Daley Corp has requested a Line of Credit(LOC)from your bank.You have been assigned to evaluate the firm, determine if a LOC is appropriate, and if you recommend the LOC -specify the LOC terms. The LOC terms are to include: maximumlimit of the LOC;estimateof when the limit will be reached;determine the firms ability to fully repay the LOC;and determinebywhen the LOC must be fully repaid.

[Note: a Line of Credit is a type of short-term loan where the client may borrow (draw down the line) up to a pre-specified limit. The loan must be then fully satisfied (100% paid down) by a date certain. All of the terms are specified in advance]

To evaluate the Daley Corp request you must prepare a Cash Budget for the next year using the following criteria & Daley Corp provided data.

The Sales forecast,Selling expenses, G&A expenses, scheduled long-term Interest payments, and scheduled IRS Income Tax payments are described in the following schedule.

The firms Collection schedule has been historically consistent and is expected to remain the same into the next year. That schedule is: 10% in current month; 50% in next month; and 40% in the following month.

The firm purchases production materials 1 month prior to the sale and the cost of the purchase is 45% of the expected sale amount.

Daleys A/P trade credit policy is to pay 25% of purchases immediately; 55% in the next month; and the remaining 20% in the following month.

Production expenses are 30% of the prior months sales.

Daleys opening cash balance at the start of Jan in the forecast year will be $9,300.

Daley Corp is required to maintain a minimum cash balance of $8,000

nov Sales Collections 15% current 60% Mth +1 25% Mth +2 Inflows Disbursements Purchases 30% current 60% Mth +1 10% Mth +2 Materials dec Jan 0 0 0 0 - May - Jun - Jul - Aug - Sep - Oct - Nov - Dec 0 0 0 0 - Apr 0 0 0 - Mar 0 0 0 Feb - - 5,120 1,536 Outflows 0 0 Net CF 0 - - - - - - - - - - - Production Selling G&A Interest pmts Tax pmts - - - - - - - - - - - - - - - - - - - - - - - - 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 7,500 7,500 7,500 7,500 7,500 7,500 7,500 7,500 7,500 7,500 7,500 7,500 0 CASH POSITION Open Balance Net CF Closing Balance Min Balance Surplus/Deficit nov Sales Collections 15% current 60% Mth +1 25% Mth +2 Inflows Disbursements Purchases 30% current 60% Mth +1 10% Mth +2 Materials dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 0 0 - - - - - - - - - - - - 0 0 0 - - - - - - - - - - - - 0 0 - - - - - - - - - - - - 0 0 0 0 0 0 0 - - - - - - - - - - - 5,120 1,536 1,536 - - - - - - - - - - - - Production Selling G&A Interest pmts Tax pmts - - Outflows 0 0 - - - - - - - - - - - 1,536 Net CF 0 0 - - - - - - - - - - - (1,536) CASH POSITION Open Balance Net CF Closing Balance 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 9,500 (1,536) 7,964 Min Balance Surplus/Deficit 7,500 2,000 7,500 2,000 7,500 2,000 7,500 2,000 7,500 2,000 7,500 2,000 7,500 2,000 7,500 2,000 7,500 2,000 7,500 2,000 7,500 2,000 7,500 464 nov Sales Collections 10% current 50% Mth +1 40% Mth +2 Inflows Disbursements Purchases 25% current 55% Mth +1 20% Mth +2 Materials dec Net CF CASH POSITION Open Balance Net CF Closing Balance Min Balance Surplus/Deficit Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 15000.00 13800.00 12900.00 13500.00 15000.00 17000.00 19000.00 21000.00 22000.00 20000.00 17000.00 16000.00 15000.00 15000.00 1500.00 1380.00 7500.00 1500.00 8880.00 14190.00 13320.00 13410.00 14600.00 16400.00 18400.00 20300.00 21400.00 20500.00 18100.00 16300.00 15400.00 6210.00 1552.50 5805.00 1451.25 3415.50 1552.50 4866.75 1290.00 6900.00 6000.00 1350.00 6450.00 5520.00 1500.00 6750.00 5160.00 1700.00 7500.00 5400.00 1900.00 8500.00 6000.00 2100.00 2200.00 2000.00 1700.00 9500.00 10500.00 11000.00 10000.00 6800.00 7600.00 8400.00 8800.00 1600.00 8500.00 8000.00 1500.00 8000.00 6800.00 1500.00 7500.00 6400.00 1552.50 -52.50 6075.00 1518.75 3192.75 1242.00 5953.50 6750.00 1687.50 3341.25 1161.00 6189.75 7650.00 1912.50 3712.50 1215.00 6840.00 8550.00 2137.50 4207.50 1350.00 7695.00 9450.00 2362.50 4702.50 1530.00 8595.00 9900.00 2475.00 5197.50 1710.00 9382.50 9000.00 2250.00 5445.00 1890.00 9585.00 7650.00 1912.50 4950.00 1980.00 8842.50 7200.00 1800.00 4207.50 1800.00 7807.50 6750.00 1687.50 3960.00 1530.00 7177.50 6750.00 1687.50 3712.50 1440.00 6840.00 6750.00 1687.50 3712.50 1350.00 6750.00 4140.00 1800.00 1000.00 Production Selling G&A Interest pmts Tax pmts Outflows Jan 3870.00 1800.00 1000.00 4050.00 1800.00 1000.00 4500.00 1800.00 1000.00 1000.00 3200.00 5100.00 1800.00 1000.00 5700.00 1800.00 1000.00 6300.00 1800.00 1000.00 6600.00 1800.00 1000.00 1000.00 6000.00 1800.00 1000.00 5100.00 1800.00 1000.00 4800.00 1800.00 1000.00 4500.00 1800.00 1000.00 1000.00 3200.00 3200.00 3200.00 4866.75 12893.50 12859.75 13690.00 19195.00 16495.00 21082.50 18685.00 19242.50 19807.50 15077.50 14440.00 18250.00 4013.25 1296.50 460.25 -280.00 -4595.00 -95.00 -2682.50 1615.00 9300.00 1296.50 10596.50 9500.00 460.25 9960.25 9500.00 9500.00 -280.00 -4595.00 9220.00 4905.00 9500.00 9500.00 9500.00 9500.00 9500.00 9500.00 9500.00 9500.00 -95.00 -2682.50 1615.00 2157.50 692.50 3022.50 1860.00 -2850.00 9405.00 6817.50 11115.00 11657.50 10192.50 12522.50 11360.00 6650.00 8000.00 2596.50 8000.00 1960.25 8000.00 8000.00 1220.00 -3095.00 8000.00 8000.00 1405.00 -1182.50 8000.00 3115.00 2157.50 8000.00 3657.50 692.50 8000.00 2192.50 3022.50 8000.00 4522.50 1860.00 -2850.00 8000.00 8000.00 3360.00 -1350.00 How much funding is needed? $3100 to cover the largest deficit in the month of April The Pay Off? July in the soonest possible payoff as there is a surplus of $3115; however, decemeber has a deficit of $1350 which will need to be funded PRINCIPLES OF FINANCIAL ANALYSIS For the Smaller Business 0 Dr. Irv DeGraw - August, 2014 1 Table of Contents Page Section I - Foundations of Financial Analysis . . . . . . . . . . . . . . . 3 Chapter 1 - Purposes and Essentials ...................... Goals .......................................... Judging Firm Health - Critical Questions . . . . . . . . . . . . . . . . . . . Past, Present, and Future Considerations . . . . . . . . . . . . . . . . . . . Our Focus - Small to Mid-sized Business . . . . . . . . . . . . . . . . . . . Cash Complications ................................. Large v. Smaller Firm Exposures ........................ Overriding Interests for Analysis ........................ 3 3 3 5 6 7 9 11 Chapter 2 - Analysis Structure Models . . . . . . . . . . . . . . . . . . . . . . . . 14 E-I-F Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 A-R-F Model. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Chapter 3 - Cases for Evaluation & Assessment .. . . . . . . . . . . . . . 25 Section II - Principles of Analysis . . . . . . . . . . . . . . . . . . . . . . 31 Chapter 4 - Role of Industry ........................ 32 Industry Life Cycle ................................. Customer Life Cycle ................................. Industry Competitive Structure ....................... .... Chapter 5 - Macro & Micro-Economic Factors . . . . . . . . . . . . . . . . . . Market Size .................................... Market Growth Rate ................................ Competitive Scope and Concentration .. . . . . . . . . . . . . . . . . . Nature of Distribution Channels .. . . . . . . . . . . . . . . . . . . . . . . Industry Demand Function .. . . . . . . . . . . . . . . . . . . . . . . . . . . Industry Production Function .. . . . . . . . . . . . . . . . . . . . . 47 47 47 48 49 50 56 33 40 43 Chapter 6 - Liquidity - The Operating Cycle & Working Capital . . . . . 61 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Operating Cycle Foundations . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Measuring the Operating Cycle . . . . . . . . . . . . . . . . . . . . . . . 66 Funding the Resource - Trade Credit . . . . . . . . . . . . . . . . . . . 67 Cash Conversion Cycle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 Operating Cycle and Industry . . . . . . . . . . . . . . . . . . . . . . . . . . 70 Operating Cycle in Action . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 Operating Cycle, Working Capital, and Financing Options . . . . . 81 2 Page Chapter 7 - Financial Analysis Considerations .................. 84 Growth .......................................... 84 Leverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 Other Concerns & Considerations . . . . .. . . . . . . . . . . . . . . . . . . 92 Predicting Financial Distress . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 Problems & Assignments ............................ 95 Section III - Tools and Methods 96 ...................... Chapter 8 - Financial Statement Analysis . . . . . . . . . . . . . . . . . . . 96 Foundations of Analysis ............................ 96 Financial Analysis Ratio Summary . . . . . . . . . . . . . . . . . . . . . . . 132 Comprehensive Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135 Problems & Assignments . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137 Chapter 9 - Cash Flow Statements ................... 138 Statement of Changes in Financial Position .............. Statement of Cash Flows - FASB-95 version .............. Statement of Cash Flows - Bankers version .............. Problems & Assignments ............................ .... Chapter 10 - Cash Budgets ............................ Foundations ..................................... Comprehensive Example ............................ Problems & Assignments ............................ 157 157 164 166 Chapter 11 - Forecasting and Pro-Forma's Developing a 3-Yr Plan / Pro-Forma Phifer Drug - a 3-Yr Pro-Forma Example Problems & Assignments ......... 167 168 177 181 Conclusion ................... ................... ................... ................... 138 142 150 156 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182 Appendix 1 - Financial Flexibility . . . . . . . . . . . . . . . . . . . . . . . 183 Financial Flexibility - Cash Flow Ratios . . . . . . . . . . . . . . . . . . 184 Using SCF to Predict Insolvency . . . . . . . . . . . . . . . . . . . . . . . 186 Appendix 2 - Benchmark Guides 191 . . . . . . . . . .. . . . . . . . . . . . . . . . . . 3 Section I FOUNDATIONS OF FINANCIAL ANALYSIS Chapter 1 - Purposes & Essentials Our Goal - Assessing business health Purpose of financial analysis is to assess the health of a business. Our goal is to examine the current health and develop realistic expectations of the future health of the firm. The health of a business is important to analysts, to prospective investors, and to both short and long term lenders. Judging firm health - critical questions Knowing we are focused on the health of the firm, the next issue is what makes for a healthy firm. The health assessment may be concentrated into one core question - namely: \"Is the firm able to generate sustainable cash flows that are sufficient to support its business activities\". We may further organize the health of the firm into four evaluation factors: Cash Profitability - does the firm have the ability to create surplus cash flows from its operations? Liquidity - does the firm have the ability to meet short-term obligations as they are due? This adds a timing feature to cash flows - not only how much cash - but when. Efficiency - does the firm use its assets efficiently? Does it need more assets than its competitors? Stability - does the firm have a demonstrated stable performance history? Is its growth consistent with its performance? While it may seem simple, several key elements are incorporated into this question. 4 1) Is the cash flow positive? Clearly a firm unable to reach a point where it can generate sufficient cash to fund its operations is not a viable entity. It is merely a \"cash burner\". 2) Are the positive cash flows sustainable? Clearly a firm must generate positive cash flows that continue over the long term. Swings between positive and negative cash flows increase the firm's uncertainties, threaten its ability to support the business, and weaken the health. 3) Are the magnitudes of the positive cash flows relatively steady, stable, and not subject to wild swings? Clearly stability in the magnitude reduces the uncertainties of the firm. Again sharp swings in magnitude - from narrow to large - increase the firm's uncertainties and threaten the firm's abilities to supports its business activities. 4) Are the cash flows both timely and sufficient to meet short-term obligations? Now firms in the earlier stages of their development present a more challenging position. In this case cash flows may be insufficient to fund operations. Such early stage firms rely on investment cash to drive the business and have a cash \"burn rate\". However, this can only be a relatively short term proposition, and there must be a clear point at which positive cash flows will occur. Otherwise, they are merely \"money pits\". Clearly these earlier stage firms are highly risky and investors or lenders must be prepared to lose 100% of any cash contributed. Notably, a firm with a proven record of stable, steady, and sustained positive cash flow - while boring - is low risk and very attractive. While not flashy, or booming, they are more attractive than their more glamorous and volatile counterparts. 5 So when examining the health of any firm we are explicitly looking for stable and sustainable positive cash flows sufficient to support the business. Evaluating the past, present, & future financial conditions Analysis of a firm involves the consideration of three time frames; the firm's past, its present, and its future. Now clearly any financial analysis is principally interested in the future of the firm. We want to know where the firm is going and what level of performance should be expected. To the investor it means estimating a return on any investment. To a lender it means the soundness of any loan and the prospects of repayment. So who cares about the past? Well, since the future is uncertain and hard to predict, the outlook for future firm performance is very difficult to evaluate or anticipate. Its tough but we need some indication of how we might expect the firm to perform over the next 3 - 5 years. Without that outlook we are merely guessing - which is not very prudent especially when considerable capital is at risk. Consequently we turn to examining the firm's actual performance over the past and into the present. Examining the past plays an important - but specific - role in any analysis. It provides an opportunity to see just how well a firm has actually performed and responded to a variety of challenges and conditions. Notably it provides a window into how the firm responds to shifting economic conditions, to competition, to growth, and to industry changes. A solid historic performance track record suggests a well managed firm that has a record of recognizing and responding effectively to challenges. Unfortunately, that is not enough. That's because the future is uncertain and successful past performance doesn't guarantee successful future performance. 6 That has been a well-established practical lesson and history is ripe with strong firms that subsequently fail. So, if I can't be sure of success, what's the value of historic performance analysis? Consider the reverse perspective. A principal contribution of historic performance analysis is \"pruning\". While we can't ensure guaranteed \"winners\