Case Study

Adobe Trading Company, Santa Fe, New Mexico

Summer is approaching and Robert and Julia Martinez-Fonts have finally decided that their idea of a successful southwest furniture, art, and jewelry trading company has come of age !hey "now that summer is a popular tourist time in #ew Me$ico and could be the best time to start this new business !he Martinez-Fonts have had a longtime interest in southwestern art and furniture Robert graduated from Florida %nternational &niversity with a finance degree '( years ago and received his M)* three years later from !e$as * + M &niversity ,e has been wor"ing in -allas, !e$as, as the controller of a major wholesale distributor company for many years ,is wife, Julia, who is a full partner in the business, spent the first '. years of her career in retail sales /ver the last several years she has assumed more administrative duties with the group she wor"s with Robert and Julia "now that together they bring the necessary e$pertise and s"ill to run a successful business, but to ensure success they have been researching the mar"et for over five years !hey also "now that they must be very careful and thoroughly research the business and industry they are pursuing !hey have traveled e$tensively to #ew Me$ico and spent a good deal of time getting to "now the local artists 0primarily s"i 1bums23 !hey believe that there is a great demand for southwestern furniture through the Southwest and prices are currently high !hey have informal commitments from local craftsmen to supply them with goods that they will display and sell !hey have also made tentative arrangements with a large and reliable firm to supply the furniture and art pieces they will need to run the business !he Martinez-Fonts have decided to open a shop in Santa Fe, #ew Me$ico, under the name *dobe !rading 4ompany, operating as both a supplier to furniture and art outlets and seller in the retail shop Robert5s e$tensive contacts with suppliers in -allas and ,ouston have given him the orders needed to get the business off the ground as soon as they begin shipping the goods Julia has already begun mar"eting the southwestern products !he arrangements with the local craftsmen will allow very aggressive pricing of the goods to retail establishments in the Southwest !his aggressive pricing has been well received and tentative orders are already in place

6 Robert has found an ideal location for the shop that is currently available !he owner is as"ing 768(,... for the space but *dobe !rading has a contract contingent on financing for 76(.,... )ased on remodeling bids, Robert and Julia estimate that they will be able to fi$ up the place for about 79(,... *lthough they will purchase the building, the land is leased on a transferable lease with :( years remaining !he Martinez-Fonts have decided to invest 76;(,..., which represents most of their savings, into the venture to ensure success Julia5s sister is also lending *dobe !rading 4ompany 7<.,... Repayment on the note is not e$pected to begin for five years !he Martinez-Fonts estimate that they will need 7';.,... in inventory to start the business and will pay for the inventory in cash to build goodwill with the local craftsmen !hey also estimate that they will need a minimum cash balance of 76.,... to conduct day-to-day operations and pay bills Finally they believe that all renovations to the building and inventory can be in place by June ;., 6.'' Robert5s approached #ancy !eachout the senior loan officer at First of -allas )an" in Santa Fe, #ew Me$ico, for financing ,is bac"ground in finance allowed him to put together *dobe5s preliminary business plan using the below assumptions= ' Sales are e$pected to be a bit lower through 6.'' because *dobe5s newness and it ta"es time for any firm to establish a mar"et presence Sales are e$pected to grow significantly 'n 6.'6 and 6.'; with lower growth in 6.'9 Sales are e$pected to be 768(,... in the final si$ months of 6.'', and 7:8(,..., 7>..,..., and 7<..,... during the three full years of operation 06.'6, 6.'; and 6.'93 Sales are e$pected to level off at 7<..,... after 6.'9 6 )ased on tentative agreements and orders, it is e$pected that cost of goods sold will average :;? of sales ; @eneral and administrative e$penses are e$pected to be 78.,... for the si$ months in 6.'', increase to 7'..,... in 6.'6 and level off at 7'6.,... from 6.'; on !he land lease e$penses and interest e$penses are included in operational e$penses

9 Selling e$penses are e$pected to be '6? of sales and Julia is e$pecting to underta"e e$tensive mar"eting and promotion efforts though the Southwest immediately after the business is opened !hese additional promotional e$penses will be 7;.,... in 6.'' only ; ( *dobe will use a '.-year straight-line depreciation of the building and improvements : *dobe5s effective ta$ rate is e$pected to be ;9? 8 * relative large portion of business is e$pected to be on credit so that *dobe will carry about 9> days of accounts receivable )ased on the type of business that they are entering, Robert and Julia e$pect to turn their inventory three times a year > )ased on the negotiations they have had with their craftsmen, suppliers, and other wholesale distributors, they estimate that they can count on about 6> days of accounts payable to help finance the business %n preparing to go to the ban" for the necessary loan, the MartinezFonts want to prepare projected financial statements for *dobe !rading 4ompany showing the company can ma"e a profit and pay bac" the loan !hey also want to "now more precisely how much they will need to borrow from the ban" to open the doors for business and help finance the initial years of the business !he Martinez-Fonts plan to prepare five years of balance sheet, income statement, and cash budget data for the ban" !hey also must develop an opening balance sheet as of the date they plan to open the doors, June ;., 6.'' !hese pro forma financial statements will aid them and the ban" officer in answering many Auestions including= ' ,ow much financing will be needed to open the doors of the business in July of 6.''B 6 Five years of pro forma balance sheet and income statement data must be prepared to determine if additional financing is needed %f so, how muchB Robert5s finance bac"ground tells him that the estimated financing needed each year will be an accounting plug figure to ensure that the balance sheet balances %f projected assets e$ceed liabilities and eAuity, the difference will be the ban" borrowing needs %f liabilities and eAuity e$ceeds projected assets purchases, these funds will

be used to pay off debt or increase cash or mar"etable securities ; )ecause this is a start-up business, it is important to identify what the loan proceeds will be used for, what the primary source of repayment is, and when to estimate total loan proceeds will be repaid &sing the pro forma projections, the primary source of repayment and when the loan will be repaid 9 9 * cash budget or cash based income statement for each year needs to be prepared because Robert "nows that the only thing that matters to the ban" is cash ( Robert needs to prepare a collateral schedule ,e "nows that the ban"er does not want the collateral but will need all he can get if the business is not as successful as e$pected /n behalf of Robert Martinez-Fonts students are reAuired to prepare= * pro forma balance sheet and income statements 0five years3 to determine the initial and additional financing if any * cash budget or cash based income statement for every year * pro forma collateral schedule %n the role of #ancy !eachout students are reAuired to analyze *dobe !rading 4ompany5s pro forma statements and answer the following Auestions= ' 6 ; 9 ( : 8 > < ,ow much initial and additional financing is reAuiredB Chat are the loan5s proceeds to be used forB Chat is the primary source of repayment for the loanB Chen will the loan be repaid using the primary source of repaymentB Chat is the secondary source of repayment for the loanB Chat type of loan covenants would you reAuireB Chat are the largest ris"s for the ban" in ma"ing this loanB ,ow would structure the loan agreement to protect the ban"B Chat is your recommendation concerning the loan reAuestB Could you ma"e or deny the loanB State your reasons

Predatory pricing, also known as aggressive pricing also known as !undercutting!", intended to drive out competitors #rom a market$ %t is illegal in some countries$ A Financing Contingency, in basic terms, is a clause in t&e &ome Purc&ase ' Sale Agreement w&ic& allows a &omebuyer t&e time necessary to apply #or, and obtain #inancing #or a new &ome purc&ase$