Blue Ridge Bike and Hike (Blue Ridge) was expanding. In the mid-Atlantic region, the chain of outdoor equipment focused on bike touring and backpack camping had increased sales by 25% for each of the last two years and was expecting about 20% growth in 2015. Blue Ridge had achieved this sales growth through carefully designed store expansions and one new store opening that together leveraged the stores reputation for helpful and knowledgeable staff. Financing the recent growth had been accomplished with little planning. Blue Ridge had increased longterm borrowing to cover some needed investments in store infrastructure (display structures and leasehold improvements), and annual income was able to finance much of the needed investment in inventory (a major commitment of resources). However, financing the anticipated growth in 2015 was going to require careful thought. Blue Ridge would need significant leasehold investments in 2015, some of which were needed to fully absorb past growth, and there was no opportunity for additional long-term borrowing. Furthermore, management was concerned that the cash balance in the companys account had not kept pace with the expansion and, in fact, was slightly below the 2012 level. Finally, as of the end of 2014, Blue Ridge had an outstanding balance on its bank line of credit equal to $101,000. While this was below the $200,000 maximum Blue Ridge could borrow against the line, this was an unusually high level for the end of the year. Pedro Morales, Blue Ridges financial manager, had joined Blue Ridge right out of college four years before as an accountant. He took over the top finance job just two years later. Now Morales was asked to put together a financial plan. Given the companys profitability, it was possible Blue Ridge might squeak by on internally generated funds. Yet it could also be the case that the company would have to seek other sources of funds or renegotiate its line of credit with National Bank, the bank that provided the credit line and had handled all Blue Ridge banking needs since its founding 11 years before. Strategy and Expansion The customer-facing strategy of Blue Ridge was built on knowledgeall staff members were hired because of their past biking and backpack camping experience and were expected to stay actively engaged. Blue Ridge encouraged employees to take time off if it involved activities related to the business; sponsored employees who participated in bike races; offered gear to employees at deep discounts for specific planned events; and even offered paid vacation time for particularly notable events. Among the floor sales staff, five had thru-hiked the Appalachian Trail within the previous three years. The staff engaged shoppers not only with information on the gear sold, but also with great stories and trip advice that motivated shoppers to be active. The business strategy of Blue Ridge was also pretty clear: Put stores in more remote areas but near to major recreational destinations and do not buy buildings (low rental expense and no mortgages); attract customers through extensive inventory (low inventory turnover); offer moderately low but not discount prices (average margins); and provide favorable terms to organizations that bought on account (long receivables). In fact, forging strong relationships with local organizations was a particularly important part of Blue Ridges strategy, even though account sales were a small part of overall salesthe vast majority of sales were credit-card sales in stores. Steadily increasing profits suggested this combination of decisions was successful. Financial statements for the last three years are shown in Exhibits 1 and 2. Funding Growth Besides retained earnings (the company paid a small but steady dividend of $50,000 each year, equal to only 15% of net income in 2014), the company financed operations with two sources of funds. The first was a longterm loan provided by a local group of investors who had organized a fund for supporting small businesses. Blue Ridge had borrowed $550,000 initially from the group, had raised that to $650,000 three years before, and last year had raised it again to $750,000. The group was pleased with Blue Ridge, but had indicated with the last increase that no further increase would be available for the next few years. The second source of financing was a bank line of credit from National Bank. This line of credit was ostensibly for the purpose of financing Blue Ridges working capital needs, primarily inventory. Given the seasonal nature of the activities of its shoppers, Blue Ridges inventory would vary during the year. There were two peaks: the first at the start of spring, as stores stocked up on items they would sell as shoppers needed them, and the second in late November, as the stores stocked up on gift items for the holidays. The inventory low point was usually at the end of the year or shortly thereafter. The high was early spring, usually around late April or early May. The difference in inventory could easily be $250,000. Financial Forecast To evaluate borrowing needs for 2015, Morales worked with the other top Blue Ridge managers to generate a set of baseline assumptions: Sales will reach $11 million by the end of 2015. Income statement ratios would be consistent with recent results: cost of goods sold at 69% of sales; operating expense at 25% of sales; and the provision for income taxes at 27% of income before income taxes. Interest expense would depend, of course, on the extent of assumed borrowing. Morales decided to assume interest expense of $65,000 for his baseline, the same as in 2014. He was aware that the average interest rate paid on all borrowings was likely to be about 7.5%. Days receivable were forecast to be 18.00 days, which was consistent with 2014 results. The 2014 ratio was historically high but consistent with the gradual shift in customers as Blue Ridge expanded sales to groups and clubs that expected generous payment terms on some purchases. This shift in customers would not be reversed nor continued, so no additional lengthening in days receivable would be expected for 2015. The target level of cash was agreed upon to be 3% of sale Inventory turnover was forecast to be 5.3 times, consistent with results prior to 2014the inventory level in 2014 was considered lower than optimal, and some stores had experienced stock outs. Days payable was expected to remain close to recent levels and forecast to be 34.00 days. Accrued expenses was expected to return to a more typical level after some unusual accruals in 2014. A reasonable forecast would be 1.4% of sales. Blue Ridge expected to increase net property by $180,000, reflecting $230,000 in capital expenditures and $50,000 in depreciation. Capital expenditures were $164,000 in 2013 and $221,000 in 2014. Blue Ridge expected to continue paying a dividend of $50,000. With these assumptions in hand, Morales turned his attention to building a forecast. He knew that the principal question on everyones mind was whether Blue Ridge would have the financial resources to keep the company going over the next year. This meant not only funding growth but funding temporary increases in inventory as well. The only financing option readily available was the banks line of credit, but Morales had reservations as to whether the line of credit was the appropriate source for financing some of the investments needed to grow the company. Exhibit 1 Blue Ridge Bike and Hike Income Statement for the Year Ending December 31 of the Indicated Year (in thousands of US dollars) 2012 2013 2014 Net sales 5,842 7,301 9,132 Total cost of goods sold 3,892 4,957 6,310 Gross profit 1,950 2,344 2,822 Operating expenses 1,587 1,855 2,257 Earnings before interest and taxes 363 489 565 Interest expense 54 59 65 Income before income taxes 309 430 500 Provision for income taxes 83 116 135 Net income 226 314 36 Blue Ridge Bike and Hike Balance Sheet as of December 31 of the Indicated Year (in thousands of US dollars) 2012 2013 2014 Cash 186 209 180 Accounts receivable 252 334 457 Inventory 732 934 1,254 Current assets 1,170 1,477 1,891 Net property 522 645 832 Total assets 1,692 2,122 2,723 Accounts payable 379 492 587 Accrued expenses 83 122 152 Bank line of credit 26 40 101 Current liabilities 488 654 840 Term loan 650 650 750 Total liabilities 1,138 1,304 1,590 Owners equity 554 818 1,133 Total liabilities and net worth 1,692 2,122 2,723