Mr.

Chan, owner of Everything Rattan, asked British Columbia Bank for a $2 million

working capital loan. The nature and purpose of this loan is for Mr. Chan to be able to “finance

the additional working capital, receivables, and inventory, resulting from the company’s

increased sales generated in the past year and a half” (page 2).

This is a working capital loan with an “upward dollar limit” (page 2). Working capital

loans are used to finance inventory and receivables, and are usually secured. Mr. Chan’s loan is

secured: “the collateral for the loan would be the company’s accounts receivables and
inventory”

(page 2). For many working capital loans the maximum loan balance may be tied to the balance

of the working capital accounts (Palepu 10-6).

Ratio Analysis through the past three years for Everything Rattan (values from Exhibit 1

Ratio 2012 2011 2010

Times Interest Earned 3.37 2.90 2.70

Current 1.46 1.33 1.39

Quick 0.46 0.43 0.49

Cash 0.00 0.00 0.04

The ratio analysis shows that Everything Rattan in the past has had good coverage on the

debts, and has had enough assets to pay off their interest. The current ratio implies that they
are

liquid, but when analyzing the quick ratio it is apparent that most of their current assets are in

inventory’s, which is not highly liquid. Especially for Everything Rattan, because “even after the

products arrived, it could take up to two months before the assembly started and the finishing

touched added” (page 2). Therefore, the firm isn’t as liquid as it appears, since their inventory is
such a large portion of their current assets, and their products tend to stay in inventory for a long

period of time. Also, the cash ratio in 2012 and 2011 equaled 0 and in 2010 equaled .04. These

values and the balance sheet show that Everything Rattan had no cash in 2012 and 2011, and

minimal cash in 2010. Therefore, the firm is not liquid, and has a cash flow problem, if they are

used to ending their years with no cash on hand. The lack of cash is worrisome for British

Columbia Bank, because if they do not have cash it is unlikely that they will be able to pay back

their interest and principal.

From 2012 to 2011 Everything Rattan’s EBIT increased by 14%, and from 2010 to 2011

increased by 9%. Therefore, in the past three years the company has seen growth. And Edward

did ask for the loan because of an increase in sales. A forecast would show that the company

would continue to be profitable by accounting standards (positive net income), but the lack of

cash is worrisome. The income statement shows that Everything Rattan already has two loans

taken out: a bank loan and a term loan. If the company does go bankrupt they would have to
use

any cash to pay these back first; therefore, it is highly unlikely that British Columbia Bank would

get any cash back, they would be entirely dependent on their collateral.

The collateral for the loan is the inventory and accounts receivable, PPE cannot be taken

on collateral because it is already secured under a previous mortgage (page 2). If Everything

Rattan goes bankrupt, it is probably because they are unable to sell their inventory; therefore,
this

inventory probably will not be worth much to the bank either. The accounts receivable, on the

other hand, might have some uncollectible accounts, but for the most part should be realized.

Given Everything Rattan’s cash flow problem and their already outstanding two loans,
the loan is risky. But since the collateral being offered is worth so much more than the loan, I

would still offer the loan to Everything Rattan.

There are many alternatives to a working capital loan. Everything Rattan has already

secured their PPE, so a term loan and mortgage loan are not possible. Since they want the loan
to

be able to increase their inventory and working capital, a lease is also not a good option. But
they

could have an open loan of credit or a revolving line of credit. A line of credit is less risky for the

bank, since Everything Rattan will only use as much as they need to at a time, instead of giving

them a lump sum upfront.