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By

MICHAEL P. CASTELLI

ARTHUR LAKES LIBRARY COLORADO SCHOOL oi MINES

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All rights reserved INFORMATION TO ALL USERS

The qu ality of this repro d u ctio n is d e p e n d e n t upon the q u ality of the copy subm itted. In the unlikely e v e n t that the a u th o r did not send a c o m p le te m anuscript and there are missing pages, these will be note d . Also, if m aterial had to be rem oved,

a n o te will in d ica te the deletion.

uest

ProQuest 10783582

Published by ProQuest LLC(2018). C op yrig ht of the Dissertation is held by the Author. All rights reserved.

This work is protected against unauthorized copying under Title 17, United States C o d e M icroform Edition © ProQuest LLC.

ProQuest LLC.

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A th esis subm itted to th e Faculty an d th e Board of T rustees of th e Colorado School of Mines in partial fulfillment of th e requirem ents for th e degree of M asters of Science (Mathematics).

Golden, Colorado Date Signed: Approved: chael P. Castelli i/D . WGfflsejT Thesis Co-Advisor Approved: ' Dr. Fr

Thesis Co-, dvisorJ . Stermole Golden, Colorado

Date 3-3 U ^

Dr. Ardel J . Boes Professor and Head, M athem atics D epartm ent

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ABSTRACT

This th esis applies operations research techniques to a sm all

b u sin ess. W alker’s F ishin’ Hole, a sm all retail b u sin ess needs additional capital to allow for growth in inventory. The purpose of th is th esis is to apply th e principles of economic analysis an d inventory control to help th is sm all b u sin e ss determ ine a n appropriate course of action. M uch of th is th esis is derived from a report analyzing different economic

scenarios for th is sm all b u sin ess. This report w as presented to three b a n k s a s justification for a line of credit to be extended to th e bu sin ess. On th e b asis of th is analysis, reported here, the line of credit w as

granted.

Although th is th esis applies operations research techniques to a p articu lar b u sin e ss an d problem, it can be applied to any sm all retail b u sin ess. O perations research is a scientific, system atic m ethod of decision m aking. This th esis will p rese n t how various operations

research techniques assisted th e decision m aker of a sm all b u sin e ss in m aking his decisions. Two operations research techniques were utilized in order to provide a solution to th e problem, these being, cash flow analysis an d inventory control. A com puter program an d spreadsheet w as designed to aid in controlling inventory for th e bu sin ess.

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TABLE OF CONTENTS Page ABSTRACT iii LIST OF TABLES V ACKNOWLEDGEMENTS vi C hapter 1. INTRODUCTION 1 Background 2 Description of b u sin e ss 4 Problem 6

Qualifications - A personal com m ent from th e a u th o r 7

C hapter 2. CAPITALIZATION 8

R esults 34

C hapter 3. INVENTORY CONTROL 37

C hapter 4. CONCLUSION 57

Topics for fu rth er research 57

Relation of th is th esis to th e Army an d th e au th o r 58

S um m ary 60

REFERENCES CITED 62

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LIST OF TABLES

Table

Page

2.1 Sum m ary of Revenue an d O perating Costs 14

2.2 $20,000 Amortization schedule 16

2.3 $20,000 Loan w ith 2 T u rn s of Inventory 18

2.4 $20,000 Loan w ith 3 T u rn s of Inventory 20

2.5 $20,000 Loan w ith 4 T u rn s of Inventory 21

2.6 $30,000 Loan w ith 2 T u rn s of Inventory 22

2.7 $30,000 Loan w ith 3 T u rn s of Inventory 23

2.8 $30,000 Loan w ith 4 T u rn s of Inventory 24

2.9 $40,000 Loan w ith 2 T u rn s of Inventory 24

2.10 $40,000 Loan w ith 3 T u rn s of Inventory 25

2.11 $40,000 Loan w ith 4 T u rn s of Inventory 26

2.12 $50,000 Loan w ith 2 T u rn s of Inventory 26

2.13 $50,000 Loan w ith 3 T u rn s of Inventory 27

2.14 $50,000 Loan w ith 4 T u rn s of Inventory 27

2.15 $20,000 Loan w ith 4 T u rn s of Inventory 28

2.16 $30,000 Loan w ith 4 T u rn s of Inventory 29

2.17 $40,000 Loan w ith 4 T u rn s of Inventory 29

2.18 $50,000 Loan w ith 4 T u rn s of Inventory 30

2.19 Sum m ary of F ishin’ Hole Economic R esults 31

3.1 Example of Inventory S preadsheet 39

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ACKNOWLEDGEMENTS

I would like to express m y appreciation to the United S tates Army for giving me a n opportunity to p u rsu e an advanced degree.

I th a n k th e in stru cto rs a t the Colorado School of Mines, especially Dr. Robert E.D. Woolsey, Dr. F ranklin J . Stermole, Dr. R u th M aurer, an d Professor J o h n M. Stermole who provided th e necessary guidance for th is thesis. I would also like to th a n k Dr. Robert Underwood, an d Professor Bill As tie for m aking a n educational experience fun.

T hanks to Larry an d S an d ra W alker for th eir friendship, confiding in me, an d allowing me to u se th eir store for m y thesis.

T hanks to my collegues Tom Spellissy, Lowell Solien, Bob Clayton, J im Knowles, Mike Pfenning, Keith Cooper, Wayne Booker, Jo e Katz, Dave Logan, Dave Kickbusch, Dave K nudson, Jo e W aldron, Dick Hewitt, an d Scott Healy for the help they have given. We all m ade it through th is program together.

The m ost im portant th a n k s to my wife Ja n e t, m y sons C hris and Mikey, an d my d au g h ter C atherine who provide th e m otivational force in m y life. T hanks to m y p a ren ts Francis A. and Crucy F. Castelli. They are always there w hen I need them . T hrough th eir love, guidance and prayers they have gotten me w here I am today. T hanks to m y in-laws, A rth u r an d R uth Lorenz. W ithout th eir effort, concern, an d love, th is th esis would n o t have been possible.

Last, b u t n ot least, I th a n k God, who m akes all things possible.

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C hapter 1

INTRODUCTION

D uring a course of stu d y concentrating in O perations Research (OR), one quickly learn s th a t battle sim ulation, a m ajor p a rt of Army OR, is only one p a rt of th e big picture. M any who stu d y OR th in k of its classical techniques, su c h as inventory control, forecasting dem and, production scheduling, cost-benefit analysis, b reak even analysis, an d optim ization modeling a s applied only to m ajor in d u stry or large

corporations.

Simply stated, operations research is the u se of logic an d m athem atics to m ake a n operation m ore efficient, productive, an d

profitable. This operation could be th e military, or a factory producing a certain good. The purpose of OR w hen applied to in d u stry is to maximize profit while minimizing cost. OR can, however, be u sed to maximize the profit an d minimize th e cost of operating th e com er book store, T -shirt shop, or neighborhood sporting goods store. The principles an d

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BACKGROUND

According to th e Sm all B usiness A dm inistration, a governm ent agency created to a s s is t in providing long term financing to sm all b u sin esses, 3 o u t of 5 sm all b u sin e sses will fail in th e first three years. T h at is a bold sta tem en t th a t deserves clarification. D u n n and

B radstreet (Berry, 1989) conducted a stu d y some years ago, and

concluded th a t 3 o u t of 5 sm all b u sin esses could no longer be identified as existing after th e first three years. This stu d y did n o t determ ine if th e b u sin ess w ent b an k ru p t, closed its doors, merged w ith an o th er company, incorporated, or changed its nam e. The SBA concludes from th is stu d y th a t w ithin th e first three years of opening u p a sm all bu sin ess, there will be a change, and, m ore th a n likely, th is change is failure of the emerging sm all b u sin ess. This conclusion so u n d s fatalistic to th e person w anting to open a sm all b u sin ess. It is m e an t th a t way. A person desiring to open u p a sm all b u sin e ss m u st realize th e w ork an d risk s involved.

Why do sm all b u sin esse s fail? U nder or over capitalization, lack of varying m anagem ent abilities, poor inventory m anagem ent, an d poor accounting procedures account for the m ajority of failures (Berry, 1989). The sm all businessow ner m u s t do a great deal of planning before startin g th e b u sin ess. It is n o t only th e sm a rt thing to do, it is required by th e SBA if they are backing th e loan. The SBA sta te s th a t here is where th e problem s start. M ost sm all b u sin e sses th a t open are a resu lt of a hobby (Berry, 1989). A person h a s a favorite pastim e or hobby, an d th in k s th a t a profit can be tu rn e d on w h at is being done. Opening u p a sm all

b u sin ess for th e "love" of w h at you are doing is th e wrong reason. The entrepreneurial spirit m u s t take root. Planning m u st be accurate, and

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"calculated" risks m u st be taken. According to th e SBA, people are so desperate to open u p a sm all b u sin e ss th a t they force the figures in th e planning stages (Berry, 1989). They are, in reality, startin g the b u sin e ss in th e red, and, m ore th a n likely will stay there. A "for profit" venture can n o t exist in th is situation.

This th esis will, in sim ple language, apply OR techniques to a sm all retail b u sin ess. It is n o t a fictitious b usiness, b u t rath er, a real-world b u sin e ss venture. Although there are m any areas of OR th a t can be applied to th is bu sin ess, th is stu d y will concentrate on two m ajor areas: capitalization an d inventory. This th esis is a n academ ic endeavor; however, it is w ritten in su c h a way th a t the person w anting to open a sm all b u sin ess can read it, u n d ersta n d th e concepts, an d utilize th e inform ation to help th e b u sin ess. No new m ethods or theory are developed, existing concepts are applied to a real world problem.

CHAPTER 2 will deal w ith capitalization. To open u p an y sm all b u sin e ss capital is required, w hether it is venture capital or a b a n k loan. W hether the proprietors are independently wealthy, receive a large gift or inheritance or receive a b a n k loan, th is capital h a s a cost associated w ith it. For th is reason, it is quite possible to over or u n d e r capitalize.

C hapter 2 will provide a m ethod to determ ine a n accurate figure for capital based on th e proprietors objectives.

CHAPTER 3 will concentrate on inventory. Inventory is th e lifeblood of any retail bu sin ess. The m ajority of its capital is tied u p in th is

inventory, an d if it is not, it should be. The only way to m ake a profit in th is situ atio n is to tu rn over th e inventory. In th e vernacular, "Earns tim es tu rn s after ta x equal profit (Earns x T u rn s = Profit)." OR

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techniques will be u sed to show how they can be applied to the sm all b u sin e ss to b etter m anage its inventory. An inventory n ot m anaged properly will lead to a d isastro u s end.

In C hapter 4 . topics for fu rth er research will be suggested. There are m any topics, in addition to the two described here, th a t a sm all b u sin essp erso n m u st know an d u n d e rsta n d in order to be successful. This ch ap ter will also relate th is th esis to th e Army an d th e a u th o r as a n

officer, pointing o u t th a t th e Army h a s m any activities th a t resem ble those of a sm all b u sin ess.

DESCRIPTION OF BUSINESS

The b u sin e ss u sed th ro u g h o u t th is thesis as a n example is a sm all retail store, W alker’s F ishin’ Hole, w hich specializes in fly fishing. It is a full service shop th a t offers classes in fly tying, rod building, casting, and fly fishing. They are also a booking agent for fly fishing expeditions to Alaska.

There are seven com petitors in th e area. Com petition between these tackle stores is keen because all deal w ith sam e type of fly fishing

products. This a u th o r observed th a t custom er service and satisfaction are th e discrim inators. O ther tackle stores in the area do n o t offer the fly fishing specialization th a t W alker’s, an d th e seven other stores, offer. Since th eir beginning in 1986, Walker’s h a s b u ilt a trem endous custom er base. W alker’s F ishin’ Hole conducts b u sin e ss country-wide.

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Larry Walker, th e owner, invented, patented, produced, an d is the sole d istributor of th e "Dubbit" - a tool used in fly tying. He is in the process of p u ttin g the "Dubbit" an d an o th er new item on th e m arket, a fact w hich is im p o rtan t to later sections of th e thesis.

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PROBLEM

To service th eir large custom er base, W alker’s F ishin’ Hole m u st increase th eir inventory to m eet th e co n stan t increase in dem and. Also, they need to add diversity to th eir expanded inventory. In solving their problem, first an d foremost, one m u st define a n objective. In th e case of W alker’s F ishin’ Hole, th e proprietors w an t to expand th e store, increase inventory, increase sales, produce m ore income, and realize a greater profit from th e bu sin ess. This th esis will employ two OR techniques, n e t p resen t value analysis an d basic inventory control modeling, as tools to aid W alker’s in reaching its objective.

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QUALIFICATIONS - A Personal C om m ent from th e A uthor

It would be difficult for th is th esis to m aintain any credibility w ithout having experience in th e sm all b u sin ess enterprise myself. I have been in th e m ilitary all of m y ad u lt life. To lend credence to th is thesis, I took it u p o n m yself to actually work in th e Fishin* Hole. For th e p a s t 18 m onths, I have worked in the Fishin* Hole, whenever I h ad the opportunity, basically on a p a rt tim e basis. Once th e owners of the store confided in me, they perm itted me to get involved in th e b u sin e ss as m u ch as I w anted, or needed. This w as done w ithout pay. I say th is becau se w hen they asked for m y opinion on certain aspects of th e store, I could be completely frank w ith them . One of the m ost im portant

elem ents th a t I learned ab o u t operating a sm all b u sin e ss is th a t it is no easy task . I did everything th a t the store owners did, from stocking shelves, to operating th e ca sh register, b u t m ost of all, dealing w ith all types of custom ers. Working in th e shop is a n im p o rtan t p a rt of th is thesis. To date, I can n o t give you a n accurate figure of how m uch tim e I have sp en t working w ith th e store owners because I have lost count. Suffice it to say th a t it is probably in excess of th ree h u n d red hours. I have conducted two 100% inventories of the store, an d helped in p u t d ata on th eir new com puter, all tim e consum ing task s. A lthough working in th e shop w as tim e consum ing, while also taking a full academ ic

curriculum , I enjoyed it immensely. The W alkers are great people, an d I h ad the opportunity to m eet other fantastic people. I learned as m uch working on th is th esis as I did in m y courses of study. I also learned a great deal ab o u t sm all b u sin esses, an d the sport of fly fishing.

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C hapter 2

CAPITALIZATION

To accom plish th e previously m entioned goals, th e proprietors need m ore capital. This capital can come from an y n u m b er of sources, e.g. b a n k loan, venture capital, silent partn er, an d borrowing from existing a ssets (savings accounts, sale of stock, investm ents, life insurance,

pension plans, etc.). To m eet th e ir objectives an d obtain capital, certain cost factors will be associated, su c h a s the cost of borrowing money, additional re n t for expansion of th e store, improved display of

m erchandise, upgrading of fixtures an d equipm ent, increased advertising an d m arketing expenses, increased payroll expenses, an d increased sales, payroll, an d income taxes.

The question th a t m u st be resolved is w hether the proposed

expansion will produce th e desired increase in profit after all additional costs are factored in. W ithout doing some type of analysis th e store owner can n o t answ er th is question. It m ay seem obvious th a t m athem atics m u st be applied in order to arrive a t a n answer, b u t

according to th e S B A , it is n o t done, and, if it is, it is n o t properly done (Berry, 1989). Hence, sm all b u sin esse s go o u t of b usiness.

The Fishin* Hole’s search for capital w ent to the bank. In a

prelim inary briefing w ith th e banker, th e b an k er w as convinced of the need for additional capital. The b an k er requested th a t the store b reak down sales an d inventory on h an d by quarter. He also w anted to see th e store’s projections w ith th e injection of new capital. The analysis w as a

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$20,000, $30,000, $40,000, an d $50,000 loan u n d e r a w orst case, sta tu s quo, an d b est case scenario. The b an k e r also w anted a n analysis of the effects of increasing m ark-up, along w ith a m arketing strategy. A profit an d loss statem en t would also be included in th e report to th e bank. This is a sizeable an d detailed report th a t th e sm all b u sin essp erso n m ay have difficulty constructing, b u t m ust.

Before beginning th e report, w hich was due in a sh o rt time, a

corporate lender from B ank of America w as contacted. This individual is th e Vice President of th e Risk M anagem ent section in th eir hom e office. It w as necessary to determ ine w h at inform ation would be p ertin en t to a b a n k in order to evaluate th e project. It w as agreed th a t Net Present Value analysis (NFV) w as th e proper m ethod (Castelli, 1989). The b a n k is only concerned w ith w hether the b u sin ess can m ake th e loan

paym ents w ith th e increase in debt financing. The b a n k w an ts loan repaym ent an d positive ca sh flow, an d is n o t concerned w ith w hether the b u sin ess m akes a profit.

In doing any kind of economic analysis, one m u st first u n d ersta n d th e tim e value of money. Simply stated, a dollar today is n o t w orth a dollar tomorrow. Net p resen t value is a way to bring future am o u n ts of m oney to today’s value. Since the b a n k w anted to know th e projections of th e F ishin’ Hole, th ese fu tu re values m u st be b rought back an d

evaluated in today’s dollars. First, a cash flow m u st be determ ined. The b e st way to explain th is is to w ork through one of th e analyses sim ilar to th e ones presented to th e bank.

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As m entioned earlier, w orst case, s ta tu s quo, and b est case scenarios for $20,000, $30,000, $40,000, an d $50,000 loan am o u n ts were prepared. Projections were for 5 years, w hich w as th e life of the loan. Year end records for 1988 showed th a t th e Fishin* Hole generated $97,000 p rese n t w orth before ta x on a $20,000 inventory. Therefore, they tu rn e d th e ir inventory over 4 tim es. Realizing th a t a n increase of inventory does n o t necessarily m ean a n increase in sales, th e b e st case estim ate w as 4 inventory tu rn s. The s ta tu s quo scenario took into account th e supposition th a t increased inventory m ay n o t equate to increased sales. Therefore, th e s ta tu s quo case w as 3 inventory tu rn s. The w orst case scenario w as 2 inventory tu rn s. Records for th e p a s t 3 years show th a t th e Fishin* Hole h a s always been able to tu rn its inventory m ore th a n two tim es. Initial d a ta for th is analysis w as from

1988 records. These were th e la te st year end figures available. All analyses were before tax, w hich w as acceptable to th e bank. Revenue w as escalated 5% p er year to take inflation into account. O perating costs were escalated a t 5% p er year. This figure w as obtained by consulting th e owners and th eir certified public accountant. R ent h a s continually increased every year, along w ith utilities, shipping costs, etc. The b an k also agreed th a t these 5% rate s were good figures. The Fishin* Hole h ad a n existing loan th a t w as being paid, an d th is w as factored into all analyses. Using the above inform ation and cash flow analysis, it could be determ ined w hether th e Fishin* Hole could cover its debts w ith th e increased cost of borrowing money, as discussed below.

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As stated, the Fishin* Hole w as requesting a 5 year loan. This

req u est w as originally $65,000; however, th e owner w as persuaded to do a more detailed analysis to see exactly w h at w as feasible. The b an k er agreed, an d gave th e figures previously m entioned. Normally a b a n k will only require a n analysis for th e am o u n t requested. This type of analysis deals w ith p rese n t an d future values of money. Therefore, future values m u s t be discounted back to p rese n t dollars. To accom plish th is the com pound in te re st form ula is used. In th is analysis, a future value is discounted to th e p resen t value w ith th e single paym ent present-w orth factor, or the P /F factor (Stermole, 1987 p. 19). To determ ine th e P /F factor for each year, th e form ula is:

i = in terest rate

n = n u m b er of years

In the Fishin* Hole analysis, all b an k s concerned (Women’s Bank, United Bank, an d F irst Bank) agreed th a t th e chosen in terest rate (discount rate), 15%, w as a good figure. If th e F ishin’ Hole w as going to borrow m oney a t 13.25%, there are other investm ents available th a t could yield the b an k 15% re tu rn on th eir investm ent. Therefore, a

discount in terest rate of 15% w as chosen. The loan life is five years. The P /F factors for five years m u st be calculated. These calculations are:

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Year 1: 1 r = .8696 (1 + .15) Year 2: l (1 + .15)2 Year 3: l (1 + .15)3 Year 4: l (1 + .15)4 Year 5: l (1 + .15)5 = .7561 = .6575 = .5718 = .4972

This could be, in m any cases, th e m ost difficult m ath th e sm all b u sin essm an will encounter in ca sh flow analysis. With these factors a t h an d , th e next step is to determ ine a cash flow. In calculating a cash flow, the sim plest way is to co n stru ct a cash flow diagram . This will be dem onstrated by u sin g th e $20,000 w orst case scenario.

To determ ine year 0 th ro u g h year 5 cash flows, revenues an d operating costs m u st be calculated.

Revenues

From 1988 records, th e F ishin’ Hole h ad $20,000 of inventory a t year’s end. This analysis w as perform ed in October 1989. In discussion w ith th e owners, $20,000 w as still a n accurate figure. The $20,000 of

existing inventory will be considered a capital (opportunity) cost for cash flow calculations. In other words, if the Fishin’ Hole w as to liquidate in

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Decem ber of 1989, th e project evaluation date, it would receive $20,000 for th e inventory in th e shop. This is th e w orst case scenario, therefore, th is inventory is tu rn e d twice. The c u rre n t m ark u p is 38%.

C.al.CMlaUQ.os

$20,000(existing)+$20,000(loan) = $40,000 $40,000 x 2 (turns) = $80,000 $80,000 x 1.38(markup) = $110,400 Year 1 revenue is $110.400 O perating Costs

O perating costs consist of th e cost of goods sold an d operating expenses. The cost of goods sold is th e am o u n t th e b u sin ess spends on th e inventory th a t is carried. If the m ark u p is 38%, cost of goods is:

Revenue

1 38 = HliRevenue)

O perating expenses, su c h as utilities, rent, post, telephone, etc. for 1988 were $38,700. Year 1 for th is project is 1990, therefore these costs m u st be escalated. The owners, certified public acco u n ta n t for th e Fishin* Hole, an d th e b a n k agreed th a t a 5% yearly increase w as a n accurate figure. As previously discussed, operating expenses have continually increased a t a rate of approxim ately 5%.

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Calculations

Cost of goods sold: $90,400 x .72 = $65,088 O perating expenses: $38,700 x (1.05)2 = $42.666

Total O perating Cost: $107,754

Year 1 operating costs = $107.754

To determ ine years 2 th ro u g h 5, revenues an d operating costs are escalated 5% per year to account for inflation, an d th e increased cost of operating th e b u sin ess. Revenues an d operating costs for years 1

th ro u g h 5 are as follows:

Table 2.1 S um m ary of Revenue an d O perating Costs

YEAR REVENUE OPERATING COSTS 1 $110,400 $107,754 2 $115,920 $113,142 3 $121,716 $118,799 4 $127,802 $124,739 5 $134,192 $130,976

The next figures, principal an d in te re st paym ents of the loan, can be obtained from th e bank, b u t can also be calculated. This is referred to as

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th e am ortization schedule. This schedule will b reak down th e principal an d in te re st paid either daily, monthly, or annually. These figures m u st be included in all calculations. The Fishin* Hole h a s a n existing loan th a t is being repaid, an d its am ortization schedule will also be included in the analysis. The am ortization schedule for any loan is easy to obtain. The b a n k will provide one, a n acco u n tan t can provide one, or one can be obtained from th e SBA. However, th e am ortization schedule calculation will be dem onstrated using the $20,000 loan. To calculate th e m onthly paym ent, th e capital recovery factor is used. This will relate a uniform series of period paym ents, A, to a p rese n t sum , P (Stermole, 1987 p. 21). The A /P factor is:

i( l + i)n

(l + i T - l

i = in te rest rate

n = n u m b er of paym ents

This is a 13.25% per year loan; however, m onthly paym ents are m ade. In th is case, i = .1 3 2 5 /1 2 , or .01104, an d n = 60, th e n u m b er of m onthly paym ents on a five year loan. S u bstituting into th e formula:

.01104(1 + . 011Q4)60 (1 + .01104)60- 1

th e A /P factor is .02288. Multiplying the $20,000 loan am o u n t by A/P(.ono4. so) yields a $458 m onthly paym ent. From th is $458 paym ent,

th e principal an d in terest com ponent m u st be calculated.

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Table 2.2 $20,000 Amortization Schedule MONTH BEGINA BALANCE B PAYMENT INTEREST C A * i D PRINCIPAL B - C END BALANCE A - D 1 20,000 458 221 237 19,763 2 19,763 458 218 240 19,523 3 19,523 458 216 242 19,281 4 19,281 458 213 245 19,036 5 19,036 458 210 248 18,788 6 18,788 458 207 251 18,537 7 18,537 458 205 253 18,284 8 18,284 458 202 256 18,028 9 18,208 458 199 259 17,769 10 17,769 458 196 262 17,507 11 17,507 458 193 265 17,242 12 17,242 458 190 268 16,975 13 16,975 458 187 271 16,704 14 16,704 458 184 274 16,431 15 16,431 458 181 277 16,154 16 16,154 458 178 280 15,874 17 15,874 458 175 283 15,592 18 15,592 458 172 286 15,306 19 15,306 458 169 289 15,017 20 15,017 458 166 292 14,725 21 14,725 458 163 295 14,429 22 14,429 458 159 299 14,130 23 14,130 458 156 302 13,828 24 13,828 458 153 305 13,523 25 13,523 458 149 309 13,214 26 13,214 458 146 312 12,902 27 12,902 458 142 316 12,587 28 12,587 458 139 319 12,268 29 12,268 458 135 323 11,945 30 11,945 458 132 326 11,619 31 11,619 458 128 330 11,289 32 11,289 458 125 333 10,956 33 10,956 458 121 337 10,619 34 10,619 458 117 341 10,278

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35 10,278 458 113 345 9,934 36 9,934 458 110 348 9,586 37 9,586 458 106 352 9,233 38 9,233 458 102 356 8,877 39 8,877 458 98 360 8,517 40 8,517 458 94 364 8,153 41 8,153 458 90 368 7,785 42 7,785 458 86 372 7,413 43 7,413 458 82 376 7,037 44 7,037 458 78 380 6,657 45 6,657 458 74 384 6,272 46 6.272 458 69 389 5,884 47 5,884 458 65 393 5,491 48 5,491 458 61 397 5,093 49 5,093 458 56 402 4,692 50 4,692 458 52 406 4,285 51 4,285 458 47 411 3,875 52 3,875 458 43 415 3,459 53 3,459 458 38 420 3,040 54 3,040 458 34 424 2,615 55 2,615 458 29 429 2,186 56 2,186 458 24 434 1,752 57 1,752 458 19 439 1,314 58 1,314 458 15 443 870 59 870 458 10 448 422 60 422 458 5 453 0 CO <N

The above am ortization schedule w as com puted on a LOTUS 123 spreadsheet. It is ra th e r sim ple to com pute. The beginning balance is th e am o u n t th a t in terest will be paid on. This is colum n A. Colum n B is th e am o u n t of m onthly paym ents, com puted earlier using th e capital recovery factor. Colum n C is th e in terest rate, .011047 tim es colum n A. Colum n D is th e principal of th e m onthly paym ent, Colum n B m inus Colum n C. Colum n E is th e ending balance th a t in terest will be paid on

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in the next period, an d is carried forward; th e sp read sh eet will perform all calculations on th is new am ount. The principal an d in terest figures will be added for each 12 m onth period because the ca sh flow analyses are com puted annually. They will also be added to th e figures of the existing loan’s am ortization schedule.

The sim plest way to com pute cash flow is to co n stru ct a cash flow diagram . This diagram is a table th a t b reak s down figures in colum nar form. The bottom line, after all adding an d subtracting, is th e cash flow. It is th is line th a t is m ultiplied by the P /F factor to obtain th e n e t p resen t value. The following is th e cash flow diagram for th e $20,000 w orst case scenario.

Table 2.3 $20,000 Loan w ith 2 T u rn s of Inventory

Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 110,400 115,920 121,716 127,802 134,192 -Oper Costs 0 -107,754 -113,142 -118,799 -124,739 -130,976 -Interest 0 -4,030 -2,684 -1,568 -1,006 -375 Net Income 0 -1,384 95 1,350 2,057 2, 842 -Principal 0 -9,188 -10,534 -4,568 -4,485 -5,117 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 33,892 0 0 0 0 0 Cash Flow 13,892 -10,572 -10,440 -3,218 -2,428 -2,275

B ecause th is is a before tax analysis, th e loan principal an d in terest need n o t be separated. If th is report w as to change to a n after tax analysis, in terest on the loan is non-taxable. For this reason, an am ortization schedule is com puted.

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Year 0: = 13,892 Year 1: (-10,572) (.8696) = -9 ,1 9 3 Year 2: (-10,440)(.7561) = -7 ,8 9 4 Y ear 3: (-3,218) (.6575) = -2,115 Y ear 4: (-2,428) (.5718) = -1,388 Y ear 5: (-2,275)(.4972) = - l , 131

Adding the above colum n, th e n e t p resen t value of th is analysis is -$7.829. The F ishin’ Hole w as borrowing $20,000. A lthough th is analysis determ ines th a t th e Fishin* Hole can repay th e loan principal an d interest, the re su lt is a negative cash flow. Obviously, th e economics of th is alternative are n o t good.

The above analysis w as h a n d calculated. For th e report to th e bank, th e Software for Economic Evaluation, developed by F ranklin J . an d J o h n M. Stermole, w as utilized.

The $20,000 w ith two tu rn s of inventory is n o t sufficient. Next, $20,000 w ith 3 tu rn s of inventory (statu s quo scenario) will be analyzed.

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Table 2 .4 $20,000 Loan with 3 Turns of Inventory Title : $20, Evaluation Date : Project Start : Evaluator : MPC 000, 3 12/89 12/89 turns of inv Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 165,600 173,880 182,574 191,703 201,288 -Oper Costs 0 -147,498 -154,873 -162,617 -170,747 -179,285 -Interest 0 -4,030 -2,684 -1,568 -1,006 -375 Net Income 0 14,072 16,324 18,390 19,949 21,628 -Principal 0 -9,188 -10,534 -4,568 -4,485 -5,117 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 33,892 0 0 0 0 0 Cash Plow 13,892 4, 884 5,789 13,822 15,464 16,512

Applying the sam e 15% P /F factor to th e bottom line cash flows, th e n e t p rese n t value (NFV) of th is scenario is $48,656. There is enough positive cash flow to cover th e loan repaym ent requirem ents of $20,000. This situation, however, w as n o t acceptable to the owners. There w as n o t enough "buffer" b u ilt in. It would be a risk from the store’s viewpoint.

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The next analysis is a $20,000 loan w ith 4 tu rn s of inventory

Table 2.5 $20,000 Loan w ith 4 T u rn s of Inventory

Title : $20, Evaluation Date : Project Start : Evaluator : MPC 000, 4 12/89 12/89 turns of inv Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 220,800 231,840 243,432 255,604 268,384 -Oper Costs 0 -187,242 -196,604 -206,434 -216,756 -227,594 -Interest 0 -4,030 -2,684 -1,568 -1,006 -375 Net Income 0 29,528 32,552 35,430 37,841 40,415 -Principal 0 -9,188 -10,534 -4,568 -4,485 -5,117 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 33,892 0 0 0 0 0 Cash Flow 13,892 20,340 22,018 30,862 33,356 35,299

D iscounting th e cash flow 15% yields a NFV of $105 .1 4 1 . This situation is feasible, b u t it is also th e b est ca se scenario. The cash flow is

adequate enough to cover th e debt, an d also generate a sm all profit. In th e $20,000 analyses, th e difference in NFV*s from th e w orst case

scenario to the b est case is $112,970. It is possible, however, for the F ishin’ Hole to do well w ith a $20,000 loan. The owners* concern is th a t $20,000 is n o t adequate. They w an t to avoid accepting a loan, and having to req u est an o th er 3 years from now. For th is reason, they were requesting $65,000. Only $50,000 of th a t loan would be u sed for actu al inventory. The rem ainder is to be u sed for debt consolidation. The cash flow diagram s for th e $30,000, $40,000, an d $50,000 loans follow.

W hen th e $30,000 loan scenarios were analyzed, th e figures began to look b etter for debt financing an d profit to th e owner. The owner w as

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now sta rtin g to realize th a t if his original req u est w as n o t approved, he could settle for som ething less. This is th e purpose of cash flow analysis. If u sed correctly, it is a n essential tool to th e sm all b u sinessm an.

The n ex t analysis is th e $30,000 loan w ith two inventory tu rn s. Revenue an d operating costs were figured u sin g th e sam e m ethod as th e $20,000 analysis.

Table 2.6 $30,000 Loan w ith 2 T u rn s of Inventory

Title : $30, Evaluation Date : Project Start : Evaluator : MPC 000, 2 12/89 12/89 turns of inv Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 138,000 144,900 152,145 159,752 167,740 -Oper Costa 0 -127,626 -134,007 -140,708 -147,743 -155,130 -Interest 0 -5,265 -3,706 -2,348 -1,510 -562 Net Income 0 5,109 7,186 9, 090 10,500 12,048 -Principal 0 -10,698 -12,257 -6,534 -6,728 -7,675 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 43,892 0 0 0 0 0 Cash Flow 23,892 -5,590 -5,071 2,556 3,772 4,372

The NFV of th is situ atio n is $ 2 1.208. This is barely enough to cover the loan am ount. This situ atio n would be highly leveraged.

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Table 2.7 $30,000 Loan with 3 Turns of Inventory

Title : $30,000, 3 turns of inv Project ID : 30K3X Run Date : 1/31/1990 Evaluation Date : 12/89 Project Start : 12/89 Evaluator : MPC Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 207,000 217,350 228,217 239,628 251,610 -Oper Costs 0 -177,306 -186,171 -195,480 -205,254 -215,516 -Interest 0 -5,265 -3,706 -2,348 -1,510 -562 Net Income 0 24,429 27,472 30,390 32,865 35,531 -Principal 0 -10,698 -12,257 -6,534 -6,728 -7,675 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 43,892 0 0 0 0 0 Cash Flow 23,892 13,730 15,215 23,857 26,137 27,856

The NFV is $ 9 1 .8 1 6 . This is a low risk situation. The resulting cash flow is enough to cover th e loan principle, an d generate a m odest profit. It is th e s ta tu s quo scenario (three tu rn s of inventory), therefore, it is highly feasible, in solving th e Fishin* Hole problem. This re su lt w as a

recom m endation to th e store owner. If he could n o t get th e am o u n t he w as requesting, he should strongly consider a loan am o u n t of $30,000.

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Table 2.8 $30,000 Loan with 4 Turns of Inventory Title : $30 Evaluation Date Project Start Evaluator : MPC ,000, 4 : 12/89 : 12/89 turns of inv Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 276,000 289,800 304,290 319,504 335,480 -Oper Costs 0 -226,986 -238,335 -250,252 -262,765 -275,903 -Interest 0 -5,265 -3,706 -2,348 -1,510 -562 Net Income 0 43,749 47,758 51,690 55,230 59,015 -Principal 0 -10,698 -12,257 -6,534 -6,728 -7,675 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 43,892 0 0 0 0 0 Cash Flow 23,892 33,050 35,501 45,157 48,503 51,340

The NPV is $ 162.423. This analysis provides a cash flow th a t covers the loan am o u n t an d a good profit. However, it is th e b est case scenario. Additional costs of m arketing would be incurred in order to obtain th is c a sh flow.

Table 2.9 $40,000 Loan w ith 2 T u rn s of Inventory

Title : $40, Evaluation Date : Project Start : Evaluator : MPC 000, 2 12/89 12/89 turns of inv Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 165,600 173,880 182,574 191,703 201,288 -Oper Costs 0 -147,498 -154,873 -162,617 -170,747 -179,285 -Interest 0 -6,501 -4,729 -3,128 -2,013 -749 Net Income 0 11,601 14,278 16,830 18,943 21,254 -Principal 0 -12,208 -13,980 -8,499 -8,970 -10,234 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 53,892 0 0 0 0 0 Cash Flow 33,892 -607 298 8, 331 9, 972 11,020

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As th e loan am o u n ts increase, th e cash flow will get better. The NFV of th is scenario is $ 5 0 .2 4 7 . The ca sh flow covers the loan principal, and provides a m odest profit. However, a t the $40,000 an d $50,000 loan am o u n ts th e b an k e r being briefed w as getting som ew hat skeptical.

A lthough th is req u est w as n o t being called a n inventory loan, he felt th a t too m uch capital would be tied u p in inventory. This is a situation where th e F ishin’ Hole could actually stock too m uch inventory.

Table 2.10 $40,000 Loan with 3 T u rn s of Inventory

Title : $40, Evaluation Date : Project Start : Evaluator : MPC 000, 3 12/89 12/89 turns of inv Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 248,400 260,820 273,861 287,554 301,932 -Oper Costs 0 -207,144 -217,501 -228,376 -239,795 -251,785 -Interest 0 -6,501 -4,729 -3,128 -2,013 -749 Net Income 0 34,755 38,590 42,357 45,746 49,398 -Principal 0 -12,208 -13,980 -8,499 -8,970 -10,234 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 53,892 0 0 0 0 0 Cash Flow 33,892 22,547 24,609 33,858 36,776 39,164

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Table 2.11 $40,000 Loan with 4 Turns of Inventory Title : $40, Evaluation Date : Project Start : Evaluator : MPC 000, 4 12/89 12/89 turns of inv Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 331,200 347,760 365,148 383,405 402,576 -Oper Costs 0 -266,730 -280,067 -294,070 -308,773 -324,212 -Interest 0 -6,501 -4,729 -3,128 -2,013 -749 Net Income 0 57,969 62,964 67,951 72,619 77,614 -Principal 0 -12,208 -13,980 -8,499 -8,970 -10,234 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 53,892 0 0 0 0 0 Cash Flow 33,892 45,761 48,984 59,451 63,649 67,381 NFV is $219.705.

Table 2.12 $50,000 Loan w ith 2 T u rn s of Inventory

Title : $50, Evaluation Date : Project Start : Evaluator : MPC 000, 2 12/89 12/89 turns of inv Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 193,200 202,860 213,003 223,653 234,836 -Oper Costs 0 -167,370 -175,738 -184,525 -193,752 -203,439 -Interest 0 -7,736 -5,752 -3,908 -2,516 -937 Net Income 0 18,094 21,370 24,570 27,386 30,460 -Principal 0 -13,719 -15,703 -10,465 -11,213 -12,792 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 63,892 0 0 0 0 0 Cash Flow 43,892 4,375 5,666 14,105 16,173 17,668

NFV is $ 7 9.286. This situ atio n provides adequate loan coverage an d a profit. It is also the w orst case scenario. Therefore, th is w as the owners m ost feasible solution.

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Table 2.13 $50,000 Loan with 3 Turns of Inventory Title : $50,000, 3 Project ID : 50K3X Run Date : 1/31/1990 Evaluation Date : 01/89 Project Start : 01/89 Evaluator : MPC turns of inv Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 289,800 304,290 319,504 335,480 352,254 -Oper Costs 0 -236,922 -248,768 -261,206 -274,267 -287,980 -Interest 0 -7,736 -5,752 -3,908 -2,516 -937 Net Income 0 45,142 49,770 54,390 58,697 63,337 -Principal 0 -13,719 -15,703 -10,465 -11,213 -12,792 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 63,892 0 0 0 0 0 Cash Flow 43,892 31,423 34,067 43,925 47,484 50,545 NFV is $178,136.

Table 2.14 $50,000 Loan w ith 4 T u rn s of Inventory

Title : $50,000, 4 Evaluation Date : 12/89 Project Start : 12/89 Evaluator : MPC turns of inv Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 386,400 405,720 426,006 447,306 469,672 -Oper Costs 0 -306,474 -321,798 -337,888 -354,782 -372,521 -Interest 0 -7,736 -5,752 -3,908 -2,516 -937 Net Income 0 72,190 78,171 84,211 90,008 96,214 -Principal 0 -13,719 -15,703 -10,465 -11,213 -12,792 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 63,892 0 0 0 0 0 Cash Flow 43,892 58,471 62,467 73,746 78,796 83,422 NFV is $276,987.

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The next analysis w as th e effect of m arkup on th e ca sh flows, as requested by th e banker. He felt th a t the F ishin’ Hole’s m ark u p w as n ot enough. This w as a point of contention for the owner. His b u sin ess deals w ith people’s recreation an d free time. He attem p ts to m ake fly fishing available to all classes of people. To accom plish th is he h a s th e lowest m ark u p in the entire Denver area, for stores of th is type. The following analysis, however, b ro u g h t some interesting facts to light for th e owner.

The following analysis will be performed on a $20,000, $30,000, $40,000, an d $50,000 loan w ith 4 inventory tu rn s. Instead of u sin g th e c u rre n t 38% m arkup, 40% will be used, only two percentage points higher. Revenue w as calculated u sin g the sam e m ethod a s th e previous analyses.

Table 2.15 $20,000 Loan w ith 4 T u rn s of Inventory

Title : $20,000, effects of markup Evaluation Date : 12/89 Project Start : 12/89 Evaluator : MPC Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 224,000 235,200 246, 960 259,308 272,273 -Oper Costs 0 -187,506 -196,881 -206,725 -217,062 -227,915 -Interest 0 -4,030 -2,684 -1,568 -1,006 -375 Net Income 0 32,464 35,635 38,667 41,240 43,984 -Principal 0 -9,188 -10,534 -4,568 -4,485 -5,117 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 33,892 0 0 0 0 0 Cash Flow 13,892 23,276 25,101 34,099 36,755 38,867

NFV of th e 38% m ark u p w as $105,141. NPV of the 40% m ark u p is $ 115 .8 7 1 . The difference is $10,730 for a 10.2% increase.

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Table 2.16 $30,000 Loan with 4 Turns of Inventory Title : $30., Evaluation Date : Project Start : Evaluator : MPC 000, effects of markup 12/89 12/89 Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 280,000 294,000 308,700 324,135 340,342 -Oper Costs 0 -227,266 -238,629 -250,561 -263,089 -276,243 -Interest 0 -5,265 -3,706 -2,348 -1,510 -562 Net Income 0 47,469 51,664 55,792 59,537 63,537 -Principal 0 -10,698 -12,257 -6,534 -6,728 -7,675 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 43,892 0 0 0 0 0 Cash Flow 23,892 36,770 39,407 49,258 52,809 55,861

NFV of th e 40% m ark u p is $176.018 while th e previous NFV w as $162,423. The difference is $25,217, or a 8.37% increase.

Table 2.17 $40,000 Loan with 4 T u rn s of Inventory

Title : $40, Evaluation Date : Project Start : Evaluator : MPC 000, effects of markup 12/89 12/89 Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 336,000 352,800 370,440 388,962 408,410 -Oper Costs 0 -267,026 -280,377 -294,396 -309,116 -324,572 -Interest 0 -6,501 -4,729 -3,128 -2,013 -749 Net Income 0 62,473 67,694 72,916 77,833 83,089 -Principal 0 -12,208 -13,980 -8,499 -8,970 -10,234 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 53,892 0 0 0 0 0 Cash Flow 33,892 50,265 53,713 64,417 68,863 72,855

NFV for the 40% m ark u p is $236.165. and for th e 38% m ark u p is $219,705. The difference is $30,681 with a 7.49% increase.

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Table 2.18 $50,000 Loan with 4 Turns of Inventory

Title : $50,000, effects of markup Evaluation Date : 12/89 Project Start : 12/89 Evaluator : MPC Period Ending 12/89 12/90 12/91 12/92 12/93 12/94 Revenue 0 392,000 411,600 432,180 453,789 476,478 -Oper Costs 0 -306,786 -322,125 -338,232 -355,143 -372,900 -Interest 0 -7,736 -5,752 -3,908 -2,516 -937 Net Income 0 77,478 83,723 90,041 96,130 102,642 -Principal 0 -13,719 -15,703 -10,465 -11,213 -12,792 -Capitl Costs -20,000 0 0 0 0 0 +Borrowed 63,892 0 0 0 0 0 Cash Flow 43,892 63,759 68,020 79,576 84,917 89,850

NFV is $276,987 for th e 38% m ark u p an d $296.312 for th e 40%. The difference being $19,325 an d a 6.97% increase.

These figures revealed to th e owner th e fact th a t as he increased his loan am ount, he m u st a d ju st h is m ark u p accordingly to maximize profit an d minimize loss.

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Table 2.19 Summary of Fishin’ Hole NFV Economic R esults Loan A m ount $20,000 Inventory T u rn s Inventory M arkup NFV 2 38% -$7,829 $20,000 3 38% $48,656 $20,000 4 38% $105,141 $20,000 4 40% $115,871 $30,000 2 38% $21,208 $30,000 3 38% $91,816 $30,000 4 38% $162,423 $30,000 4 40% $176,018 $40,000 2 38% $50,247 $40,000 3 38% $134,866 $40,000 4 38% $219,705 $40,000 4 40% $236,165 $50,000 2 38% $79,286 $50,000 3 38% $178,136 $50,000 4 38% $276,987 $50,000 4 40% $296,312

The bank, along w ith th e SBA will always require a m arketing

strategy for any sm all b u sin e ss requesting a loan. The Fishin* Hole is no exception. It is im portant to note th a t none of the preceding analyses

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took into account increased m arketing costs. A m arketing plan for the F ishin’ Hole m u s t be im plem ented to generate a n increased sales volume. The report th a t w as given to the b a n k included a new m arketing strategy. It m entioned th a t the F ishin’ Hole cannot go o u t to th e custom er.

Therefore, ways of bringing custom ers to th e store were discussed. These include utilizing th eir fly tying clinics, classes, etc. Advertising dollars were also m entioned. A new Yellow Pages advertisem ent w as recently published in th e new edition. The b est form of advertising for a sm all b u sin e ss is th e Yellow Pages, especially in th e case of W alker’s Fishin* Hole. Denver a ttra c ts m any bu sin essm en to th e city. Colorado is one of th e b e s t fishing areas in th e continental United States. M any of these visiting bu sin essm en fish, and, quite often, browse through shops on th eir free tim e. The only advertising m edium they have a t h an d is th e Yellow Pages in th eir hotel room. As m entioned earlier, W alker’s

conducts b u sin e ss country-wide. They do b u sin ess w ith bu sin essm en su c h as these. They also have a m onthly flier th a t is mailed to

approxim ately 900 custom ers. They have increased advertising in local fishing new sletters an d publications. The F ishin’ Hole participates in the yearly Denver S portsm an’s Exposition. Although expensive, th is h a s bro u g h t a great deal of custom ers to the shop. The Fishin’ Hole is also re-thinking th eir m ark-up policy. Although th eir p resen t policy is to give th e fly fisherm an th e fairest price, they could increase th eir m ark-up on m ost lines, an d still accom plish th is objective.

It is im p o rtan t to u n d ersta n d how the b a n k will analyze th e figures. They will sim ply apply th e 5 "P’s" of lending (Castelli, 1989): people, purpose, paym ent, protection, an d perspective. The b a n k will look a t th e

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people. The F ishin’ Hole is presently doing b u sin e ss w ith th is bank, so th e b a n k will n o t need additional inform ation. They will also determ ine if th e people are knowledgeable ab o u t their b u sin ess, b u t more

im portantly, operating th eir b u sin ess. The b a n k w as im pressed to h ea r th a t they were utilizing operations research techniques (this thesis) to m ake th eir operation m ore efficient. The b a n k will th e n look a t the purpose of th e loan. They will determ ine if m eaningful economic value exists, or if value can be created. Paym ent is self-explanatory. Can W alker’s Fishin’ Hole service its debt? The above analysis determ ined th a t it can. Protection is backing for the loan, or collateral. The b an k will look a t th e cu rren t balance sheets to determ ine th e value of the shop’s liquid assets. They will also req u est "key man" life insurance. Personal asse ts of th e owners will also be considered. In th e case of the F ishin’ Hole, th is is their w eakest area, as it is w ith m ost sm all

bu sin esses. Perspective brings th e preceding "P’s" together. This is th e subjective, or intangible p art. This is based on th e cu rre n t economic situation, an d outlook, for th e area. If any of these "P,s" raise th e "red flag," approval of th e loan will be questionable.

The above inform ation is sim ilar to th e d a ta th a t the b a n k w as presented. Everyone agreed, including the bank, th a t more capital w as needed. The analysis determ ined th a t the F ishin’ Hole could cover its debt an d tu rn a profit. As profit is m ade, more capital can be injected into the operation. The estim ates in th e analysis were co n serv a tiv e. This is im portant to th e b a n k an d the SBA. For th e sm all b u sin ess opening, or already in existence th a t seeks capital, th is is a n im portant point. As stated in th e introduction, figures cannot be forced.

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RESULTS

The Fishin* Hole did n o t receive th e am o u n t of the loan th a t they requested. However, th e b a n k th a t received the report d id inject capital into th e shop. The b a n k repaid th e principal th a t th e Fishin* Hole h ad paid on th eir existing loan, an d wrote th a t as a line of credit. This

decreased th e F ishin’ Hole’s m onthly paym ents by approxim ately $400 a m onth. They can now take th is $400 and invest it in inventory. Also, th e owner realized th a t he m ay have been asking for too m uch capital. The cash flow analysis m ade th is evident. Also, th e cash flow analysis showed th e owner th a t the higher the loan am ount, th e m ore he would have to increase th e m arkup.

Not receiving th e full am ount, th e Fishin’ Hole w ent to two other ban k s. One stated th a t th is is the classic case of a sm all b u sin e ss being under-capitalized. The other b a n k w anted to go through th e SBA. This is a n im portant point. W hen th is b a n k saw th e report th a t w as

presented to the first bank, no additional work w as required, other th a n filling o u t the required SBA forms. The analysis w as more th a n w h at the SBA expects from a sm all b u sin ess. If a sm all b u sin e ss could produce su c h a report, it m ay increase the chances of loan approval.

It is im portant to note th a t b an k s in th is area, Denver, are not aggressively approving sm all b u sin ess loans. This is a resu lt of the p rese n t depressed economy in the area. The F ishin’ Hole h a s th is

situ atio n working against them . Also, it is difficult for a sm all emerging b u sin e ss to obtain th e required collateral to back a loan of any

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be u sed solely for inventory. However, the b an k s considered th is to be a n inventory loan. Presently, b a n k s will only approve 50% financing on inventory loans.

The owner of th e store is n o t willing to give up. This is th e

entrepreneurial spirit th a t w as m entioned in the introduction. There are other ways of obtaining capital for his sm all b usiness. He h a s w ritten an advertisem ent in th e Vail, Colorado new spaper seeking venture capital. He h a s already received a n inquiry referencing the advertisem ent. People are interested in investing in b u sin e ss ventures. A lawyer w as contacted in order to have a b ette r insight on th e legal ram ifications of th e plan. An independent investor will w an t to see figures th a t are different from w h at th e b a n k an d SBA requires. For example, th e v en tu rers will w an t to be provided income an d growth on th e investm ent. W hen those term s en ter in, th e n th e Fishin* Hole is dealing with Security an d Exchange Com m ission (SEC) regulations. The legal fees alone would require a loan. The lawyer frankly stated th a t the Fishin* Hole would find it

difficult, a t best, to find investors - u n til he heard of th e owner’s patent. This is a potential selling point for a n injection of capital. Most investors do n o t w an t to invest in inventory. However, they are willing to invest in a m arketable product. It is very possible th a t one or two individuals will inject capital into m arketing th e owner’s patent. Extrem e caution should be exercised. The Fishin* Hole does n o t w ant those individuals to have control of the patent. If n o t done correctly, the owners could lose both th e store an d the patent. To date, th e owners are looking for ways to

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m ass produce th eir product. They will th en seek private investors to inject capital into th e product. If th is does happen, it is possible th a t the owner’s p a te n t could finance th e entire operation of th e Fishin’ Hole.

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C hapter 3

INVENTORY CONTROL

Let u s assu m e th a t th e c a sh flow analysis of th e projections w ent well, th e b a n k approved the loan request, and th e necessary capital is now available to be tu rn e d into inventory. This inventory m u st be

properly m anaged. As m entioned earlier, th e life blood of an y sm all retail b u sin ess is its inventory. Im proper handling of th e inventory will resu lt in failure a t w orst, certainly sub-optim ization a t best. In researching the W alker’s F ishin’ Hole problem, there is a high dem and for su c h type of

stores in th e geographical area. Denver is the largest city in a world class fishing area. One need only look a t th e nationally published sporting m agazines to see th a t Colorado is one of th e b e st tro u t fishing areas in th e nation. People will spend a great deal of m oney to fish th is state. Among W alker’s com petition, one store does n ot ap p ear to be doing m uch b etter th a n any of the others. They all ap p ear to be doing well by the am o u n t of inventory th a t they carry, b u t they all m u s t realize th a t too m uch inventory can be h u rtin g them . An inventory control analysis w as done w ith W alker’s owner utilizing Economic O rder Q uantity (EOQ) an d discounting item s to help them u n d e rsta n d th e concepts of inventory control. W alker’s problem is th a t w hich is sim ilar to m ost retail businesses: How can they keep high dem and item s in stock, an d increase dem and for slow moving item s?

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First, one m u st u n d e rsta n d th a t a store of th is type h a s th e m ajority of its capital tied u p in its inventory. In W alker’s case, from the owner’s records, inventory is valued a t 64% of gross income. One way to in su re survival is to invest in item s th a t tu rn over rapidly. The b e st way to explain th is idea is to th in k of th eir store a s if it were a bank. If their average m ark u p is 38%, w hen a n item tu rn s over, they m ake 38% on th eir investm ent. If a n item rem ains on th e wall, there is no re tu rn on investm ent, an d holding costs an d inflation actually resu lt in a loss on th eir investm ent.

Next, one m u s t know exactly w h at is on h an d . Some type of

accounting procedure m u st be m aintained for th e inventory. In the case of a sm all b u sin ess, a m an u al system m ight be adequate. If th e sm all b u sin e ss h a s th e luxury of owning a com puter, a sim ple sp read sh eet program would help th e owners m ore efficiently m anage th eir inventory. The Fishin’ Hole now owns a com puter. In dealing w ith inventory

control, W alker’s inventory w as p u t on a spreadsheet.

The following is a n example of th e first 20 lines of th e fly inventory on th e Lotus S preadsheet. The sp read sh eet is divided into 3 sections here in order to fit it on the page. The original is 21 colum ns wide.

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Table 3.1 Example of Inventory Spreadsheet

DEPT ITEM DESCRIPTION SUPPLIER COST-A COST-B FL FL1001-10 BREADCRUST US 0 .6 6 0.6 6 FL1001-12 BREADCRUST US 0 .6 6 0.6 6 FL1001-14 BREADCRUST US 0 .6 6 0.6 6 FL1001-16 BREADCRUST US 0 .6 6 0.6 6 FL1001-18 BREADCRUST US 0.6 6 0.6 6 FL1001-4 BREADCRUST US 0 .6 6 0.6 6 FL1001-6 BREADCRUST US 0 .6 6 0.6 6 FL1001-8 BREADCRUST US 0 .6 6 0 .6 6 FL1002-10 BUCKSKIN US 0 .6 6 0 .66 FL1002-12 BUCKSKIN US 0 .6 6 0 .66 FL1002-14 BUCKSKIN US 0 .6 6 0 .6 6 FL1002-16 BUCKSKIN US 0 .6 6 0 .6 6 FL1002-4 BUCKSKIN US 0 .6 6 0.6 6 FL1002-6 BUCKSKIN u s 0 .6 6 0 .6 6 FL1002-8 BUCKSKIN u s 0 .6 6 0 .6 6 FL1003-12 BRASSIE u s 0 .6 6 0.6 6 FL1003-14 BRASSIE u s 0 .6 6 0.6 6 FL1003-16 BRASSIE u s 0 .6 6 0.6 6 FL1003-18 BRASSIE u s 0 .6 6 0.6 6 FL1003-20 BRASSIE u s 0 .6 6 0.6 6

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RETAIL JAN STOCK

JAN STOCK

DOLLARS PURCHASEJUNE

JUNE STOCK DOLLARS MID YEAR STOCK JUNE SALES JUNE SALES DOLLARS 1.10 18 11.88 2 4 15.84 30 12 7.92 1.10 5 3 .30 2 4 15.84 17 12 7.92 1.10 0 0 50 33.00 12 3 8 25.08 1.10 0 0 4 8 31.68 6 42 27.72 1.10 0 0 2 4 15.84 13 11 7.26 1.10 0 0 0 0 0 0 1.10 0 0 0 0 0 0 1.10 10 6 .6 0 24 15.84 4 30 19.80 1.10 21 13.86 0 0 12 9 5.94 1.10 14 9 .2 4 0 0 9 5 3.30 1.10 10 6 .6 0 0 0 10 0 0 1.10 0 0 0 0 8 -8 -5.28 1.10 0 0 o 0 0 0 1.10 0 0 0 0 0 0 1.10 0 0 0 0 0 0 1.10 5 3 .3 0 24 15.84 29 19.14 1.10 6 3.9 6 24 15.84 12 18 11.88 1.10 12 7.92 24 15.84 1 35 23 .1 0 1.10 7 4.62 5 2 1.32 1.10 12 7.92 12 7.92

References

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