Baumgarten Electrical SupplyBaumgarten Electrical Supply1As Wai-Chin “Ann” Chung sorted her mail on January 20, 1994, she was happy to see thelarge envelope from Mr. Mike Baumgarten. Mike was the primary owner of BaumgartenElectrical Supply, BES, and had sent Ann his 1993 financial statements as was required byloan covenants. About a year ago, Ann, a commercial lending officer for the CommercialBank of Utah, had lent Baumgarten Electrical Supply $100,000 to finance the firm’sgrowth and expansion into retail sales. Mike Baumgarten had faithfully made his monthlyinterest payments; however, on January 31, 1994, the first of four annual principalpayments of $25,000 was due. Ann’s initial, cursory look at the financial statements ledher to agree with Mike’s handwritten note, 1993 was an “exceptional year” for BES.Although her time was limited, Ann planned to spend a few minutes analyzing thestatements in more detail.Baumgarten Electrical Supply was established in 1965. The company was a wholesalesupplier of a wide range of electrical products and tools to electrical contractors. About 40percent of BES’s business was tied to the cyclical construction market. Except for therecent economic downturn (summer of 1990 until the spring of 1991), BES hadexperienced steady growth since the early 1980s. The unprecedented drop in interest ratesduring 1992 resulted in an unusual increase in the number of housing starts in Utah.Consequently, BES experienced sales of $1,570,000, an increase in the 15% over 1991sales. 1992 growth in sales was accompanied by a growth in BES’s management team, astwo of Mike’s children joined the firm. In March of 1992, Todd Baumgarten left hiselectrical engineering position at Hewlett-Packard in Stanford, California, to help his dadmanage the relationship with the customers and to provide them with technical support onthe newer, more sophisticated products. Then, in June of 1992, Sarah Baumgartengraduated with a business degree from the University of Washington and decided to joinher father and brother back in Utah. Sarah began managing the financing and marketingaspects of the firm.In January of 1993, all three Baumgartens had walked into Ann’s office seeking a loan.They had explained the BES had outgrown its old warehouse and showed her plans for anew one. The necessary building permits had been obtained and a general contractor hadbeen chosen. The contractor’s bid was for $90,000. Sarah had explained that part of thenew warehouse would be dedicated to a retail showroom. The expansion into retailing wasmotivated by Sarah’s belief that the higher prices charged to retail customers would morethan offset the extra sales, advertising, and floor space expenses.Ann was impressed with the plan that had gone into the loan request. The Baumgartenshad brought their 1992 financial statements together with proforma statements for 1993(columns 1 and 2 of Exhibit 1). The forecasts for 1993 had included higher sales andhigher margins in anticipation of the move to retail as well as wholesale sales. Sarah hadexplained that the forecasts called only for a $63,200 loan and the extra $36,800 was to actas a buffer against unforeseen problems. Ann was particularly impressed that the company1 This case was written by Grant McQueen.had no existing long-term debt at the time of the loan request. Given the strength of thecompany and the quality of the management team, the $100,000 had been granted.The interest rate was fixed at 6 ¼ percent and collateralized by the warehouse. Interest wasdue each month on the outstanding balance which was to decrease by 25,000 each January31. Since the original loan was made, intermediate term interest rates had fallen and werejust below 6 percent in January 1994. Ann expected rates to increase during the rest of1994 as fears of an overheating economy and inflation were becoming evident.After reading the rest of her mail, Ann decided to spend a little more time analyzing theBaumgarten statements. First she copied the 1993 actual results down on the oldstatements provided when the loan was granted last year (column 3 of Exhibit 1). Then,before analyzing the statements, Ann reread the handwritten note that accompanied thereports:Dear Ann:Enclosed are the statements you requested when you took out the loan. As you can see, we have had an exceptional year surpassing all of our goals. Who could have guessed mortgage rates would hit 6¾ percent? It occurs to me that you have not seen our new warehouse and showroom. Please drop by for a tour and some donuts.Sincerely,Mike Baumgarten Questions for Students1. Contrast the planned performance in 1993 with the firm’s actual performance. Itmay be helpful to look at the planned and actual Statement of Cash Flows over theperiod.2. Can the first $25,000 payment on the loan be made? What would you do if youwere Ann? Appraise the actual developments in terms of their impact on thesoundness of the bank loan.To answer these questions and to get a better picture of BES, complete Exhibits A (Ratios),B (Normalized Income Statements), and C (Statements of Cash Flow) and evaluate.Baumgarten Electrical Supply Exhibit 1Balance Sheet as of Dec 31Actual Forecasted ActualASSETS 1992 1993 1993Cash $47,300 $50,000 $37,200Marketable Securities 27,500 36,800 0Accounts Receivable 156,100 145,000 181,700Inventories (a) 194,200 234,000 368,600Current Assets 425,100 465,800 587,500Gross Fixed Assets 110,700 160,700 (b) 183,700 (b)Less: AccumulatedDepreciation 49,400 16,400 (b) 16,600 (b)Net Plant and Equipment 61,300 144,300 167,100Total Assets $486,400 $610,100 $754,600(a) Inventories on December 31, 1991 were 178,500(b) After write-off during 1993 of a fully depreciated old building carried at $40,000LIABILITIES AND STOCKHOLDERS’ EQUITYAccounts Payable (c) 57,400 60,000 196,900Miscellaneous Accruals 7,300 7,500 8,900Income Tax Payable 10,100 11,000 12,800Bank Loan, Current 0 25,000 25,000Current Liabilities 74,800 103,500 243,600Bank Loan, due after one year 0 75,000 75,000Capital Stock 150,000 150,000 150,000Retained Earnings 261,600 281,600 286,000Total Liabilities and Stockholders’ Equity 486,400 610,100 754,600(c) Terms were typically 1/10, net 30Baumgarten