SEAGULL WORKS (PTY) LTD-case study

Required:

Consider a loan application from Seagull Pty Ltd to purchase a fixed property of $380 000 and a request from them to increase the existing overdraft facility of $60,000 to $140,000 to enable them to put down a deposit of $60,000 on the property and to pay Transfer fees of $20,000. The total loan application will therefore amount to $400,000 ($320,000 mortgage bond and $80,000 additional overdraft facility). Mr. Davies, the Managing Director of Seagull, is of the opinion that they will be able to repay the overdraft quite quickly from the cash flow in the next twelve months - therefore the short term (overdraft) and long term financing (mortgage bond) combination.

In addition to all the aspects that you will consider and base your loan application on, you should also use the budget information provided by Seagull to determine the repayment ability of the company by drawing up a cash flow budget on the spreadsheet provided on blackboard and put all cash flow items including the loan repayments in the cash flow. For purposes of including the additional expenditure that the mortgage and overdraft will have on the cash flow, students should use the following information:

• Overdraft interest rate 13% for existing and new overdraft
• Repayment period of mortgage loan - monthly over 25 years
• Mortgage loan interest rate – 8% per annum compounded monthly
• If transaction is approved, the additional overdraft facility will be utilized in May 20XX and first mortgage payment will have to be made in May 20XX.

Very important: Use the guidelines on blackboard regarding the process that you should follow for compiling your proposal and structure the proposal according to that format.

SEAGULL WORKS (PTY) LTD

BACKGROUND: INTERVIEW WITH MANAGING DIRECTOR

The company is managed by Mr Davies as the managing director. Mr Davies is assisted by his daughter and son as co-directors.

Mr Davies started the business five years ago, after he spent fifteen years as a technical supervisor at the Duckworks Naval Maintenance.. Mr Davies is therefore equipped with a sound background regarding all the operations in an engineering workshop that undertakes work for the shipping industry. He has extremely good technical abilities and knowledge with regard to all the techniques and equipment to manufacture items from engineering drawings. He has extensive experience in working with naval architects and engineers in the shipping industry.

Mr Davies is a firm believer in quality and innovation, therefore all the machines used by the company were imported from the KNC Company in Japan and are the latest computer numerically controlled equipment available on the market.

Mr Davies refuses to use any other equipment and his opinion is that:

“Of course we can use other cheaper machines, but they are not reliable. Most of them are also not that good at keeping within close tolerances. That’s important in the shipping business. You can’t exactly stop and have a peek at what’s wrong under the bonnet if the vessel breaks down somewhere.

During the last three years our CNC machines only suffered three breakdowns. Though the spares must be specially imported, as the local agents don’t keep it, we had replacement parts within three weeks.

We import most of our specialised materials from either Japan or Germany. Generally available materials are not as good as the material we import.

My plan is to replace all the existing machines with the latest technology during next year when the existing machines will have been paid for in full. This will enable us to improve the quality of our machine shop operations further.”

The children of the owner are involved in the management of the business. They started working in the business directly after completing school, as it is Mr Davis’s wish that the company should be inherited by his children. His daughter has been involved with the business since its establishment, whilst the son has been involved for two years.

Neither of Mr Davies’s children is involved with the engineering activities. His daughter is responsible for the financial management and general administration of the business and his son is responsible for the marketing of the company’s services. Mr Davies is quite adamant about the division of duties:

“I know the shipping engineering business inside out, the new computer-controlled stuff too. I have worked in engineering shops my whole life and love it. I hate any paper work. My kids obviously know nothing about the technical side of the work, but we work as a team because we don’t get in each other’s way.”

The business provides the following types of engineering work:

· Specialised valves for bulk carrier vessels.

· Control gear for the fishing industry.

· Rudder pintles for fishing boats.

· Deck handling equipment for container vessels.

· Control gear for all vessels.

The business did not do too well previously but the position improved vastly during the past year. The reason for the improvement can be ascribed to the fact that Seagull is at present the only specialised engineering works on the North Quay at the Fremantle Inner Harbour. A previous competitor Dockside Works, closed down as a result of the international financial crisis.

Mr Davies regards general shipping business as the primary target market for their services as they have received very few requests from shipping lines representing bulk carrier vessels since the establishment of the company five years ago.

Mr Davies is of the opinion that the shipping lines and fishing fleets can give more support to Seagull. According to his estimates his company obtains about fifteen percent of available business from visiting ships and boats. According to him other engineering businesses in Perth and other parts of Australia attract shipping operators by charging lower costs. His opinion about this is:

“They should - like ourselves - concentrate on the community in which they are located and leave the markets of other engineering firms alone.”

Seagull will have to cut the prices of their services in order to match their competitors. Mr Davies and his co-directors are willing to do so but they get no reaction from the advertisements which they place weekly in West Australian newspapers and in general shipping magazines.

There are rumours that an existing large competitor in the industry, currently based in Sydney, plans to open a branch in Fremantle’s Outer Harbour. This competitor is well known in Australian and other shipping circles.

EXCERPT FROM SHIPPING MAGAZINE “ROARING FORTIES”

The port of Fremantle, Western Australia, is often described as the gateway to that part of the continent.

This port handles about $ 20 billion in trade on an annual basis.

Run as a state enterprise, the port features two major harbours. The Inner Harbour handles most of the container cargo in addition to other general cargo. The Outer Harbour where bulk handling facilities are present, is one of Australia’s major bulk cargo ports. Grains, petroleum products and mining produce are imported and exported at this facility.

Various projects are underway to enlarge and increase the capacity of the Outer Harbour. The Outer Harbour is where high growth in seaborne traffic is expected to handle imports and exports.

The growth in seaborne traffic has also led to an increase in demand for different types of services to the shipping industry. One such service is specialised engineering services for repairs on the various types of vessels that dock here.

Specialised engineering services may receive a welcome boost should Sydney-based Shipshape Engineering open a branch here. There are rumours that this large specialised repair engineering concern is to start operations at the Outer Harbour soon, though Roaring Forties could not get a firm confirmation from Shipshape’s technical director that this is on the cards.

Currently there are few engineering firms in Fremantle or Perth able to handle the total spectrum of repairs ships of various tonnages may require upon their arrival at Fremantle. Experts calculate that the demand for specialised services may grow by fifteen percent over the next five years.

A move by Shipshape to commence operations at Fremantle is viewed with scepticism in some circles. Due to the fact that low-cost repair services are available in Singapore, a sea journey only five days away, has a major impact on profitability of any shipping-related engineering business. In order to compete, companies have to keep their profit margins low and ensure that their businesses are well-run from a cost point of view.

REMAGEN BANK ACCOUNT INFORMATION REGARDING SEAGULL WORKS (PTY) LTD

Seaull’s banking relationship with Remagen stretches back 5 years. The bank has provided Seagull with both a secured loan (as shown in the balance sheet) and an overdraft. The loan is paid back in instalments and the instalments are up to date. Seagull has never skipped the due date for payment of the loan instalments. (See below).

The reason that Mr Davies provided for the excesses on the account were that delays in the payments by shipping lines and ship owners resulted in a shortage of cash flow at times when stock had to be purchased or expenses had to be paid. Mr Davies, however, indicates that the delayed payments by debtors have now been resolved and that Seagull should not experience such problems again in future.

According to bank statements the turnover on the cheque account of Seagull was $3,250,000 during the past twelve months. Various internal data screens of Remagen Bank are reproduced below.

REMAGEN BANK: REPORT BY INTERNAL VALUER

Property at 31 Rous Head Industrial Area, Inner Harbour, Port of Fremantle, was inspected on 2 March for purpose of establishing security value. Option to purchase property is currently held by Seagull Works (Pty) Ltd who holds a lease on the same property and currently occupies the premises.

The property is in good condition with access to major roads and service amenities. The property is also in close proximity to the Port of Fremantle’s North Quay 1 common user area and container terminals.

Properties in the Ross Head Industrial Area are held under free title and mortgage can be registered.

Other independent valuations on same property:

• Insurance replacement value: $ 1,200,000.
• Value of building and improvements (Port of Fremantle) for property tax purposes: $ 500,000.

As property is restricted to industrial/commercial use, capitalisation of lease/rentals was used to determine a value of the property. Using leases/rentals for similar premises in the vicinity the value of the property is $ 650,000.

(Signed)

P. Knox Chief Commercial Valuer

REMAGEN BANK: CONFIDENTIAL REPORT FROM WHO-OWES-WHO CREDIT AGENCY

Dear Sir/Madam

Following your request 819-42 our records were scrutinised for the following:

Seagull Works (Pty) Ltd

Mr. I.J. Davies (56)

Ms. A.M. Davies (26)

Mr. I.J. Davies (Jnr) 22

1. Judgement for debt in civil litigation

Not one of listed parties appears on any Civil Court Judgements records for civil judgment/s handed down during past five years.

2. Open accounts in the name of Seagull Works (Pty) Ltd

Remarks:

1: No late payments on account

2: Frequent late payments but settled within 30 days after due date.

3. Amount/s outstanding for period longer than 30 days after payment due.

4. Handed over for collection.

3. Directorships held

4. tered property (fixed)

Rory Incorporated

tered Accountants and Auditors

Report to shareholders of Seagull Works (Pty) Ltd

We have audited the financial statements of Seagull Works (Pty) Ltd set out on the following pages for the year ended February 20XX. These financial statements are the responsibility of the company’s directors. Our responsibility is to report on these statements based on an audit.

Scope

The audit was conducted in accordance with generally accep

SEAGULL WORKS (PTY) LTD

NOTES TO FINANCIAL STATEMENTS - 28 FEBRUARY 20XX

1. ACCOUNTING POLICIES

1.1 Fixed assets

Fixed assets are depreciated on a straight line basis at rates considered appropriate to the estimated useful lives of the assets concerned.

1.2 Stock

Stock comprising printing materials and work in progress has been valued at the lower of cost or net realisable value on a first in first out basis, consistent with that of the previous year. Work in progress includes an appropriate portion of overheads.

1.3 Financial statements

Financial statements are prepared on the historical cost basis.

1.4 Bank balances

Bank balances are stated at the amounts as reflected by the company’s bankers. Unpresented cheques are included in creditors.

2. Share capital

20XX Previous

Year

Authorised - 1 000 ordinary shares of $ 1 each 1,000 1,000

Issued - 1 000 shares 1,000 20

3. Long term liabilities

3.1 Secured by plant and equipment:

3.1.1 Instalment sale over certain plant and equipment, 143,190 7,670

book value $163,528 - interest at 13% per annum

- repayable at $ 5,166. 40 per month.

(Capital portion $4,000 )

3.2 Unsecured

3.2.1 Directors loans

Interest free -

no fixed repayment terms 418,930 553,330

3.2.2 Loan payable

interest at 13% per annum -

repayable at $ 5,674.30 per month

(capital portion $ 4,073.30) 177,300 200,340

Total long term liabilities 739,420 761,340

Deduct : current portion of long term liability 96,880 35,120

642,540 726,220

20XX Previous

year

The company has entered into an agreement

with the directors’ whereby they have

subordinated their claims against the

company in favour of its remaining creditors.

4. Fixed assets

Plant and equipment, patent, motor vehicles,

furniture, fixtures and fittings.

Cost 830,280 708,000

Accumulated depreciation 377,380 284,460

452,900 423,540

5. Investments

Shares in private companies - at cost: 22,500 22,500

200 shares – Deckhand Charters (Pty) Ltd

10 shares – North Quay Security Services (Pty) Ltd

The directors have valued the investments

according to the company’s proportion of

shareholders equity in the abovementioned companies.

This amounts to $ 52,493.90 at the year end.

6. Stock

Raw materials 190,950 112,500

Work in progress 18,000 19,000

208,950 131,500

7. Turnover

Turnover represents income derived after

providing for Sales Tax and goods returned.

8. Profit

The net profit is stated after:

Income

Dividends received 17,000 14,000

Depreciation recouped 640 -

Expenditure

Auditors fee 34,000 24,000

Depreciation 112,440 116,170

Directors’ salaries 200,000 120,000

Interest 82,290 13,270

20XX Previous

year

9. Taxation

No provision for taxation is required due to

the company having a computed tax loss

amounting to $ 416,810. (Previous year $ 443,520)

10. Directors’ emoluments

Fees as directors Nil Nil

Other emoluments 200,000 120,000

11. Contingent Liabilities

The company has entered into an agreement

to purchase a property at a price of $ 400,000,

to be exercised in May 20XX. This will be financed by way of

a mortgage loan from Remagen Bank.

BUDGET FOR THE PERIOD 1 MARCH 20XX to 28 FEBRUARY 20XX+1

Seagull Works completed the following inputs to be used for their cash flow plan.

1. Total turnover for the year will amount to $ 3,600,000 and will take place as follows:

March to May $ 300,000 per month

June $ 340,000

July to October $ 290,000 per month

November to December $ 400,000 per month

January and February $ 200,000 per month

2. Cost of sales will represent 39% of turnover.

3. The collection of debtors will be as follows:

Existing debtors: Will be collected as follows: March 25%, April 25% and May 50%.

New debtors: 20% sales will be cash

30% within 30 days

50% within 60 days

4. Creditors will be paid as follows:

Existing creditors: Will be paid in three instalments during March, April and May. (25%in March and 25% in April and 50% in May)

New creditors: 20% within 30 days

20% within 60 days

40% within 90 days

20% within 120 days

5. Other income consists of dividends of $ 20,000 which will be received during June.

6. Expenses will be as follows:

Audit and accounting fees $ 3,400 per month

Directors’ emoluments $ 19,000 per month

Rent $ 11,000 per month

Salaries and wages $ 100,000 per month

Other $ 20,000 per month

7. All possible bad debts were written off during the previous year -being the reason for the extremely high bad debt figures. No bad debts are envisaged for this year.

8. Depreciation is calculated in the same way as previously - 20% per annum based on the cost price of fixed assets.

9. Other commitments:

Instalment sale agreement on equipment:

Capital repayment $ 4,000 per month

Interest $ 1,160 per month

Medium term loan:

Capital repayment $ 4,070 per month

Interest $ 1,600 per month

LENDING CASE STUDY COMPLETION GUIDELINES - SEAGULL PTY LTD

The best way to complete the case study successful is to understand what is exactly required from you and how to go about to address the requirements in a logical sequence.

This case study mimics a real business loan application received by a bank. In order to determine whether the loan application should be approved or not will require the following from you:

Step 1

Read chapters 8, 10 and 11 of the text book.

Step 2

Read the case study information provided to you as well as the extract from the credit policy of Remagen Bank.

Step 3

Write a short introduction indicating the needs of the business (less than half a page).

Step 4

Calculate the monthly repayments that the mortgage bond of $320,000 will require based on the information contained in chapters 6.

Step 5

Refer to the credit proposal structure contained in chapter 11 of the textbook and use the structure as reference to construct your own credit proposal. You will note that the structure provided in the textbook is very complete and addresses plenty aspects. Since it is a generic structure, there may be aspects contained in the structure that is not really relevant to the specific case study that you are working on – the structure intends to cover all possible things that bankers should consider when assessing credit applications from businesses. Although a credit proposal should contain all important relevant information, you do not have to include information about aspects that are not really relevant or important for the business to which the credit proposal applies.

Start with the background part of the credit proposal. Use the information provided in the case study and other important public information that you may possess about the business/industry/macro environment to write the information up to provide the reader a good understanding of:

· The business profile

· Owners/shareholders of the business

· The business management

· The ability of the business to survive

· The business premises

· The existing financial relationships of the business

· Credit records of the business

· Borrowing powers applicable to the business

This background part should be maximum three pages.

Step 6

Use the standard income statement structure that bankers apply (page 229 in chapter 10) as well as the extract from the credit policy of Remagen Bank to restructure the Income Statement and balance sheet of the business.

In the case of private companies always check whether the balance sheet of the business contains any shareholder or director loans. If yes, remember that shareholder or director loans are always debt provided to the business and can be withdrawn from the business by them. If there are shareholder or director loans then scrutinize the notes to the financial statements to determine whether such loans have been ceded to any specific creditor or been subordinated to the loans of all other creditors or just specific ones. This is a very important issue. If the loans have been subordinated to the loans of all creditors or specifically to loans from your bank (not only other banks or creditors), then the shareholder or director loans can be regarded as equity – otherwise it should be regarded as debt. If the shareholder or director loans have been ceded to your bank, then it can also be regarded as equity. If ceded to any other creditor, then it remains debt.

You must ensure that the shareholder or director loans are reflected as debt in the balance sheet if not ceded or subordinated to all creditors or specifically to your bank. On the other hand when subordination applies to all creditors or specifically to your bank, then you should regard it as part of equity. In the case of the shareholder or director loans ceded to your bank, you should also regard it as equity. The reason why the shareholder or director loans are regarded as equity by banks is such cases is because the shareholder and director loans that are subordinated or ceded cannot be withdrawn legitimately by the shareholders or directors of the company until such time that all creditors to whom it is subordinated/ceded has been repaid in full. The shareholder or director loans will therefore remain part of the business capital similar to equity until the debt to the relevant creditors has been repaid.

In essence – make changes to the balance sheet based on the aforementioned information regarding subordinated or ceded shareholder or director loans.

The restructured income statement and balance sheet should be included in the credit proposal.

Construct the budgeted cash flow for the business based on the information provided in the case study and by using the cash flow budget template provided. Please note that the template contains specific formulas for cells to do automatic calculations to assist you.Step 8

After writing up and interpreting the background and historical financial position of the business - construct a “Strengths, Weaknesses, Opportunities, Threats (SWOT)” matrix in which you list a maximum of five strengths, five weaknesses, five opportunities and five threats. The SWOT therefore serves as a summary of the background and historical financial position. Please note that this should be done by just stating each one in a single sentence, since the reason for each of the SWOT statements is already reflected in the background and historical financial position sections where information was provided more comprehensively.

SWOT ANALYSIS

Step 9

Your cash flow budget is be correct if it shows a closing overdraft balance of +$313,655.63 in February.

Step 10

Assess the realism of the budgeted cash flow figures by comparing it to previous year financial statement figures and ratios like debtors, creditors etc. and also the SWOT analysis information.

Adjust three figures in the budgeted cash flow to make it more realistic. Indicate which figures you changed by footnote at the bottom of the cash flow with very brief reasons.

Comment about the future repayment ability of the business.

Step 11

1. List all loans of the business to your bank including the new loans applied for as well as existing and new collateral offered to your bank/ required by your bank in the following format:

Step 12

Discuss the suitability of the transaction (only one or two paragraphs).

Step 13

Discuss the profitability of the transaction from the bank’s point of view (only one or two paragraphs).

Step 14

Provide a recommendation (maximum half a page) whether the transaction should be approved or not