In late 2022, Taylor Armstrong was finalizing plans for opening his own bookstore in Little Rock, Arkansas.
Question:
In late 2022, Taylor Armstrong was finalizing plans for opening his own bookstore in Little Rock, Arkansas. Although it was his first effort at entrepreneurship, Armstrong was well aware of the pitfalls in starting a small business. He had spent much of the last 5 years, including the pandemic period, researching the market and identifying a niche where his firm could succeed. He had family in Little Rock and knew the city and area well, even though he was not a native. Armstrong's Bookstacks would specialize in retailing hardbound and paperback books written for general audiences as well as reprints of classic fiction and nonfiction. It would also carry a wide range of stationery, greeting cards, and party items. As part of his marketing effort, Armstrong plans to display rare books from his personal collection. He recognizes that having a strong web presence providing search and sales and service for customers to shop online is essential. He plans to expand on this by helping customers locate out-of-print titles. Armstrong hopes to align with Bookshop, and online consortium of independent booksellers designed as an alternative to Amazon. Bookshop helps match orders with local shops for sales over their nationwide networks for a fee. To encourage repeat business with Bookstacks Armstrong will offer a book reward club to obtain discounts throughout the year.
Armstrong intended to plan the first years of operation very carefully. He knew that most small businesses failed for lack of initial capital and managerial skill. He felt comfortable with his business background and wanted to impress his banker by preparing a comprehensive business plan. After graduating from college with a degree in economics, Armstrong had gone to work as a sales representative in Dallas for a major college textbook publisher. He was eventually promoted to publisher of the firm's economic and finance group. Having served in that capacity for 10 years and tired of working for a large conglomerate, he was now ready, at age 48, to start his own business.
Armstrong recently learned of an opportunity to buy a small building in the large and growing shopping area in far West Little Rock. The building, which had previously been occupied by a franchise of a national computer chain, was located in a growth area with other popular retailers and restaurants, and many young families and college students nearby. A major advantage of the building is that it the previous owners had wired the building for high speed Bookstacks, page 2 Internet access. In addition, the surrounding retail area was fully leased and did not have a bookstore. The asking price for the building and land on which it was located was $400,000. Armstrong, however, had reached a tentative agreement with the current owner to acquire the building for $350,000; contingent upon completed negotiations by December 31, 2022.
Armstrong arranged a meeting with the chief loan officer of Premier National Bank to discuss financing needs for the building and residual cash flow requirements for the first year of operations. He estimated that he would need $95,000 to modify the layout of the building's interior, $200,000 in inventory to begin operations, and a $25,000 cash balance to meet daily transactions requirements. Armstrong also prepared the following estimates for projecting the firm's balance sheet and income statement:
1. Cost of goods sold will equal the industry standard of 62 percent of sales.
2. Armstrong expects Bookstacks to keep a large and diversified inventory to handle Internet sales and specialty books, hence inventory is expected to turnover twice a year (annualized).
3. With the exception of the initial stock, Armstrong expects to receive approximately 52 days (annualized) to pay book suppliers for merchandise purchases.
4. Armstrong expects to supply books to commercial and business clients as well as a strong retail trade. Local and regional Internet sales will be provided as well. Even with commercial customers, the widespread use of credit cards leads him to forecast only about 25% of sales will be credit sales. He expects to collect on A/R about every 36 days (annualized).
5. Selling and administrative expenses will average $25,000 per month with all other operating expenses, including advertising, equal to 10 percent of sales.
6. Financing costs are expected to be as follows. Armstrong's brother is requesting 6% rate of interest (1.5% per quarter) and the bank is charging 10% (2.5% per quarter) for outstanding debt during the quarter.
7. The building and renovations will be depreciated on a straight-line seven-year schedule. This amount is not included in the expenses listed above.
8. Special promotion and grand opening expenses of $20,000 will be paid in January 2023 and expensed for accounting purposes. All expenses other than merchandise purchases will be paid for in cash.
9. The applicable income tax rate is 34%.
Bookstacks, page 3 Armstrong projected that sales for the first 3 months of operation would be only $120,000. He expected sales to increase slowly during the second, third, and fourth quarters at $160,000, $190,000, and $250,000, respectively. Sales are expected to level off at approximately $260,000 during 20224. Armstrong planned to invest $300,000 of his life savings in the new business and had raised $150,000 from his brother in return for unsecured notes of the proposed firm. All remaining funds needed to run the bookstore would be provided by the bank and company profits. Principal payments on the $150,000 note were set at $25,000 per year beginning in 2025. Armstrong intended to open the bookstore's doors on January 1, 2023, with the building remodeling completed and the initial inventory in place. Both the remodeling contractor and the inventory vendors would have to be paid in full during December.
1. Estimate how much bank financing is required for Bookstacks to open its doors for business on January 1, 2023.
2. Calculate quarterly pro forma income statements and balance sheets for the four quarters of 2023. The bank financing requirement is a plug figure to ensure that total assets equal total liabilities plus equity. Make assumptions and run projections beyond 2023. Use this information to answer the following questions: a. What size loan is required? b. What will the loan proceeds be used to finance? c. When will the loan be repaid? d. How will the loan be repaid? What is the source of repayment? e. What collateral should the bank require?
3. Generate a cash-based income statement for each quarter in 2023. Interpret the figures by comparing cash flow from operations with the estimated change in bank loan needs.
4. Generate a cash budget for the four quarters of 2023. Compare the results to those from the pro forma statements and cash-based income statements.
5. Develop a list of collateral available to secure this loan.
6. Develop a list of questions you would ask Howard Armstrong or other relevant
Smith and Roberson Business Law
ISBN: 978-0538473637
15th Edition
Authors: Richard A. Mann, Barry S. Roberts