Case Link Question (10) Directions: Click the Case Link above and use the information provided in Hearth and Home, Parts A, B, and C, to answer this question: The owners of Hearth and Home are asking for a substantial increase in their line of credit, based on the sales increases they expect in the future. Given the facts of the case, would you increase the line of credit? Why? If not, what would you do instead? O NO. The fact that the company has not been able to clean up its line of credit during two consecutive years indicates financial problems. Look for a way out of the relationship. Yes. An increase in the line of credit will support the company's sales growth, which is evident in its inability to clean up the current line of credit. No. The company is experiencing long-term sales growth and an increase in core current assets. Those should be financed with long-term credit. With this new financing, the current line of credit will be sufficient. Yes. The proposed 20% increase in the line matches the sales growth rate expected next year, so it makes sense. Hearth and Home Part A Company Information Hearth and Home sells, installs, and services residential fireplaces. Formed 22 years ago by Len Wilkinson as a retailer of fireplaces and accessories, the company installed virtually all of the old and guaranteed its work for 10 years. The company built a reputation for prompt, quality workmanship and gradually, starting six years ago, several of the area's leading contractors began to subcontract chimney and fireplace installation to Hearth and Home During its early years, most of the company's sales took place from October to March. As it expanded, subcontracting sales occurred throughout the year, though slightly more in the summer months. Sales are now fairly evenly divided between retail and subcontracting The Wilkinsons have financed the company with long-term debt. The family has provided term loans totaling $350,000, and your organization has provided $200,000 in long-term debt. Your organization also made available to the company what is now a $400,000 revolving credit. H and H may borrow up to 50 percent of receivables outstanding for less than 60 days and up to 40 percent of inventory, excluding inventory work in process. The company must be out of debt for 30 consecutive days during the second quarter of every calendar year. Until the end of 2043, the company was a model customer, meeting the second-quarter 30-day clean-up requirement fairly easily in 20Y1 and 2072. At the end of fiscal 20Y3, however, the company was unable to clean up the line. In fact, at the end of June, the outstanding balance was $101,000, the company having been unable to reduce the line significantly below $100,000 at any time during the entire second quarter. The balance outstanding on the last day for which you have data was $153,000. John Holmgren is the lender responsible for the relationship, and he has asked you for assistance in deciding how to handle the loan. When the company could not meet the cleanup requirement, John waived the requirement based on the company's past history and performance. In John's opinion, H and H's management has such high integrity that your organization will be able to recover its money, he believes that the owners would sell their houses if necessary to repay the debt. Having said that, John is also aware that the owning family depends upon dividend income and considers an annual dividend of at least $80,000 to be mandatory John is feeling the dissatisfaction of credit management, which is unhappy with his decision to waive the clean-up. He needs to come up with a solution to the problem that will meet both the company's and your organization's needs. As you and John discuss the situation, he tells you that H and H's management expects sales to increase significantly in 2014 and that part of that increase will be due to additional contracting - mainly repairing older installations by a couple of competitors that have since gone out of business, The Wilkinsons have proposed that the limit on the revolving credit be increased to $500,000. Hearth and Home Part B Hearth and Home Balance Sheets (in $000s) As At June 30 2013 2012 2011 $ 123 $ 100 ASSETS Current assets Cash Accounts receivable Inventory Other current assets Total current assets 303 66 3769 5474 107 461 70 957 240 417 117 1,096 874 Fixed assets 3134 257 245 Trademarks and goodwill 10771 71 TOTAL ASSETS 1.516 $ 1,285 $ 1,190 67 $ LIABILITIES AND OWNERS' EQUITY Current liabilities Current portion-LTD Notes payable Accounts payable Accrued expenses Other current liabilities Total current liabilities 244 46 527 Long-term debt Other noncurrent liabilities Owners' equity 639 501 389 TOTAL LIABILITIES AND OWNERS' EQUITY $ 1,516 $ 1,285 $ 1,190 Working investment $ 610 $ 496 $ 452 Hearth and Home Part B Hearth and Home Income Statements (in $000s) Years Ended June 30: $ 2013 3,570 2,467 1,103 Sales Cost of goods sold Gross profit $ 2012 3,000 2,093 907 2011 2,500 1,773 727 36 Interest expense Depreciation expense Operating expense Profit before taxes 50 33 52 477 345 371 Taxes 149 Net profit after taxes 233 $ Dividends 95 84 Earnings retained $ 138 $ 112 Hearth and Home Part B Quick Cash Flow (in 9000s) W GFA (U) U S S Company Name Health and 233 Net profit Plus: Depreciation, amortization expense Plus (or less): 4 Working investment Equals: Cash after operating cole Plus (or less): A Gross fixed assets Equals: Cash after capital investment cycle (92) (95) 167 (75) Less: Dividends declared Equals: Cash available for all debt repayment Less: Current portion long-term debt (prior year) Equals: Cash available for other debt repayment Change in working investment Accounts receivable (net) Plus: Inventory Less: Accounts payable Less Accrued expenses Equals: Working investment BEGINNING ENDINS 303 240 417 204 452 496 Beginning working investment Less: Ending working investment Equals: A Working investment 2042 BEGINNING ENDING 376 Change in working investment Accounts receivable (net) Plus Inventory Less Accounts payable Less: Accrued expenses Equals: Working investment 461547 204 496 610 496 Beginning working investment Less: Ending working investment Equals: A Working investment 2093 ENDING BEGINNING Change in working investment Accounts receivable (net) Plus: Inventory Less Accounts payable Less: Accrued expenses Equals: Working investment Beginning working investment Less: Ending working investment Equals: A Working investment Are any changes in income taxes payable interest payable, prepaid expenses, investments, or miscellaneous other accounts large enough to distort quick cash flow? Hearth and Home Part C Cash Flow Summary (in S000s) Company Name: Hearth and Home Line Number 20Y2 3.000 2013 3.570 (73) 3.497 0 2937 12.093) (2.467) U (2,081) (2,513) - U - 856 (586) (10) (12) (8) + (12) = (13) (581) 403 154) 1189) 1242) 16: (36) Sales revenue (net) A Accounts receivable Cash collected from sales Cash cost of goods sold A Inventory Accounts payable Cash paid for production Cash from trading activities Cash SG&A expense A Prepaid expenses A Accrued expenses Cash paid for operating costs Cash after operations Other Income (expense) A Other current and non-current accounts Income tax expense A Deferred income taxes A Income taxes payable Taxes paid and other income (expense) Net cash after operations Interest expense A Interest payable Dividends declared or owners withdrawals A Dividends payable Cash paid for dividends and interest Cash after financing costs Current portion long-term debt (prior year) Cash after debt amortization A Fixed assets A Investments A Intangibles Cash paid for plant and investments Financing surplus (requirement) A Short-term debt (notes payable) A Long-term debt A Preferred stock A Common stock Total external financing Financing surplus (requirement) Total external financing PROOF: A Cash and marketable (95) 0 (131) (20) + (25) = (20) (67) (37) (26) + (27) = (28) (20) (30) (116) (116) (153) (20) + (32) = (33) (35) (37 (33) . (36) (39)