Good Deal Furniture, Inc.

Case Context

During the time frame of the case, 1982, there was a recession. Bankruptcies rose to 50% of the previous year. Borrowing money become expensive during this time because of high interest rate. The sale of retail furniture was dragged down by economic recession. Furniture purchases are considered to be deferred during tough economic times. Moreover, the sale of furniture is predicated on new housing constructions, which also had a tough time in this time frame. The banking industry also felt the effect of the recession especially that they just came from a wave of deregulation. By mid-1982, the high interest rates took it toll, causing the number of bank failures to increase steadily. But, amongst all sector, the farmers were the one hit hard. The recession caused the agricultural exports to decline and crop prices to fall. The high interest rate also lowered the expected value of profits and at the same time makes borrowing more expensive.

Point of View

The case involves two different entities, State Bank of Crystal Springs (SBCS) and Good Deal Furniture, Inc. (GDF). They currently need to come up with decisions which will affect both of them. Both sides should be examined to be able to address all the issues given in the case. Thus, the group decided to assume the point of view of a third person who is independent from the bank and the furniture retailer and can professionally check and assess the condition of the two entities and other factors. A financial consultant who was hired by both the bank and the retailer, and came from an independent consultancy agency would be best for this case.

Problem

Good Deal Furniture is planning to buy more inventories so he went to the bank to request for a higher credit line. Considering financial performance and position, current economic conditions and other factors, the two entities have a reciprocal problem. On the side of the bank, should Mr. Wells grant the request of the furniture dealer? For Mr. Jones, should he really invest in inventory and is borrowing the best option to support it?

Assumptions

Using the information given in the case, the Group has made these following assumptions which would aid in our analysis:

1. In computing for ratios and other needed financial numbers, the group used 360 days in a year.

2. The time frame of the case is February 1982, when Mr. Robert Jones approached Art Wels regarding the increase in Good Deal's line of credit.

3. The management of Good Deal Furniture, Inc. is aggressive in terms of increasing sales. Based on the case, the company makes sure that its products are well-advertised and it is willing to have high number of accounts receivable just to increase sales.

4. State Bank of Crystal Springs is applying calculated risk approach. The bank would want to make its evaluation on Good Deal Furniture to determine if it is a good credit risk and apparently will allow the extension of credit line.

5. Mr. Robert Jones had already established good relationship with the bank. He has been a customer of the bank for many years and his father had done business with the bank since a year in 1940s. This could be an important consideration, as a delicate factor, for the bank.

6. The financial consultant whom the group has chosen is independent minded. As a significant assumption, the consultant hired both by the bank and Good Deal would not give biased analysis and recommendations to be able to give appropriate solutions for the issues given.

6. In computing the Inventory turnover ratio the group used the inventory of the current year and not the average inventory. This is for the primary reason of consistency in computing the previous and present ratio.

Areas to Consider

The financial consultant would give recommendations to address the problems of the bank and Good Deal. Prior to that, analysis on some areas and information of both the SBCS and GDF should be done.

For the BANK

Credit Analysis

Credit analysis means evaluating a business or company to determine its likelihood to pay or live up with its obligations. To perform in-depth credit analysis, a popular method could be used, called the five C's of credit or the common characteristics of the company being evaluated which a lender is commonly and likely looking for before allowing credit to it.

a) Character

This refers to the applicant's record of meeting past obligations. The case didn't give much information on Good Deal's records for analyzing the company's character except on exhibit 3 which shows that GDF is having a grade of satisfactory on meeting current obligations to SBCS. In addition, based on the financial statements given, the short-term borrowings of the company have increased by over 100 percent from 1981 to 1982 (from $66,00 to $133,000). This might be a bad indication of managing its current liabilities.

b) Capacity

Cash flow is the primary determinant if the company could repay the obligation. Statement of cash flow by the company is not given, but looking on its balance sheet, there is not enough cash to pay the $50,000 addition to credit line and other current liabilities such as accounts payable and accrued miscellaneous payables are huge amount and still outstanding.

c) Capital

To examine GDF's capital structure, the consultant should check its solvency and profitability ratios. The debt to equity ratio on 1982 is 1.30, higher than the last year (0.91) and the industry average (1.0) which implies worse proportion of D to E. Checking if the additional debt can be justified, the return on asset and return on equity on 1981 and 1982 should be compared. ROA and ROE both decreased from 1981 to 1982. (See tables)

This means that a higher borrowing is not appropriate for the company since it would not give additional returns or earnings.

d) Collateral

For securing the loan through collateral, GDF has large amount of assets like receivables, inventories, and fixed assets.

e) Condition (Furniture and Agriculture Industries)

Furniture industry in general is currently affected by the slowdown of economic activity and inflation (could be a recession during that time). The retailers are having slower growth