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Please ensure that this case study is completed in standard written English.
Please ensure that all questions are answered accurately and thoroughly.
Case: Context
RST Inc is a company that produces cardboard cups for various customers. It can produce a variety of sizes and
shapes of cups, with or without the customer’s logo.
For many years now, demand for customized logo-printed cardboard cups has increased dramatically. It now
represents most of the sales for this company.
A new machine (production line) has been purchased this year to accommodate a single major customer’s
increase in demand.
RST Inc has been a customer of the Bank for many years now. Unfortunately, the account manager has left his
position many months ago, and the customer is somewhat upset about this. He would like to build a longlasting relationship with his banker based on trust and to be advised on the foreseeable growth of the
company.
The customer would like to have his revolving line of credit increased to $ 1,250,000. Furthermore, a new
machine of $ 400,000 must be purchased to satisfy the increase in general demand for the cardboard cups.
While analyzing the financial statements that are provided here, you need to answer a few questions about
RST Inc:
1) On the premises, during a customer visit, he mentions the fact that he is so happy about his last financial
year, ended on July 31st, 2020. What is he referring too? Do you agree with his assessment of his situation?
A) The customer is certainly talking about the Income Statement. He had a very good year.
B) Nice increase in sales and in profits as well.
C) At the personal level, a very good year also (salary and a good dividend distribution).
D) At the finance level for the company, the situation is not as interesting.
E) The company has lost a lot of liquidity. The cash position has gone from $ 300 K in the bank account to
(750 K) almost using the entire line of credit.
F) The customer does not manage adequately the Balance sheet and will have to explain the fact that the line of credit is used so much at year end.
2) What are the elements you can observe that have contributed to the customer’s actual situation?
Comment on each of these elements.
The liquidity loss is due to multiple factors notably :
A) The increase in sales is connected to the important increase in accounts receivables. Accounts receivables
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have increased because of the sales increase AND because of the collection rate of accounts receivables
(increase in the number of days).
B) Inventory has substantially increased as well.
C) The Dividend distribution is quite substantial and financed by the line of credit.
D) The new machine added this year has not been financed at 100%, thus creating an unfunded capital
expenditure of about 120 K (including the new commercial sorter).
E) Debt repayment has been completely done from the line of credit since increase in accounts receivable,
inventory and dividend payout has absorbed all the company’s liquidity.
F) Customer is doing an advance to shareholder exactly at the wrong moment.
3) Why should you believe that the customer’s actual situation will probably continue?
Why does he want to increase the revolving line of credit?
A) Since we are forecasting an increase in sales, and with the fact that the new machine has only produced for
a couple of months in 2020 (increasing sales by $ 2 MM, this eventual increase in accounts receivables will
greatly affect the liquidity level for this company.
B) The amount of inventory for a company that makes made to measure products is alarming We must
understand why the customer is holding on to such a high level of inventory.
C) If the customer continues with a dividend distribution program as aggressive as this year, he will risk
jeopardizing his liquidity position.
D) The customer wants to increase his revolving line of credit because if sales keep increasing and the number
of days of accounts receivables continues to grow, he will be in a dire situation. The customer wants the Bank
to take a risk position concerning the accounts receivables.
4) Do you agree that the line of credit should be increased and to extend financing for the new machine?
Please use some calculations to support your answer.
A) The turnover rate for accounts receivables is now 61 days, which is quite reasonable but is increasing since
the prior year (from 40 to 61 between 2019 and 2020)
B) The revolving line of credit can be assessed by using these criteria :
1) 80 % of AR (80 % * $ 1175 K = $ 940 K. (We must consider taking out an amount for prior claims
and including a certain amount for raw materials only)
2) 15 % (of sales) * $ 7055 K = $ 1060
Considering these 2 criteria, the amount of revolving line of credit of $ 1,250,000 is not justified.
BUT If we consider the forecasted increase in sales, the previous calculations could provide the basis for an
increase in the authorized amount of the revolving line of credit. We must also consider the new
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amount of accounts receivables and the age of these accounts. The inventory level should also be
considered.
C) Considering the financing of the new machine, we must calculate the FCC (Fixed Charges Coverage) in order
to understand if the ratio is still reasonable :
Earn. Dep Int Taxes Div Capex Advances
EBITDA – Adjustments = 180 + 176 + 119 + 46 = 521 – 300 – 119 – 46 = 56 = 0,16
CPLTD + Int 150 + 120 + 60 + 15 = 345
CPLTD Int (future) + (cap+int) future debt
With an FCC ratio at 0,16, this customer cannot face its obligation in debt repayment. The line of credit is used
at a high amount because it must support the tremendous increase in accounts receivables, the
reimbursement of the long-term debt and the increase in inventory.
So, for the moment, with this situation the answer is no.
But….
This is what we can suggest to the customer:
If we take out the dividend’s payment, and the cash pullout created by the advances to a shareholder, the FCC
calculation is going to improve dramatically. Furthermore, all this is not taking into consideration the
forecasted increase in sales and , hopefully the increase in EBITDA.
The calculation could become :
Earn Dep Int Taxes Div Capex Advances
EBITDA – Adjustments = 180 + 176 + 119 + 46 = 521 – 0 – 119 – 0 = 422 = 1,22
CPLTD + Int 150 + 120 + 60 + 15 = 345
CPLTD Int (future) + (cap+int) future debt
This can increase the quality of the file and allow us to conclude that this customer is generating a satisfactory
amount of cashflow, on the condition that the cashflow is left in the company.
The usage of the operating line of credit must be monitored. It could be increased accordingly if a quality
cashflow management is maintained.