Summer is approaching and Robert and Julia Martinez-Fonts have finally decided that their idea of a successful southwest furniture,
“Case Study
Adobe Trading Company, Santa Fe, New Mexico
Summer is approaching and Robert and Julia Martinez-Fonts have finally decided that their idea of a successful southwest furniture, art, and jewelry trading company has come of age. They know that summer is a popular tourist time in New Mexico and could be the best time to start this new business. The Martinez-Fonts have had a longtime interest in southwestern art and furniture. Robert graduated from Florida International University with a finance degree 15 years ago and received his MBA three years later from Texas A & M University. He has been working in Dallas, Texas, as the controller of a major wholesale distributor company for many years. His wife, Julia, who is a full partner in the business, spent the first 10 years of her career in retail sales. Over the last several years she has assumed more administrative duties with the group she works with.
Robert and Julia know that together they bring the necessary expertise and skill to run a successful business, but to ensure success they have been researching the market for over five years. They also know that they must be very careful and thoroughly research the business and industry they are pursuing. They have traveled extensively to New Mexico and spent a good deal of time getting to know the local artists (primarily ski “bums”). They believe that there is a great demand for southwestern furniture through the Southwest and prices are currently high.
They have informal commitments from local craftsmen to supply them with goods that they will display and sell. They have also made tentative arrangements with a large and reliable firm to supply the furniture and art pieces they will need to run the business.
The Martinez-Fonts have decided to open a shop in Santa Fe, New Mexico, under the name Adobe Trading Company, operating as both a supplier to furniture and art outlets and seller in the retail shop. Robert’s extensive contacts with suppliers in Dallas and Houston have given him the orders needed to get the business off the ground as soon as they begin shipping the goods. Julia has already begun marketing the southwestern products. The arrangements with the local craftsmen will allow very aggressive pricing of the goods to retail establishments in the Southwest. This aggressive pricing has been well received and tentative orders are already in place.
Robert has found an ideal location for the shop that is currently available. The owner is asking $275,000 for the space but Adobe Trading has a contract contingent on financing for $250,000. Based on remodeling bids, Robert and Julia estimate that they will be able to fix up the place for about $45,000. Although they will purchase the building, the land is leased on a transferable lease with 65 years remaining. The Martinez-Fonts have decided to invest $235,000, which represents most of their savings, into the venture to ensure success. Julia’s sister is also lending Adobe Trading Company $90,000. Repayment on the note is not expected to begin for five years. The Martinez-Fonts estimate that they will need $130,000 in inventory to start the business
and will pay for the inventory in cash to build goodwill with the local craftsmen. They also estimate that they will need a minimum cash balance of $20,000 to conduct day-to-day operations and pay bills. Finally they believe that all renovations to the building and inventory can be in place by June 30, 2011.
Robert’s approached Nancy Teachout the senior loan officer at First of Dallas Bank in Santa Fe, New Mexico, for financing. His background in finance allowed him to put together Adobe’s preliminary business plan using the
below assumptions:
1. Sales are expected to be a bit lower through 2011 because Adobe’s newness and it takes time for any firm to establish a market presence. Sales are expected to grow significantly 1n 2012 and 2013 with lower growth in 2014. Sales are expected to be $275,000 in the final six months of 2011, and $675,000, $800,000, and $900,000 during the three full years of operation (2012, 2013 and 2014). Sales are expected to level off at $900,000 after 2014.
2. Based on tentative agreements and orders, it is expected that cost of goods sold will average 63% of sales.
3. General and administrative expenses are expected to be $70,000 for the six months in 2011, increase to $100,000 in 2012 and level off at $120,000 from 2013 on. The land lease expenses and interest expenses are included in operational expenses.
4. Selling expenses are expected to be 12% of sales and Julia is expecting to undertake extensive marketing and promotion efforts though the Southwest immediately after the business is opened. These additional promotional expenses will be $30,000 in 2011 only.
5. Adobe will use a 10-year straight-line depreciation of the building and improvements.
6. Adobe’s effective tax rate is expected to be 34%.
7. A relative large portion of business is expected to be on credit so that Adobe will carry about 48 days of accounts receivable. Based on the type of business that they are entering, Robert and Julia expect to turn their inventory three times a year.
8. Based on the negotiations they have had with their craftsmen, suppliers, and other wholesale distributors, they estimate that they can count on about 28 days of accounts payable to help finance the business.
In preparing to go to the bank for the necessary loan, the Martinez-Fonts want to prepare projected financial statements for Adobe Trading Company showing the company can make a profit and pay back the loan. They also want to know more precisely how much they will need to borrow from the bank to open the doors for business and help finance the initial years of the
business. The Martinez-Fonts plan to prepare five years of balance sheet, income statement, and cash budget data for the bank. They also must develop an opening balance sheet as of the date they plan to open the doors, June 30, 2011. These pro forma financial statements will aid them and the bank officer in answering many questions including:
1. How much financing will be needed to open the doors of the business in July of 2011?
2. Five years of pro forma balance sheet and income statement data must be prepared to determine if additional financing is needed. If so, how much? Robert’s finance background tells him that the estimated financing needed each year will be an accounting plug figure to ensure that the balance sheet balances. If projected assets exceed liabilities and equity, the difference will be the bank borrowing needs. If liabilities and equity exceeds projected assets purchases, these funds will be used to pay off debt or increase cash or marketable securities.
3. Because this is a start-up business, it is important to identify what the loan proceeds will be used for, what the primary source of repayment is, and when to estimate total loan proceeds will be repaid. Using the pro forma projections, the primary source of repayment and when the loan will be repaid.
4. A cash budget or cash based income statement for each year needs to be prepared because Robert knows that the only thing that matters to the bank is cash.
5. Robert needs to prepare a collateral schedule. He knows that the banker does not want the collateral but will need all he can get if the business is not as successful as expected.
On behalf of Robert Martinez-Fonts students are required to prepare:
• A pro forma balance sheet and income statements (five years) to determine the initial and additional financing if any.
• A cash budget or cash based income statement for every year
• A pro forma collateral schedule
In the role of Nancy Teachout students are required to analyze Adobe Trading Company’s pro forma statements and answer the following questions:
1. How much initial and additional financing is required?
2. What are the loan’s proceeds to be used for?
3. What is the primary source of repayment for the loan?
4. When will the loan be repaid using the primary source of repayment?
5. What is the secondary source of repayment for the loan?
6. What type of loan covenants would you require?
7. What are the largest risks for the bank in making this loan?
8. How would structure the loan agreement to protect the bank?
9. What is your recommendation concerning the loan request? Would you make or deny the loan? State your reasons.
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