Ashley Palmer Clothing, Inc., produces dresses for women. The firm was launched in June 2009 by Ashley Jantz and Amanda Palmer, both graduates of Boston College. Ash- ley Palmer designs apparel for the modern woman's shape rather than using the traditional standard sizing. Sales continued to increase over the next three years, reaching $4.7 million in 2013. During this same time, the number of employees grew from 7 to 16. The company also moved into a 4,000-square-foot facility and added addi- tional sewing equipment and presses. History of Sizing Clothing In 1939, the National Bureau of Home Economics of the U.S. Department of Agriculture was charged with stan- dardizing sizing for women's clothing. Over a two-year period, some 15,000 women were given full-body measure- ments. This system created the sizing system that is still in use today. Studies have found that the average body proportions of American women when the sizing charts were created are different from the body proportions of today's women. Specifically, American women in 1939 were markedly more slender and shorter. The result is that it is difficult for some women to find clothing that fits well. In the Septem- ber 2009 issue of Fashionista Magazine, Jantz, who stands six feet tall, said: [We were tired of not finding the clothes that were the right fit so we decided it would be a good venture to create products for today's women based on bust measurement, cup size and torso length. Planning for Growth In August 2013, Ashley Palmer ventured into creating pro- fessional attire for young women. The products received rave reviews. Within three months, the retail outlets had sold over 90 percent of their inventories, quickly placing orders for more products. The founders, while excited about the prospect of sales growth, began to worry. Based on their estimates, the company would most probably experience a 50 percent growth rate, compared to the 25 percent they had experi- enced over the past two years. They knew that if they were to avoid cash flow problems from the anticipated growth, they needed to anticipate the asset requirements and addi- tional financing that would be required to sustain their business. The owners believed they would need to purchase state-of-the-art industrial sewing machines, cutting tables, and pressing machines at a cost of $280,000. The new equipment would be depreciated over 14 years, using straight-line depreciation. Jantz also thought that the fol- lowing assumptions were appropriate: 1. Cash, accounts receivable, and inventory would follow their same relationships to sales as in the past two years; that is, each asset would maintain the average asset-to-sales percentages experienced in 2012 and 2013 2. Both cost of goods sold and marketing expenses are variable and would approximate the same percentage of sales as in 2012 and 2013. 3. General and administrative costs are fixed in nature but should increase to $130,000 in the next year. 4. The interest rates on the already outstanding debt would be renegotiated, which would reduce the inter- est on this debt to $45,000. 5. The firm's tax rate should be about 40 percent. The Opportunity For Jantz and Palmer, this problem represented an oppor- tunity. After considerable research, they decided to start a business that produced fitted clothing for today's young women. They recruited a young up-and-coming fashion designer, Joy Lee, who had experience in apparel design for several major women's clothing brands. Seven months after starting the business, they offered their first dresses for sale online. Then, in early 2010, the firm began supplying clothes to two well-known high-end retailers. Within a year after becoming a supplier to these exclusive retail outlets, the company's production orders had more than doubled. In order to keep up, the firm added five more team mem- bers in October 2010. To meet the firm's financing needs, Palmer has negoti- ated a line of credit (short-term debt) with Amway Bank for up to $100,000. The bank has also agreed to loan the firm $150,000 for purchasing new equipment; this is to be repaid over five years. The principal on the latter loan is to be repaid in $30,000 annual payments, with interest pay- ments being made on the remaining balance of the note. Both notes will carry a 5 percent interest rate. The short- term notes payable and long-term debt owed in 2013 will be reduced by S50,000 and $30,000, respectively. Accounts payable and other current liabilities should increase pro- portionally with sales increases. Finally, Jantz and Palmer are willing to provide more of their own money in the form of equity up to a total of $100,000 in equity if needed. They will also lower the amount of dividends they have been paying themselves (about 40 percent of earnings over the past two years). They both have decided to limit their dividends individu- ally to $15,000, or a total of $30,000. 2013 $4,700,000 (3,877,500) $ 822,500 (275,000) 100.0% 82.5% 17.5% 5.9% Ashley Palmer Clothing, Inc. Income Statements for the Years Ending December 31, 2011, 2012, and 2013 2011 2012 Sales $3,000,000 100.0% $3,760,000 100.0% Cost of goods sold (2,400,000) 80.0% (3,045,600) 81.0% Gross profits $ 600,000 20.0% $ 714,400 19.0% Marketing expenses (215,000) 7.2% (250,000) 6.6% General & administrative expenses (90,000) 3.0% (100,000) 2.7% Depreciation expense (25,000) 0.8% (25,000) 0.7% Operating profits $ 270,000 9.0% $ 339,400 9.0% Interest expense (66,000) 2.2% (66,000) 1.8% Profits before taxes $ 204,000 6.8% $ 273,400 7.3% Taxes @ 40% (81,600) (109,360) 2.9% Net profits $ 122,400 4.1% $ 164,040 4.4% 2.3% 0.5% 8.8% (110,000) (25,000) $ 412,500 (66,000) $ 346,500 (138,600) 1.4% 7.4% 2.9% 4.4% 2.7% $ 207,900 Dividends paid Addition to retained earnings $ (48,960) $ 73,440 $ (65,616) $ 98,424 $ (83,160) $ 124,740 2012 2013 Ashley Palmer Clothing, Inc. Balance Sheets for the Years Ending December 31, 2011, 2012, and 2013 2011 Assets Cash $ 48,000 Accounts receivable 150,000 Inventory 335,000 Total current assets $ 533,000 Plant & equipment $ 560,000 Accumulated depreciation (125,000) Net plant & equipment $ 435,000 TOTAL ASSETS $ 968,000 $ 60,000 246,816 511,500 $ 95,424 175,000 390,000 $ 660,424 $ 560,000 (150,000) $ 410,000 $1,070,424 $ 818,316 $ 560,000 (175,000) $ 385,000 $1,203,316 2013 $ 135,000 275,000 Balance Sheets for the Years Ending December 31, 2011, 2012, and 2013 (continued) 2011 2012 Debt (Liabilities) and Equity Accounts payable $ 128,000 $ 153,000 Short-term notes payable 250,000 275,000 Other current liabilities 46,000 50,000 Total current liabilities $ 424,000 $ 478,000 Long-term debt 300,000 250,000 Total debt $ 724,000 $ 728,000 Owner's capital $ 155,560 $ 155,560 Retained earnings 88,440 186,864 Total equity $ 244,000 $ 342,424 TOTAL DEBT AND EQUITY $ 968,000 $1,070,424 51,152 $ 461,152 275,000 $ 736,152 $ 155,560 311,604 $ 467,164 $1,203,316 Questions 1. Given the assumptions that Jantz and Palmer have made, prepare a pro forma income statement and balance sheet for 2014. Assume that the line of credit provided by the bank will be needed for the full year. 2. Using the financial ratios presented in Chapter 10, compare Ashley Palmer's ratios over time, including the pro forma ratios for 2014. If the bank requires a current ratio of at least 1.5 and a debt ratio not to exceed 55 percent, can the owners expect to be able to honor these covenants? 3. Prepare a statement of cash flows for 2013 and the 2014 projections. What did you learn from these statements? Ashley Palmer Clothing, Inc., produces dresses for women. The firm was launched in June 2009 by Ashley Jantz and Amanda Palmer, both graduates of Boston College. Ash- ley Palmer designs apparel for the modern woman's shape rather than using the traditional standard sizing. Sales continued to increase over the next three years, reaching $4.7 million in 2013. During this same time, the number of employees grew from 7 to 16. The company also moved into a 4,000-square-foot facility and added addi- tional sewing equipment and presses. History of Sizing Clothing In 1939, the National Bureau of Home Economics of the U.S. Department of Agriculture was charged with stan- dardizing sizing for women's clothing. Over a two-year period, some 15,000 women were given full-body measure- ments. This system created the sizing system that is still in use today. Studies have found that the average body proportions of American women when the sizing charts were created are different from the body proportions of today's women. Specifically, American women in 1939 were markedly more slender and shorter. The result is that it is difficult for some women to find clothing that fits well. In the Septem- ber 2009 issue of Fashionista Magazine, Jantz, who stands six feet tall, said: [We were tired of not finding the clothes that were the right fit so we decided it would be a good venture to create products for today's women based on bust measurement, cup size and torso length. Planning for Growth In August 2013, Ashley Palmer ventured into creating pro- fessional attire for young women. The products received rave reviews. Within three months, the retail outlets had sold over 90 percent of their inventories, quickly placing orders for more products. The founders, while excited about the prospect of sales growth, began to worry. Based on their estimates, the company would most probably experience a 50 percent growth rate, compared to the 25 percent they had experi- enced over the past two years. They knew that if they were to avoid cash flow problems from the anticipated growth, they needed to anticipate the asset requirements and addi- tional financing that would be required to sustain their business. The owners believed they would need to purchase state-of-the-art industrial sewing machines, cutting tables, and pressing machines at a cost of $280,000. The new equipment would be depreciated over 14 years, using straight-line depreciation. Jantz also thought that the fol- lowing assumptions were appropriate: 1. Cash, accounts receivable, and inventory would follow their same relationships to sales as in the past two years; that is, each asset would maintain the average asset-to-sales percentages experienced in 2012 and 2013 2. Both cost of goods sold and marketing expenses are variable and would approximate the same percentage of sales as in 2012 and 2013. 3. General and administrative costs are fixed in nature but should increase to $130,000 in the next year. 4. The interest rates on the already outstanding debt would be renegotiated, which would reduce the inter- est on this debt to $45,000. 5. The firm's tax rate should be about 40 percent. The Opportunity For Jantz and Palmer, this problem represented an oppor- tunity. After considerable research, they decided to start a business that produced fitted clothing for today's young women. They recruited a young up-and-coming fashion designer, Joy Lee, who had experience in apparel design for several major women's clothing brands. Seven months after starting the business, they offered their first dresses for sale online. Then, in early 2010, the firm began supplying clothes to two well-known high-end retailers. Within a year after becoming a supplier to these exclusive retail outlets, the company's production orders had more than doubled. In order to keep up, the firm added five more team mem- bers in October 2010. To meet the firm's financing needs, Palmer has negoti- ated a line of credit (short-term debt) with Amway Bank for up to $100,000. The bank has also agreed to loan the firm $150,000 for purchasing new equipment; this is to be repaid over five years. The principal on the latter loan is to be repaid in $30,000 annual payments, with interest pay- ments being made on the remaining balance of the note. Both notes will carry a 5 percent interest rate. The short- term notes payable and long-term debt owed in 2013 will be reduced by S50,000 and $30,000, respectively. Accounts payable and other current liabilities should increase pro- portionally with sales increases. Finally, Jantz and Palmer are willing to provide more of their own money in the form of equity up to a total of $100,000 in equity if needed. They will also lower the amount of dividends they have been paying themselves (about 40 percent of earnings over the past two years). They both have decided to limit their dividends individu- ally to $15,000, or a total of $30,000. 2013 $4,700,000 (3,877,500) $ 822,500 (275,000) 100.0% 82.5% 17.5% 5.9% Ashley Palmer Clothing, Inc. Income Statements for the Years Ending December 31, 2011, 2012, and 2013 2011 2012 Sales $3,000,000 100.0% $3,760,000 100.0% Cost of goods sold (2,400,000) 80.0% (3,045,600) 81.0% Gross profits $ 600,000 20.0% $ 714,400 19.0% Marketing expenses (215,000) 7.2% (250,000) 6.6% General & administrative expenses (90,000) 3.0% (100,000) 2.7% Depreciation expense (25,000) 0.8% (25,000) 0.7% Operating profits $ 270,000 9.0% $ 339,400 9.0% Interest expense (66,000) 2.2% (66,000) 1.8% Profits before taxes $ 204,000 6.8% $ 273,400 7.3% Taxes @ 40% (81,600) (109,360) 2.9% Net profits $ 122,400 4.1% $ 164,040 4.4% 2.3% 0.5% 8.8% (110,000) (25,000) $ 412,500 (66,000) $ 346,500 (138,600) 1.4% 7.4% 2.9% 4.4% 2.7% $ 207,900 Dividends paid Addition to retained earnings $ (48,960) $ 73,440 $ (65,616) $ 98,424 $ (83,160) $ 124,740 2012 2013 Ashley Palmer Clothing, Inc. Balance Sheets for the Years Ending December 31, 2011, 2012, and 2013 2011 Assets Cash $ 48,000 Accounts receivable 150,000 Inventory 335,000 Total current assets $ 533,000 Plant & equipment $ 560,000 Accumulated depreciation (125,000) Net plant & equipment $ 435,000 TOTAL ASSETS $ 968,000 $ 60,000 246,816 511,500 $ 95,424 175,000 390,000 $ 660,424 $ 560,000 (150,000) $ 410,000 $1,070,424 $ 818,316 $ 560,000 (175,000) $ 385,000 $1,203,316 2013 $ 135,000 275,000 Balance Sheets for the Years Ending December 31, 2011, 2012, and 2013 (continued) 2011 2012 Debt (Liabilities) and Equity Accounts payable $ 128,000 $ 153,000 Short-term notes payable 250,000 275,000 Other current liabilities 46,000 50,000 Total current liabilities $ 424,000 $ 478,000 Long-term debt 300,000 250,000 Total debt $ 724,000 $ 728,000 Owner's capital $ 155,560 $ 155,560 Retained earnings 88,440 186,864 Total equity $ 244,000 $ 342,424 TOTAL DEBT AND EQUITY $ 968,000 $1,070,424 51,152 $ 461,152 275,000 $ 736,152 $ 155,560 311,604 $ 467,164 $1,203,316 Questions 1. Given the assumptions that Jantz and Palmer have made, prepare a pro forma income statement and balance sheet for 2014. Assume that the line of credit provided by the bank will be needed for the full year. 2. Using the financial ratios presented in Chapter 10, compare Ashley Palmer's ratios over time, including the pro forma ratios for 2014. If the bank requires a current ratio of at least 1.5 and a debt ratio not to exceed 55 percent, can the owners expect to be able to honor these covenants? 3. Prepare a statement of cash flows for 2013 and the 2014 projections. What did you learn from these statements