Question

Johnny Checkpay has had his last bad day at work. Starting tomorrow, Johnny is putting his life savings into starting up his own company. The first thing he is going to do is put together a financial plan as part of the business plan he will take to the bank in an effort to obtain the financing that he needs. Johnny already knows the type of balance sheet he will need to get started:

Checkpay, Inc - Starting Condensed Balance Sheet
	(in $000s)
Net working capital	$100
Fixed assets	100
Total Assets	$200
Bank loan	$100
Equity	100
Total Debt and Equity	$200

Thus, Johnny knows that in order to obtain the net working capital and fixed assets he needs he will require a $100,000 bank loan in addition to his life savings of $100,000. Johnny has also forecasted the income statements he expects for the first 4 years (we ignore depreciation and taxes):

Checkpay, Inc. - Forecasted Condensed Income Statements
				(in $000s)
	Year 1	Year 2	Year 3	Year 4
Revenues	$100	$200	$300	$450
Expenses	170	230	300	360
Net income	$–70	$–30	$ 0	$ 90

Johnny plans to go to the bank with a request for a $200,000 loan. He arrived at the amount by adding together the $100,000 immediate need for money to purchase assets as well as an additional $100,000 to cover the losses he expects to suffer in the first 2 years as the company gets going. Other than needing money to cover unexpected losses, can you think of anything that Johnny is forgetting?

Answer 1

Johnny need to factor in below points while arriving at the overall loan requirement:

• As mentioned, Johnny has put his entire life savings of $ 100,000 into his new business. He needs to provide himself with monthy salary to take care of his day to day expenses.
• Net Working capital is a function of revenues. As revenues increases from 2nd year onwards, overall Working capital requirement shall also increase which needs to be funded.
• Johnny needs to factor in monthly interest expenses that shall be incurred on the loans.
• Banks usually provides Term Loan to purchase fixed assets which have fixed repayment schedule; Johnny needs to factor in the Principal repayments on the term loan.