that this is without the extension of Deviltech Outfitters. With the extension, however, this cost

will go up. Although, assumptions have been made that the cost of goods will decrease to 65%.

But practically it is unlikely, since the company is having a hard time keeping their cost of goods

under control in 2007 without any extension. We can also see that the current ratio is lower

than the industry average, which basically tells us that the company will have a hard time

paying their immediate debts and liabilities. The current ratio is for 2007, and if the company

acquires more debt, it will have an even harder time repaying their loans. Lastly, the company’s

quick ratio is even lower than their current ratio, which is extremely concerning. A low quick

ratio tells us that the business has lower liquid assets than liabilities, so in cases of default

where the company cannot repay the loan, there are insufficient liquid assets to cover the loan

repayment.

Character: Steven Donnie has been in the business since 1994 and he has been fairly successful

despite having his store destroyed by the fire. He is a very positive person who has a passion for

sports and sporting goods. There are a few areas of concern. Since 2002, Donnie has not been

able to clear any of his long-term financial debts, although the amounts did fluctuate but were
not cleared. There also hasn’t been any mortgage payments since 2006 and no plans to do so

until 2009. Another negative factor is that Donnie does not have any experience selling “soft

goods” and that his future success depends on the success of the expansion. With minimal

experience, it seems unlikely that Donnie will be able to repay the loans acquired on top of his

already existing liabilities. Another aspect we need to consider is the fact that Donnie wishes his

wife Allison to manage the new store. From the information provided, we can tell that Allison

had no management experience and could prove to be a liability to the business than an asset.

Collateral: looking at the 2007, we can see that the business had some fixed assets like land for

the amount of $54,945 and building and store fixtures of $220,588, and both have been

amortized every year as well. The business also has about $189,000 of inventory as well. In

2007, the company already had $283,723 in current and long-term liabilities, if the company

were to get another $150,000 loan and an increase of $20,000 in line of credit. The total

liabilities would result in $453,723; this clearly shows that the business does not have the

collateral to repay the loan in case of default. Another area of concern would be the high

inventory; if the company defaults, they might not be able to liquidate the inventory as quickly

and for the full amount. Therefore, the company would not be sustainable with such a high

debt ratio.

Credit: In a business credit between the business and their customers and suppliers are very

important. For Mountainarious, we will look at their 2007 accounts receivable and accounts

payable. Firstly, we can see that there is a balance in the accounts receivable, which basically

suggests that money hasn’t been received from sales. This, however, is an area of concern

because the business is a retail store and transactions take place instantaneously, so for them
to have an accounts receivable means it could result in bad debt in the near future. Also,

Mountainarious’s accounts receivable days are 5 days, meaning if a customer purchased an

item on credit, their payment should be received within 5 days from sale. As for their accounts

payable, Mountainarious has a large balance in their accounts payable which is $71,456, with

payable days of 47.2; here we can observe that the business takes 47.2 days on average to pay

suppliers. This is relatively high because most suppliers give a 30-day credit with early purchase

discounts if amounts are paid early. Not only is Mountainarious unable to take advantage of the

early discount purchases, but they have a hard time paying suppliers within the credit days.

Therefore, this proves a high credit risk for the bank which may result in rejection of loan.

Answer 6:

As McDougall, what are your options?

1. The first option is to increase the line of credit by $20,000 but reject the $150,000 loan.

2. The second option is to accept the $150,000 loan and reject credit increase for the line

of credit.

3. The third option is to pass both the $150,000 loan and credit increase of $20,000.

4. The fourth option is providing a smaller loan in order to decrease the risk on the bank’s

behalf.

5. The fifth option would be to reject both the loan and credit increase because of their

financial standing.

Answer 7:
As McDougall, I have decided to reject both the loan and the credit limit increase. Below are

both quantitative and qualitative reasons why.

Qualitative:

 The profit for “hard goods” has declined due to increased competition from big-box

retailers and other specialty store.

 Donnie wants to start selling “soft goods” yet he has no experience in “soft goods” retail

before.

 Donnie wants to have his wife Allison manage the new business, but Allison lacks

management experience and therefore, will have an adverse effect on the success of

the business

 Donnie does not have any e-commerce capability; Online selling had been rapidly

growing, to ensure profitability, Donnie should consider online selling as well.

 Donnie has calculated his expenses optimistically for the future projections. The

practical cost of adding a new store to the existing location will be much high, including

increased labour and overhead expense.

Quantitative:

 2007 Profitability is only at 2.6% compared to the industry average of 12.5%. This is

alarming because it tells us that the business has high expenses resulting in lower

profitability.
  The current ratio for the business is only 1.30 compared to the industry average which is

1.9 meaning the company will have a harder time clearing their immediate liabilities.

This becomes a red flag when considering lending money to the business.

 Even though we can see a sales growth of 12.3% in 2007, the net income has declined

by -52.2% suggesting poor cash flow management.

 The company’s cost of good sold is at 68.1% of sales while the industry is at 60%

suggesting a poor inventory management.

 Another area of concern is the age of accounts payable, which is at 47.2 suggesting that

the company has a hard time paying off suppliers with the appropriate credit days of 30.

This also means the company is not able to take advantage of early purchase discounts.

 The company also has a low interest coverage ratio of 1.8 which is lower than an

acceptable rate of 2.0 therefore, suggesting that the company is burdened with more

interest expense than it should be.

 Based on the acid test the company has only 7 cents for every $1 owed without securing

the new financing.

 The sales growth of 15% and 30% in 2008 and 2009 seems unrealistic. If the growth in

sales is in line with the company’s historical data, the company’s net income would be

much lower in 2008 and 2009 where in 2009 the company would have a negative

cashflow after making loan payments.

References:
Murray, J. (2007-10-05). Mountainarious Sporting Co. Richard Ivey School of Business. Harvey, J.
ADMN 2167: Business Decision Making. University of Nipissing.