It seems to us that Butler has a decision to make. The problem appears to be whether to accept a new relationship or to stay with the present bank under the current borrowing limit. In order to know which solution is better we are going to create a pro-forma balance sheet and an income statement. We are going to look into purchases and calculate the amount, which represents his ten-day spending on purchases. We are going to assume that he lowers his accounts payable to that amount. In order to forecast some of the figures we attached the common size balance sheet and income statement. The sales amount for the year of 1991 are going to be assumed at 3,600,000 while relying on banks estimate.
While projecting the income statement we
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One way is to assume that his net worth in the company would remain the same and that the notes to the bank, excess A/P and trade debt would be eliminated by the new note payable. By going with that route we can use simple calculating to arrive at the only unknown number which is the amount of new note with comes up to 571,000 (due to rounding error), which is pretty much the same number we got from the calculations in paragraph 4. However knowing that 571,000 is the amount Mr. Butler will be unable to obtain second option seems more feasible.
In the second scenario we enter the amount of 465,000, note payable to a new bank and then we come up with the unknown number, which is net worth. When we compare the net worth under this assumption to a net worth in the previous one we see that is higher by the amount that he had to come up with on his own around 107,000 which is perfectly reasonably since this is the investment he made into his business.
To summarize, we don’t know which one of the balance sheets will become actual at the end of the year because that will depend on the decision Mr. Butler will make. At this point, however, it seems that he will have to take the $465,000 line of credit and come up with the remaining part on his own, possibly from his house