Case Study #2: Growing Pains

Antiniero, Jastine
Gardose, Bless M.
Guanco, Leanne Kristelle M.
Mahusay, Stella Mae
COMA2_A

25 September 2021

Felix D. Cena, CPA, PhD

FINMA1_C
 I. Brief Background

Vicky and Mason Coleman started their business called “Oats ‘R’ Us” in 1998 though
Mason never intended himself to start his own business. In 2004, they reached over four million
dollars in sales with the help of their suppliers; the local retailers, and the sponsorship they have
in a major bread company. Mason is confident that the company will be able to achieve the
industry growth forecast at 30% or to beat the rate of sales growth.

As the business successfully operates, Mason is somewhat disturbed by the rapid growth
of their company and with Vicky, they initiate certain ideas and actions to at least avoid losing.
Mason called their treasurer, Jim Moroney, asking for the records with how much additional
funding they will need for the next operating year and to forecast. The owners expected sales to
be between 25% and 40%. Jim put aside his errands to work on what Mason is requesting of him.

II. Statement of the Problem

In general, the case seeks to provide Oats 'R' Us with information to aid in the company's
potential growth.

The study, in particular, presented issues to:

● The company's best rate of growth sales

● The best external financing option to fund additional sales and the networking
capital used in proportion to the company's forecasted growth.
III. Areas of Consideration

A. Oats ‘R’ Us Financial Status

1.1 The Need for Financial Planning and Forecasting

Since its operation, Oats ‘R’ Us has experienced rapid growth, with sales
reaching $4 million in just six years. Vicky and Mason foresee a sustained rise in
their products as a result of the sales increase, projecting an increase in growth
rates, where a financial forecast can be used as a reference to analyze the
variables.

A financial forecast, according to Bryce Warnes (2019), predicts how a

company’s finances will appear in the future. Furthermore, the use of pro forma
statements would demonstrate how those forecasts are fairly solid. The company
would be able to examine and determine present and future possible additional
finances needed to maintain their growth through forecasting. In addition,
forecasting would assist management in making informed decisions.

As a result, the following are the aforementioned statements:

 Table 1. Oats ‘R’ Us Forecasted Income Statement at 90% Operating Capacity

Table 2. Oats ‘R’ Us Forecasted Income Statement at Full Operating Capacity

Table 3. Oats ‘R’ Us Forecasted Balance Sheet at 90% Operating Capacity

 Table 4. Oats ‘R’ Us Forecasted Balance Sheet at Full Operating Capacity

1.2 Oats ‘R’ Us Current Financial Condition

According to the firm’s balance sheet, Oats ‘R’ Us’ debt to equity ratio has
been falling over the last three years, implying a low risk because the company
has been less aggressive in funding its expansion with debts. Its current financial
situation is not as dire as it could be due to its low debt-to-equity ratio.
Furthermore, the corporation is less likely to go bankrupt in the near future.

The following are the conceivable ratios of the forecasted financial

statements, ranging from 25%, 30%, 35%, and 40% growth rate in 90 percent and
full capacity of financial assets.
Table 5. Financial ratios from 25%, 30%, 35%, and 40% growth rate in 90% and full capacity of
financial assets.

B. Forecasting Model to Use

All of this is Jim’s first time. It is preferable for him to learn about the
robust models or approaches so that he can build more realistic models in the
future, even if the projected results are not as accurate (Corporate Finance
Institute, n.d.). With his limited skills and time, he is attempting to prepare
pro-forma financial statements for potential sales growth rates with external
finance. Using this method, Mason will have a general idea of how the financial
accounts will look in the coming year, as well as a list of Additional Funds
Needed (AFN) to choose from.

C. Achieving at or beyond the industrial growth rate

According to the case, the industrial growth rate is 30%. The growth rate
of Oats ‘R’ Us is roughly steady at 25%, according to historical financial
statements. Mason, on the other hand, believes that the corporation will reach or
exceed 30% the following year. As a result, Jim is required, at Mason’s request, to
 prepare forecasted financial statements with growth rates ranging from 25% to
40%.

D. Additional funds needed by Oats 'R' Us

Mason is concerned about the company’s future financial performance and

hopes to meet (or even exceed) the industry’s 30% sales growth rate. In
preparation, Jim must present him with all potential forecasted financial
statements so that Mason can carefully consider and select the appropriate
quantity of external funds to be obtained, allocated, and utilized.

Below are the different AFN presented:

Table 6. If the Fixed Assets were not operating at full capacity or at 90%.
Table 7. If the Fixed Assets were operating at full capacity

Table 8. Basis for computations on Table 6.

 Table 9. Computations of Table 7.

E. Internal Growth Rate of the Company

Assuming that Oats 'R' Us is operating its fixed assets at full capacity, the
company can continue to grow at a rate of 12.27% without the need for any
additional external financing.
 Table 10. Computations of Internal Growth Rate

F. Sustainable Growth Rate of the Company

The following assumptions must be considered when calculating growth:

(1) the debt-equity ratio will remain constant; (2) no new equity will be issued; (3)
the assets turnover ratio for the following year will remain the same as the current
year; and (4) all liability accounts except debt will increase at a rate equal to the
growth rate of common equity.

The first assumption is reasonable, but it has advantages and

disadvantages. A constant debt-equity ratio is a management guideline that can be
easily met. However, the fact that creditors supply more than half of the funds,
 namely 53.50 percent, raises a red signal. Borrowing further capital without
acquiring more equity than debt would be costly for Oats ‘R’ Us. Creditors would
be unwilling to lend the company more money.

The second assumption can be kept, but it is unreasonable. If no new stock is

issued, the retention rate will remain constant. The final two assumptions are
similarly implausible. The amount of assets required to sustain every dollar of
sales is considered to be the same as in the previous year. Given that the company
is operating at full capacity, assets will grow faster than sales. The total asset
turnover will decrease. These assumptions are challenging to assess because the
retention rate, assets, and liabilities are more dependent on sales than equity.

IV. Alternative Courses of Action

1. Using the Percentage of Sales Method in conducting their financial forecast.

Using the Percentage of Sales Method will allow them to efficiently forecast its sales, and
many items on the balance sheet and income statement will be assumed to change proportionally
to change proportionally with sales. Additionally, this permits the making of a projected balance
sheet and income statement, this will also fill in as the underlying strategy to begin with the
forecasting system.

2. Using Pro forma to present its financial projections.

A large portion of the income statement and balance sheet items are expected to keep a
consistent proportion to sales. The work of the monetary state of the organization once a valuable
change happens, such consideration of expected future occasions in the pro-forma financial
statements will permit the organization an extraordinary chance to shape the introduction of their
monetary circumstance.
 3. Increase the Growth Rate of the Company

There is no exact formula for determining a good growth rate because it varies depending
on the industry, resources, revenue, outlook for sustainability, and other factors a company has.
Aiming to grow at a rate of 25% to 40% per year would result in a change in value on the
financial statements.

4. Continue with Company’s normal operation

The company can choose to retain its operations as is without altering or doing changes
and additional assets. But this could produce a high risk for the upcoming years of operation
since forecasting is necessary to predict and provide assumptions to the future state of the
business. This alternative could not ensure the possible progress of the company.

5. Obtain additional financing from external sources

Oat ‘R’ Us can explore the chance of getting cash from outside sources to fund the
additional assets that the business is to acquire because of the boost in the sale. Outside sources
that the business can get funds include the additional contributions from owners, borrowings
from banks, or selling debt instruments. However, external funding may lead to a change in
ownership.

6. Using of the available resources within the business

The business can utilize the accessible funds in abundance of what is required in the
business ordinary tasks and may utilize this to finance the additional assets that the company is to
get due to the boost in the sales. In internal funding, it excludes dilution of ownership and
control, there are also no legal obligations, lower cost, no approvals needed, and it helps improve
the business credit rating. However, the company will depend intensely on making more sales to
have excess funds. It would likewise need to foster a proficient framework in collecting accounts
receivable to have real access to the money produced from sales.
V. Recommendation

Preparing sales forecasts would be a good action to start up and should be established
with direct assumptions with regards to the economic trends and state. Based on the
computations above, the growth rate is only 12.27% which means that the company could
progress without the need of external funding. But then, the Oats ‘R’ Us would need other
external sources to reach the target growth rate at full capacity which the owners expect. The
company AFN signifies that the company needs additional funding. If ever the company wants to
reach the growth rates to 25%, 30%, 35%, and 40% then the AFN if the fixed assets were
operating at full capacity, the AFN in respective rates are $43,941.00, $86,817.20, $129,693.40,
and $172,569.60

Here are the recommended possible ways to acquire the amounts needed for the
company’s target growth rate: (1) If the owners of the company are stable in providing extra
funds, they can use their sources to fund additional investment. (2) The owner could perhaps
acquire loans for the additional funds but then the banks might have high interest rates. In this
case, the debt ratio of the company might get affected. (3) They could sell their equity or debt
instruments. This might be a means for the company to meet the objective. Selling the equity of
the company might be a disadvantage to the owners as they could have lost some of the controls
in the company. Meanwhile, in selling debt instruments, this might not affect the ownership in
the company but then it can produce high interest rates. High debt might increase the risk of the
company. From the three possible ways to acquire, the best option for the owners would be to
invest additional funds from their personal funds if it is sufficient because acquiring loans and
selling equity and debt instruments would be a possible risk to the company.

Furthermore, the safest option would be to settle the industrial growth rate of 30%. In this
case, the management may decide to reduce the payout ratio temporarily to one percent. This is
better than maximizing financial assets' total capacity, as the transformation of its operation
without rest cannot be sustainable. It is important to balance the owes of the company with the
income, and to do so, the change is best as far as Oats 'R' Us and Jim are concerned.