Corporate finance

Memorandum

To: Drew Pearson, Senior Account Manager, Royal Bank of Canada

From: Jenna Jones, Owner, JAS Ltd.

Subject: Budget 2006

Date: March 25, 2006

(Brief introduction)

Decision Making

Quarter 1

Cash flows prior to financing are at their lowest point in Quarter 1. Not only is this quarter the slowest period for sales due to the seasonal nature of aerial spraying operations, but there are also minimal accounts receivable collections from Quarter 4 (also a slow quarter) and chemical inventories must be built up for Quarter 2 – this is the busiest quarter of the year. With the acquisition of the radios, JAS’s current ratio will fall to 1.3, which is below the bank requirement of 1.5. Since the new radios are important for the safety and efficiency of company operations, it is felt that their acquisition should not be delayed. As the proforma financial statements indicate, the current ratio will rise to well above the bank requirement in Quarters 2, 3, and 4, so it is requested that RBC waive this financial covenant for this period only. The debt ratio will also rise to well above the optimal level of 35% with this acquisition, but it is expected financial leverage will fall naturally over the year as the company retains all profits and limits capital expenditures to modest office renovations in the coming period.

Quarter 2

Cash flows prior to financing increased dramatically this period with only modest capital expenditures and a dramatic increase in revenues from both aerial spraying and flight instruction. Surplus cash was used to pay the line of credit down to zero and the remainder was placed into a temporary investment to fund the possible acquisition of a new plane in the coming periods and to maintain financial flexibility so the company never again has to ask the bank to waive its current ratio requirement. The current ratio will be well above the minimum bank requirement and the debt ratio will begin to decline.

Quarter 3

Cash flows prior to financing are at their highest level due to continued strong sales, the collection of large accounts receivable balances from the previous period, no major capital expenditures, and greatly reduced purchases of chemicals as large inventories are drawn down to zero as the busy summer season comes to an end. Surplus cash is again placed in a temporary investment to fund the acquisition of a new plane – enough has been now saved to make the required down payment assuming 60% financing by the bank. The current ratio also continues to rise and the debt ratio to fall.

Quarter 4

Cash flows prior to financing continue to be high despite a dramatic decrease in sales due to the collection of large accounts receivable balances from the previous period, no major capital purchases, and no need to build up chemical inventories for Quarter 1. Another large contribution was made to the plane purchase fund and the company has approximately 2/3rds of the cost of the new plane. Purchasing the plane at this time would result in a dramatic deterioration in the company’s financial ratios. Also, the plane is not needed as the company is in a seasonal low when no aerial spraying is taking place. The plan is to patiently wait till the company has accumulated sufficient funds so the acquisition does not expose it to significant financial risks.

Recommended Changes