Criteria of GE Capital in Determining whether to Approve the Application of Its Clients for a Loan - Example

I. ment of Problem Steve Rendl, the assistant account manager for the Commercial Equipment Financing Divison of GE Capital Canada in Toronto, Ontario, Canada has to make a decision on the loan request for $270,000 submitted by an existing client-Clark Carriers Ltd (CCL) to purchase two new transport trucks, trailers and satellite system for its expansion. Such report will be submitted to the senior account manager for approval because it exceedshis account manager’s credit limit of $200,000 and he has to make a well thought-out decison being new with the company. II. Sub-problem Steve Rendl has to figure out if CCL has a cash surplus on its projected balance sheet to pay back its requested loan. If CCL would still be a going concern as a business despite its debt servicing that will ensure its capacity to meet future obligations. III. Analysis a. Profitability Return on assets (ROA) Net income/average total assets 71,728.83/618,176=11.60% CCL has a return of 11.60% of all the assets employed to generate profit for the business. This provides a glimpse on how effective CCL uses its resources to generate profit. Return on Equity (ROE) net income/average stockholders’ equity 71,728/188,573.83 = 38.03% Return on equity is very promising for CCL because it yields an above industry average return of 38.03%. This ratio shows CCL capacity to generate revenue from the capital invested in the business and thus a capacity to pay its loans. b. Stability Debt/equity = total liability/total stockholder’s equity 429,602.83/188,573=2.28x CCL’s portion of debt compared to its capital is 2.28:1 way below the GE Capital loan loan refusal of 4:1 percent debet equity ratio. This means that CCL is stable enough to remain as a going concern for it to service its loans in the future. c. Liquidity Current ratio(Current asset/current liability) 254,552.66/73,202.83 = 3.48X CCL’s current ratio of 3.48:1 is way above the industry average of 1.1:1. For every dollar liability, CCL has an asset of $3.48 to cover or pay such debt. Such, this answers Steve Rendl’s question whether CCL has the capacity to pay back its loan in case CCL’s application for loan will be approved. Acid test ratio = cash+ar+short term investment/current liability 176,999.45/73,202.83 = 2.41X CCL’s available cash for the year 2003 can cover its immediate liability. Thus, CCL does not run the danger of defaulting on its loan due to illiquidity. d. Efficiency Compared to the industry’s 42.6 days age of receivables, CCL only holds an average of 18 days for its receivables. It means that CCL is efficient in collecting its outstanding balances from the customers that will be used in the operation of the business. For its payables, CCL only holds out 19 days before paying its debts which is a good indication of the company’s propensity to pay its outstanding obligations. Statement of Earnings Clark Carriers Ltd. For period 2002-2003 2003 2002 Revenue (835,295x60% increase) 1,336,472.00 835,295.00 Cost of sales (62.1%) 829,949.11 62.10% 518,805.00 Gross Margin 506,522.89 37.90% 1,354,100.00 Operating expense Salaries 180,259.00 13.49% 120259 General & administration 21,512.00 1.61% 8,512.00 Telephone & fax 14,701.19 1.10% 8,924.00 Legal & accounting 1,491.00 0.11% 1,491.00 Travel & auto 14,701.19 1.10% 9,430.00 Rent & utilities 10,075.00 0.75% 10,075.00 Bank charges & interest 35,805 2.68% 18,505.00 Bad debts 26,729.44 2.00% 1,302.00 Depreciation expense 68,160.07 5.10% 42,795.00 Advertising & promotion 1,336.47 0.10% 1,235.00 Meals & entertainment 1,336.47 0.10% 1,042.00 Total 376,106.84 28.14% 226,277.00 Earnings before tax 130,416.05 28.14% 11,409.00 provision for tax 58,687.22 45.00% 3,084.00 Net earnings after tax 71,728.83 5.37% 48,674.00 *Revenue increased by 60 percent as projected with the recent contract signed with Ford Balance Sheet 2003 2002 2001 2000 Current Assets Cash 176,999.45 4,230.00 2,605.00 8107 Accounts receivable(1336472/365*18) 65,908.21 42,004.00 28,230.00 21912 Other receivables 400.00 429.00 478.00 482.00 Prepaid expenses 11,245.00 15,065.00 12,820.00 16,237.00 Total current assets 254,552.66 61,728.00 44,133.00 46738 Fixed assets Trucks & trailers (cost) 550,000.00 463,800.00 426,500.00 95,000.00 Fixtures (cost) 5,480.00 5,480.00 5,480.00 5,480.00 Company vehicle (cost) 21,500.00 21,500.00 21,500.00 21,500.00 Computer (cost) 3,200.00 3,200.00 3,200.00 - Assets before depreciation 580,180.00 493,980.00 456,680.00 121,980.00 Less accumulated depreciation 216,556.00 186,556.00 143,761.00 95,196.00 Total fixed assets (net) 363,624.00 307,424.00 312,919.00 26,784.00 Total Assets 618,176.66 369,152.00 357,052.00 73,522.00 0.00 Liabilities Accounts payable(COGS of 829,949.11/365*19 days) 43,202.83 27,307.00 15,881.00 13,676.00 Bank line of credit ($50,000 limit) 30,000.00 - - - Total current liabilities 73,202.83 27,307.00 15,881.00 13,676.00 Long-term liabilities Loan (Newcourt credit) 189,000.00 189,000.00 273,000.00 0 Less: payments $7000x12 mos 84,000.00 36,000.00 - - Outstanding loan from Newcourt 105,000.00 225,000.00 273,000.00 0 Outstanding loan from GE Capital 36,000.00 Less:payments ($800 x 12) 9,600.00 Outstanding loan from $36,000 26,400.00 Additional loan from GE Capital 270,000.00 Less: payments May-Dec (5,625*8) 45,000.00 outstanding debt from $270,000 loan 225,000.00 Total Liabilities 429,602.83 252,307.00 288,881.00 13,676.00 Owners Equity Share capital 60,000.00 60,000.00 60,000.00 60,000.00 Retained earnings 128,573.83 56,845.00 8,171.00 -154 total owners equity 188,573.83 116,845.00 68,171.00 59,846.00 Total Liabilities & Owners Equity 618,176.66 369,152.00 357,052.00 73,522.00 Retained Earnings 2003 2002 2001 2000 Beginning retained earnings 56,845.00 8,171.00 (154.00) (121.00) Add: Net earnings after taxes 71,728.83 48,674.00 8,325.00 (33.00) Ending retained earnings 128,573.83 56,845.00 8,171.00 (154.00) Projected Cash Flow Clark Carriers Ltd. For the year 2003 Short term Long term Sources of cash Other receivables 82.00 Prepaid expenses 4,992.00 Accounts payable 32,835.83 Loan (Newcourt) 32,000.00 105,000.00 Loan (GE Capital) 3600 principal 26,400.00 270000 principal 225,000.00 Retained earnings 185,418.83 TOTAL SOURCES 37,909.83 541,818.83 579,728.66 Uses of cash: Accounts receivable (65,908.20-21,912) 43,996.21 Net fixed assets 336,840.00 loan counterpart of 10%     30,000.00 TOTAL USES 43,996.21 336,840.00 30,000.00 410,836.21 Net cash increase (decrease) 168,892.45 Cash, December 31, 2000 8,107.00 Cash, December 31,2003 176,999.45 IV. CEF requirements for granting a loan a. CEF did not deal with any company that had been in business for less than three years CCL was founded on 1987 and has been in the business for almost 16 years. CCL qualify on tenure criteria of CEF. b. Enough cash flow to cover the monthly interest payments of the new loan As shown in the cash flow, CCL has more than enough cash surplus of $187,177 to remain liquid even after the servicing of loans. This will ensure that the company is still liquid to cover the other expenses in operating the business. c. Debt to equity ratio could not be greater than 4:1 including the new loan 429,602.83/188,573=2.28x CCL’s portion of debt compared to its capital is 2.28:1 way below the GE Capital loan loan refusal of 4:1 percent debet equity ratio. d. Value of the asset is not financed more 90 percent by loan CCL has already shelled out $30,000 as its counterpart of the requested additional loan of $300,000 (net loan availed is $270,000). This complies with GE Capital loan requirement of assets not being financed more than 90 percent of loan. e. Character of the owners Doug Clark and his wife Anette Clark has been in the business for almost sixteen years and has survived the ups and downs of the business including the crisis between 1989 and 1993. CCL does not have any record of payment delinquency in their payment loans. V. Recommendation Based on the five criteria used by GE Capital in determining whether to approve or deny the application of its clients for a loan, CCL has passed the five requirements. First, CCL is relatively an old timer in the industry having been around since 1987. As shown in its cash flow, CCL has also the capacity not only to repay its loan but also has a surplus cash of $176,999.45 after debt servicing to cover any expenses during the operation of the business. Its liability to capital ratio is also manageable and within GE Capital’s threshod of 4:1. CCL has also allocated 10% or $30,000 as its counterpart for the applied loan to guarantee that none of its assets will be financed more than 90% of loan. Above all, the owners of Clark CarrierLtd., has established a good credit reputation of being able to service its previous loans without any delinquency. It is also worth mentioning that the projected increase of sales in 2003 be at sixty percent which is a big leap from its current capacity. This increase in sales offers a tremendous opportunity for CCL not only to service its loans but also to grow as a company. Considering that Clark Carrier Ltd., has passed all the requirements of GE Capital for an approval of a loan, it is hereby recommended that the applicant’s request for an additional loan of $270,000 be granted. Read More