Chapter 9, Problem 1SBA

Small-Business Analysis

Purpose: To help you understand the importance of cash flows in the operation of a small business.

Your business has been doing pretty well since you first opened the doors five years ago You’ve been thinking, for the past six months or so, about expanding the business. There is some property right next door that fits your expansion plans. It would take some renovations to the building, but in order to continue to grow, you know you’re going to need more room. But here’s the problem: How are you going to pay for the building and the renovations? Your cash account is in pretty good shape, but you remember the sage advice of the business consultant that helped you when you were just getting started That advice was to always have enough available cash to cover three months’ worth of expenses just in case of some unexpected business interruption. Your available cash and short-term investments of $100,000 is right at that benchmark.

Some preliminary investigation into the property next door indicates that the existing owner would probably be willing to accept $200,000 for the property. You also have a discussion with a contractor associate who tells you that the renovations to your specifications would cost about $50,000. So your dilemma is: How are you going to come up with $250,000? You figure that the best place to start is with a visit to your banker.

At the meeting, with the banker, he tells you:

“Frank, we would be pleased to help you out with your expansion plans. We would require you to take out a mortgage on the building, and we would need a down payment of 20 percent of the total amount. So, the balance we would be lending you would be 80 percent of the total you need, or $200,000. Your down payment amount would be $50,000. At 8 percent for 20 years, your monthly payments would be $1,672.88.”

You are somewhat pleased with the outcome of the meeting, but you tell the banker you will get back to him in a day or two. You know that this is a big step and a long-term Investment for the business.

Requirements

After thinking through the details of the plan the banker gave you, what are your thoughts? The down payment is going to use up about half of your available cash. Does that concern you? What about the long-term commitment of 20 years?

Assume you go ahead with the mortgage, and you purchase and renovate the property. Journalize the transactions to acquire the property and make the renovations. Where will the building and the renovations show up on your financial statements? Where will the mortgage show up on your financial statements? If the interest portion of your first payment is going to be $1,333.33, journalize the transaction to make your first mortgage payment.