Paul Zamora considers himself to be a talented entrepreneur. In late 2006, he purchased a chain of neighborhood groceries from Mr. Brandon Velasco. The stores had good locations, with reasonably large, well-maintained spaces. The negotiations between buyer and seller did not involve typical corporate due diligence and business valuation procedures. They just negotiated until they agreed on a price. The fixed assets had a net book value of $ 240,000 as at December 31, 2006, but Brandon asked for $350,000; claiming he could actually sell the business to an international retailer for $400,000.

The pair finally agreed on a price of $300,000, which covered the lease of the spaces, and included all fixed assets. Paul also made an additional payment of $80,000 was for the inventory held at the time of the purchase.

By January 1, 2007, what used to be 6 neighborhood shops were established as The Groovy Grocer Minimart Inc. Of the total 750,000 shares issued, Paul Zamora subscribed and paid for 300,000 shares, while other investors took up the rest at $1 per share.

From January 1, 2007, through March 31, 2007, The Groovy Grocer incurred the following expenditures:

• January 1 – Paid Brandon Velasco $380,000 for the acquisition of his business.

• January 7 – Paid $6,000 annual fire and property insurance premium.

• January 15 – Paid $7,000 in legal fees, and other incorporation costs.

• February 10 – Spent $60,000 on minor fixtures, new signages for the stores.

• March 22 – Purchased $122,000 worth of additional inventory.

• March 29 – Placed an order for $78,000 worth of fast-moving grocery items.

Towards the end of March, Paul presided over the company’s stockholders’ meeting as the company’s President and General Manager (GM). The company targeted April 1 as the start of store operations, with a manpower of 10 experienced employees.

Lorna Ng, a local resident who invested in the company, mentioned that local residents were eagerly anticipating the stores’ reopening and that a number of suppliers are keen on offering their products through the shelves of The Groovy Grocer. A popular mall was also offering retail space for The Groovy Grocer.

With all these exciting business prospects, one shareholder, Mr. Biggie, who was not that familiar with business and financial statements, raised his personal concern. “All this discussion of our business plan is good but how come three months ago, we had $750,000 and now we only have $175,000. We’ve already lost $575,000 without even starting yet,” Mr. Biggie said.

In fairness to Mr. Biggie, between January 1 and March 31, the company’s bank balance had indeed fallen from $750,000 to $175,000. Ms Julie Zamora, a stockholder and a relative of Paul Zamora, d explained that since the company’s operations were not yet in full swing, these are actually pre-operating outlays that should be considered as business investments rather than losses.

The shareholders agreed to meet again in early February 2008 to review the state of the corporation. They expected the company to be in full operation by then and the “birth pains” of the pre-operating period overcome by year-end.

During the remaining nine months of 2007, The Groovy Grocer successfully went into full operation. To prepare for the shareholder’s meeting in early February 2008, Mr. Calum, the company’s bookkeeper, produced the following data:

A. On April 1, 2007, all the stores were opened for business. Sales for the first month were

$288,000. Sales for the subsequent months were as follows:

May - $257,000

June - $262,000

July - $277,000

Aug - $281,000

Sept - $272,000

Oct - $290,000

Nov - $308,000

Dec - $344,000

Of the December sales, $17,000 was paid by customers using credit cards, which were not reimbursed by the credit card companies until early January 2008.

B. In April, The Groovy Grocer spent $4,000 on flyers and $10,000 in newspaper ads to announce the store opening. Five big suppliers paid $6,000 each to sponsor the advertisement.

C. On July 1, The Groovy Grocer borrowed $200,000 from the bank. The interest paid on the loan for the six months is $5,000.

D. During the nine months from April to December 2007, The Groovy Grocer issued new orders to purchase additional stocks totaling $2.20 million. All the invoices from suppliers were verified against good deliveries and paid, except for invoices for purchases made in December amounting to $280,000.

E. The Groovy Grocer paid salaries and wages amounting to $142,000 for the nine months. It paid Mr Zamora $36,000 for managing the business and another $40,000 for other corporate expenses. Rent and other fixed expenses amounted to $207,000, all paid for and supported by invoices.

F. Toward the end of September, a further $190,000 was spent on new chillers and additional racking.

G. In December, one of the managers found out that some of the inventory purchased from the previous owner were past their expiry dates. A full check revealed $43,000 worth of dairy products with expired shelf lives. It was also unsure if the previous owner would refund the value of the expired inventory.

In preparing the year end reports, Mr. Zamora initially noted that the company’s cash balance had improved from $175,000 in March to $335,000 in December. However, he realized that the cash balance already included the $200,000 cash that was loaned from the bank. Excluding the bank loan, the cash balance would only be $135,000 - even worse than the cash balance at the end of March. It puzzled him because he supposed the company was faring well and he couldn’t understand why the bank balance did not seem to reflect this condition. Upon reviewing the cash outflow for the entire year, he noted the following:

I. A 100% inventory count revealed that there was $455,000 worth of goods in the company’s stores, as at December 31.

II. The company’s fixed assets have a useful life of 10 years, although the stores are refurbished every 5 years. The fixed assets purchased from the previous owner still have a remaining useful life of 3 years from April 1.

III. Mr. Zamora noted that there was a difference between the net book value of the company’s assets and the price he paid to the previous owner. The owner demanded that he pay a bit more to close the deal, but how should this difference be recorded in the books? Should they record it as additional expenses since there are no fixed assets to match the said difference?

Mr. Zamora knew that he scored a good deal when he bought the business and, should he decide to do so, he could even sell it for more to a foreign-owned retailer.

IV. It was also noted that a lot of damaged goods were being thrown away at times and such went unrecorded. Mr. Zamora wanted to know how much this will affect the company’s profits.

V. Come January 2008, the company racked up sales of $332,000, exceeding expectations. February 2008 sales were even better. Sales for the first week of February reached $113,000 and were forecast to hit a total of $500,000 by the end of the month, thanks to the company’s plan to extend store hours.

Despite his entrepreneurial talent, Mr. Zamora was struggling on how to present all this to the stockholders. He believed that the company was performing well, but he did not know how to properly convey this to the other shareholders.

Help Mr. Zamora report to the shareholders, by answering the following:

Paul Zamora also succeeded in obtaining the profit and loss statement of his main competitor, SUSSY Mart. You were asked to help Paul analyze how The Groovy Grocer fares against its competitor and identify any areas for improvement.

Profit and Loss for the year ended 31 December 2007

SUSSY Mart

Sales $ 5,702,012

Gross Profit 1,271,549

Other income 85,530

1,357,079

Operating Expenses

Salaries and wages

(399,141)

GM salary (85,530)

Corporate expenses (96,934)

Insurance - annual (13,266)

Advertising (expense) (45,616)

Rent and utilities and other operating expenses (467,565)

Depreciation - acquired assets (125,444)

Depreciation - new assets (45,616)

Total expenses (1,279,112)

Profit before Interest and tax (PBIT) 77,967

Legal fees, charter costs, printing (2,000)

Interest expenses (6,000)

Profit before tax (PBT) 69,967

Provision for income tax at 20% (13,993)

Profit (loss) after tax (PAT) 55,973

SUSSY Mart had a closing inventory balance of $612,320 as at end 31 December 2007.

Questions

Q1. Compare the % of sales ratios of the two companies and evaluate.

Q2. Compare the stock days of the two companies.