Gainsborough Fashions Ltd operates a small chain of fashion shops in North Wales. In recent months the business has been under pressure from its suppliers to reduce the average credit period taken from three months to one month. As a result, the directors have approached the bank to ask for an increase in the existing overdraft for one year to be able to comply with the suppliers’ demands. The most recent financial statements of the business are as follows:

15.7 15.6 611 CHAPTER 15 FINANCING THE BUSINESS Balance sheet as at 31 May

£ £

Non-current assets Property, plant and equipment Fixtures and fittings at cost 90,000 Less Accumulated depreciation 23,000 67,000 Motor vehicles at cost 34,000 Less Accumulated depreciation 27,000 7,000 74,000 Current assets Inventories at cost 198,000 Trade receivables 3,000 201,000 Total assets 275,000 Equity

£1 ordinary shares 20,000 General reserve 4,000 Retained profit 17,000 41,000 Non-current liabilities Borrowings – Loan notes repayable in just over one year’s time 40,000 Current liabilities Trade payables 162,000 Accrued expenses 10,000 Borrowings – Bank overdraft 17,000 Taxation 5,000 194,000 Total equity and liabilities 275,000 Abbreviated income statement for the year ended 31 May

£

Sales revenue 740,000 Operating profit 38,000 Interest charges (5,000)

Profit before taxation 33,000 Taxation (10,000)

Profit for the year 23,000 A dividend of £23,000 was paid for the year.

Notes:

1 The loan notes are secured by personal guarantees from the directors.

2 The current overdraft bears an interest rate of 12 per cent a year.

Required:

(a) Identify and discuss the major factors that a bank would take into account before deciding whether to grant an increase in the overdraft of a business.

(b) State whether, in your opinion, the bank should grant the required increase in the overdraft for Gainsborough Fashions Ltd. You should provide reasoned arguments and supporting calculations where necessary.

612 EXERCISES