CASE

"Aspiring entrepreneurs Bill and Fiona Russell have always had a passion for homebrewing on a small scale. After recent work changes, Bill started researching opening a small brewery, and through an attorney, Bill and Fiona organized Rusty Bucket Brewing Co. LLC. While still in the development stage, they are dedicated to seeing this venture through and need help with all finance-related calculations and assessments that a startup business should understand. Using Microsoft Excel, this case guides undergraduate students through the finances of starting, operating, and growing a small business venture.

Bill and Fiona Russell have always enjoyed craft beer, and in recent years have started making small batches at home. As they have experimented, they mastered several niche recipes including a key lime pie pilsner, peanut butter porter, mint chocolate stout, and a banana bread lager, among other traditional IPAs and ales. They amassed some equipment, but only enough for personal use. Over the years, a groundswell of support came from friends and family urging the pair to take their talents into a full-blown business. Bill and Fiona began entering local and regional homebrew contests, bringing home gold and silver medals in almost every category. At first, these acknowledgments were simply for fun, but over time the two started discussing the idea of starting a business.

Bill Russell has a bachelor's degree in management from a local public university. For the last 6 years he has worked as a sales manager for a local payroll and benefits firm, overseeing a sales staff of eight individuals. Prior to that, Bill worked as a sales manager for a regional distribution company for 8 years. Bill has some exposure to small business and substantial experience in management. However, his overall knowledge of finance, especially as it relates to owning a small business, is lacking.

Fiona Russell has a master's degree in education, and she has taught second grade at the same elementary school since finishing graduate school. Growing up, her family owned a restaurant specializing in Irish fare, so she has some experience working in and around small businesses.

The U.S. Small Business Administration defines a small business as an independent business having fewer than 500 employees (U.S. Small Business Administration, June 2016). As of 2013, there were 28.8 million small businesses and only 18,600 companies with 500 employees or more. While only 20% of these small businesses are employers, they accounted for 63% of net new jobs created between 1992 and 2013. In fact, U.S. small businesses make up 99.7% of U.S. employer firms and employ nearly half of the nation's private-sector workforce (U.S. Small Business Administration, 2017).

Self-employment has surged in recent years as more individuals seek purpose in their careers and the rewarding feeling of owning a small business. However, opening a small business is risky. Approximately two-thirds of businesses survive at least 2 years, only about half survive for at least 5 years, and only about one-third last more than 10 years (U.S. Small Business Administration, 2012). According to Jessie Hagen of U.S. Bank, 82% of small businesses fail because of poor cash flow management, while 79% fail due to insufficient initial funding. These rates have not changed much over the years and are consistent across industries.

Obtaining financing, however, has become easier in recent years. During 2015, bank loans to small businesses totaled almost USD 600 billion (U.S. Small Business Administration, July 2016). Overall, banks still cannot support the financing needs for all small businesses, so these entities typically seek funding from other sources during different stages of their life cycle. During 2015, U.S. small businesses borrowed an additional USD 593 billion from financing companies, angel and venture investors, mezzanine lending, and buyouts. Mezzanine lending represents financing that has seniority to a claim on capital assets of the company. Financing from buyouts occurs when an outside investor or management team purchases a controlling interest in a company.

Development Stage

Bill and Fiona began looking at local commercial properties available for rent or purchase. They also began pricing out the necessary operating equipment and envisioning the ideal venture. Assuming that they could obtain financing, they ultimately settled on developing a microbrewery with enough capacity to manufacture and distribute their beer to local bars/restaurants and retail stores in the forms of kegs and cans, respectively.

Family and friends have continued to be extremely supportive of the venture and have offered to provide some financing. Bill and Fiona have found a location available for rent that would suit all of their manufacturing and restaurant needs. In negotiating terms with the commercial property owner, the couple has agreed to a long-term lease deal at a reasonable rent that will also allow them to make necessary leasehold improvements to the facility.

The couple has met with their friend Madeline, a local business attorney, to discuss entity formation options. These options include a sole proprietorship, C Corporation, S Corporation, limited liability company (LLC), and others. After discussing the possibilities at length, they ultimately settled on an LLC with 50/50 ownership under the legal name Rusty Bucket Brewing Co. LLC. They chose the LLC entity structure based upon the limited liability protection for owners, avoidance of double taxation, and ownership and management flexibility.

Throughout the development stage, Bill and Fiona have done extensive research to estimate their costs. Many of their estimates resulted from their real-estate search while others came from a meeting with another local brewery owner. They have also spoken with a number of retail outlets to negotiate pricing and shelf space for product distribution.

These estimated costs are included on the first tab of the Excel Worksheet. In Phase I, you will calculate annual survival revenues (SR) at these current estimated variable and fixed costs. SR represent the breakeven point where revenues are equal to variable and cash fixed costs. This is also the point where earnings before depreciation, amortization, and taxes (EBDAT) is equal to zero.Please finish the tab labeled Phase ISurvival Revenues in Excel.

Now that Rusty Bucket Brewing Co. LLC is established, the couple hopes to obtain initial commercial lending from a mid-size regional bank. The bank has requested projected income statements, balance sheets, and cash flow statements for the first six months of operations. To provide these projections, the couple must first prepare sales, purchase, and wage payment schedules, as well as a finish cash budget.

As they develop these schedules, Bill and Fiona have made several assumptions. First, they have decided to open the brewery on May 1. Next, they forecasted sales for the first seven months, as given in

They expect most of the sales to come from distribution to local grocery and convenience stores, as well as local restaurants and bars. The brewery will also have its own bar for patrons to buy and consume beverages on-site or take some home in glass bottles called growlers. As such, the LLC estimates that 90% of each month's sales will be credit sales from distribution and 10% cash sales from their on-site bar. The company expects to collect 100% of credit sales in the following month.

For purchases, the couple has decided that target ending inventory for a given month should equal 75% of next month's sales. Additionally, based on industry benchmarks, cost of goods sold is approximately 40% of the current month's sales. Since payment terms with suppliers average 15 days, the company expects cash disbursements to result in 50% of the current month's purchases being paid in the current month, with the remaining 50% to be paid in the following month. Additionally, the company has forecasted monthly wages as shown in

Payroll taxes and benefits are estimated to equal 18% of salaries and wages. Based on the company's payroll schedule, they expect to pay 75% of the salaries earned in any given month, with the remaining 25% paid in the following month as an accrued liability.

Additional monthly expenses for cash budgeting purposes are as follows:

• Rent: USD 16,500, paid monthly on the first of every month.
• Real-estate taxes: USD 20,000 paid in two separate payments of USD 10,000 due and paid in October and USD 10,000 due and paid in January.
• Professional fees: USD 5,000 paid in each of the first three months (May, June, and July) for services rendered for various startup costs.
• Utilities: USD 1,500 paid monthly on the 15th of every month
• Insurance: USD 4,800 paid May 1 for a six-month policy beginning May 1, 2018 and ending October 31, 2018.
• Maintenance: USD 625 monthly.
• Supplies: USD 750 monthly.
• Licenses: USD 250 monthly.
• Advertising: USD 1,650 monthly.

Bill and Fiona have decided that they must maintain a minimum monthly cash balance of USD 25,000, representing approximately one month of payroll expenses. Thus, they have obtained a small line of credit from a family friend who also happens to be an angel investor. The line of credit has a maximum borrowing limit of USD 100,000 with an annual interest rate of 19% paid on any outstanding balance. Interest is due and paid each month following any month with an outstanding balance. In addition, if there is cash in excess of USD 25,000at the end of any month, the outstanding balance on the line of credit will be paid until either the company has hit the USD 25,000 minimum or the loan is paid in full.

The couple has estimated the total cost of opening the brewery at USD 1,000,000. Of this total, USD 150,000 will be used for opening-day working capital or beginning cash balance, with the remaining USD 850,000 used for leasehold improvements, machinery, equipment, and other capital expenditures. Including certain state incentives, Rusty Bucket Brewing Co. LLC believes they will be able to obtain an SBA-guaranteed loan from the bank for USD 750,000. The estimated terms of the note indicate that the monthly payment will be approximately USD 7,300 each month, split between principal payments and interest expense at approximately USD 5,000 and USD 2,300 each month, respectively. In addition, Bill and Fiona have gathered USD 250,000 of their own money from savings, friends, and family, which will be contributed to the business as their beginning owners' equity. In the remaining tabs of Phase I, you will finish the sales, purchases, and wages schedules as well as the corresponding cash budget.Please complete the tabs labeled Phase ISchedules and Phase ICash Budget in Excel.

In meeting with local bankers to discuss a possible loan of USD 750,000 for initial business operations, each bank has requested short-term projected financial statements. The banks require monthly projected income statements, balance sheets, and cash flow statements for the first six months of operations beginning May 1, 2018. For the purposes of these projections, assume that monthly depreciation expense is USD 8,645.

In Phase II, you will prepare the monthly projected income statements, balance sheets, and statements of cash flows for May through October 2018.Please complete the three tabs labeled Phase IIProjected I.S., Phase IIProjected B.S., and Phase IIProjected Cash Flow in Excel.

Survival Stage

It is now October and Rusty Bucket Brewery Co. LLC has been open for six months. While the initial performance has not gone as well as anticipated, the business has still made a small profit and is surviving in the short term. The actual financial statements through six months are presented in the first three tabs of Phase III in the Excel spreadsheet. Net income and cash flows from operations for the period fell short of projections. To better understand how well the company is performing, Bill and Fiona would like to compare their overall financial performance to industry benchmarks.

In Phase III you will complete a number of ratios based upon the actual company results and compare those to the industry benchmarks provided when applicable. These ratios include cash burn and cash build variations. Cash burn rates represent how much the company spends on its operating and financing expenses and its investments in assets. Cash build rates represent how much the company's cash increases from sales less any increase in accounts receivable. Additionally, you must critically examine and comment thoroughly on the ratio analysis and industry comparisons calculated.Please complete Phase IIIRatios in Excel, including comments on the ratio analysis.

Rapid-Growth Stage

Fourteen months later, Rusty Bucket Brewery Co. LLC has not only amassed a good customer base and greater than expected market share, but it is starting to experience a production crunch due to high growth. That's not to say that everything has been great. Bill and Fiona experienced some unforeseen production problems that resulted in significant unexpected expenses and bottlenecks due to waste. The company has experienced increased raw material costs, as well as increases for labor and other operational issues. This is not uncommon during the rapid-growth stage for any business. During this stage, demand often exceeds production capabilities, causing the company to expand or outsource production. Rusty Bucket Brewery Co. LLC had decided to outsource some production to other local breweries with capacity, which has led to substandard production (waste) and increased costs of production overall. Bill and Fiona are at a crossroads, trying to decide if they can continue to grow organically using internally generated funds or if they need to seek debt or equity from external sources to purchase additional production equipment to meet all forecasted production demands in-house.

The complete 2019 financial statements for Rusty Bucket Brewery Co. LLC are displayed under the tabs labeled Phase IV in Excel. Sales appear strong. However, even with supplier discounts for volume purchasing, the gross margin rate has slipped slightly due to waste and outsourcing costs. Cash from operations was extremely strong during the period, providing cash of USD 113,195. However, cash used by financing activities was almost equivalent at USD 103,223, representing cash paid for principal and interest on already-existing debt. In addition, the balance sheet was still very strong, providing a current ratio of 2.4at December 31, 2019. The beginning equity in 2019 was USD 217,500, and no distributions (dividends) have been paid or will be paid soon.

With the injection of additional capital to meet production needs, Bill and Fiona believe the company could grow at a much faster rate than it has been currently. When looking at projected outcomes and forecasts, and based upon previous growth, the couple believes that there is a 40% probability of a 25% increase in sales, a 40% probability of a 15% increase in sales, and a 20% probability of a 5% increase in sales over the next year. Rusty Bucket Brewery Co. LLC. also needs to determine the amount of additional funds needed to meet their current growth forecast, assuming that spontaneously generated funds increase by USD 7,814.

In Phase IV, you will calculate the sustainable sales growth rate, expected sales growth rate, and additional funds needed. Sustainable sales growth rate represents the maximum rate of growth that a company can sustain internally before needing to finance growth with additional equity or debt.Please complete Phase IVRapid-Growth in Excel.

Now that Bill and Fiona understand just how much additional equity the company will need to grow, they must determine whether to raise this money by selling debt or equity. Equity represents selling an ownership interest in their company in exchange for cash needed, in this case for expansion. Debt represents money borrowed that must be paid back with interest, but does not require giving up any ownership interest. In meeting with the bank, lenders are only willing to provide additional financing of USD 50,000 with three-year repayment terms at an interest rate of prime (currently 4.75) + 3, or 7.75%. Next, the couple will meet with the angel investor that provided the company with the short-term line of credit necessary to overcome working capital shortfalls in year 1. The potential angel investor is not interested in financing the company on a long-term basis, but has expressed interest in listening to a pitch to become an investor and part-owner in Rusty Bucket Brewery Co. LLC.

Before the meeting, Bill and Fiona need to understand how to value the equity in their business. This calculation will be an important starting point in negotiating how much money they seek as an investment, and how much ownership they may need to give up to obtain this additional capital. Rusty Bucket Brewery Co. LLC forecasted cash flows for the next four years are USD 45,000 this year, USD 55,000 next year, USD 68,000 in the third year, and USD 85,000 in the fourth year. In the fifth year, the company expects cash flow of USD 100,000. This USD 100,000 is expected to grow at a constant rate of 7% per year after year 5. The expected return for investors from a mature firm is 15%, but angel investors will most likely require a return of approximately 40%. Additional research has also indicated that the comparable industry enterprise value/EBITDA multiple is 7.0 times.

In Phase V you will calculate the equity value of the company based upon two methods. The discounted cash flow method represents calculating the net present value of equity based upon future estimated cash flows of the company at assumed growth and discount rates. The multiple of EBITDA method utilizes an industry benchmark multiple which, when multiplied by the EBITDA of a company, results in enterprise value. Enterprise value is a measure of the company's total value including short- and long-term debt. In order to arrive at equity value, you must subtract short- and long-term debt (not payables or accrued expenses) from the enterprise value.Please complete Phase VEquity Valuation in Excel.

Time to make your pitch! You have 15 minutes to present to the group of angel investors. Remember to focus on your ask (how much money for how much equity) as well as important financial factors that you believe will enhance the group's willingness to invest. Feel free to use Microsoft PowerPoint, Prezi, Excel, handouts, or anything else that you feel is appropriate. Make it count!Please complete Phase VIPresentation."

ANSWER

1. Loan Evaluation

The bank should examine the financial statements, credit history, business plan, and management expertise of the company to assess Rusty Bucket Brewing Co. LLC's request for a USD 750 000 loan. The bank should also consider the loan's objective and the company's capacity for repayment. To secure the loan, the bank may also request collateral or a personal guarantee.

2. SBA Program

Collateral or guaranty is a significant element that is absent from the review above. By establishing lending requirements and lowering lender risk, SBA assists small firms in obtaining capital. It is simpler for small enterprises to obtain the necessary finance thanks to SBA-backed loans. Based on the requirements, quantity, intended use, and credentials of the borrower, the SBA offers a range of loan programs (SBA.gov, n.d). Based on the intended use of the proceeds and the loan size, Rusty Buckets qualifies for an SBA 7(a) loan. For equipment purchases, leasehold improvements, and working capital, they require a $750,000 loan. The SBA 7(a) program has a maximum loan amount of $5 million, which makes it superior to other programs in this regard.Some programs include maximum loan amounts that are less than the necessary $750,000, or the loan's intended use disqualifies it for the Rusty Bucket Brewery. The company's repayment terms under the SBA 7(a) program are similarly favorable. Looking at the other SBA lending program, none of the other programs gives $750,000 in financing.

The loan for Rusty Bucket Brewery Co. LLC would probably be funded by the bank through the SBA 7(a) program. A portion of the loan is offered a government guarantee through the SBA 7(a) program, lowering the risk for the lender. Another choice is the SBA 504 program, which is more frequently utilized to purchase major pieces of equipment or real estate. The SBA 7(a) program would be preferred in this circumstance because it gives the borrower more freedom in how the funds can be used.

3. Limitations

The unpredictable nature of future events and market conditions is one of the difficulties in producing predicted financial statements, cash budgets, sales, purchases, and wage schedules. Reasonable assumptions based on historical data, market trends, and industry benchmarks should be made to ensure that these reports are as accurate and helpful as practicable. It's also essential to regularly update the projections and adjust them as necessary in light of actual results

4. How to move further on?

If I were them, wouldbe to look intothe ratios for StageIII,the SurvivalStage,anddeterminehow every single ratioimpactsthecompany.I'llfocus particularly onsales, gross margin, and operatingmargin to evaluate the state of the firm and pinpoint potential areas for improvement. When determining whether the business is profitable enough to last over the long term,I would alsotakecash flow ratiosinto account. Afterward, I shall devise a plan of actiontotake up those concerns, and I'll monitor the results to measurethesuccess of that plan. In addition to working to increase our gross margin, The improvement of the inventory turnover percentage will remain my primary concern. To make sure they have enough cash on hand to cover their current obligations, I would, however, look at the liquidity ratios. The debt-to-cash ratios might have also been examined to ensure that there was sufficient cash on hand to repay the loan and that it wasn't being utilized excessively. To determine whether the business is still profitable in the survival stage, I'll keep going and look at the ratios. If the business is not making money, I will seek ways to cut costs.

I would look at the ratios that represent the financial health of our firm to ensure we are making progress in the most crucial areas. I'll also take a look at their ratios to evaluate how we stack up against our rivals and where we need to make adjustments. I would also keep trying to lower expenses and raise revenue. We'll keep working to invest in the future and save money for unforeseen expenses.

Likewise, I'll look into the business's competitors.

5. Investment

Rusty Bucket Brewing Co. LLC's choice to invest would be based on several factors, including the company's financial performance, growth potential, and industry projection, based on what we know at the end of Phase V. Also, it would depend on the investor's risk appetite and investing goals. It is essential to conduct a thorough analysis of the company's financial statements, business plan, and market trends before making an investment choice.

The business, on the other hand, has a strong management team and a clear plan. That might be a wise investment if everything goes as the corporation has planned. This deal does, however, include a substantial risk. Based on the financial health of the company, I wouldn't invest.

6. Expected change ingross profit, income from operations, and net income

One would predict that the gross profit, income from operations, and net income would rise over time given the company's projected expansion and ongoing sales growth. However, real changes in these indicators would depend on several variables, including the pricing strategy, cost structure, and market situation of the organization. Also, it's critical to keep an eye on the company's cash flow and liquidity to make sure it can sustain its expansion ambitions.

PLEASE PROVIDE PROPER INTRO AND CONCLUSION