Case: Expanding Horizons - Cornerstone Furniture
Company: Cornerstone Furniture (Established furniture store)
Industry: Retail Furniture
Financials (Year-End):
Revenue: $5 million
Gross Profit Margin: 40%
Net Income: $800,000
Cash on Hand: $1 million
Debt-to-Equity Ratio: 1:1 (meaning $1 of debt for every $1 of equity)
Challenge: Cornerstone Furniture has enjoyed steady growth in its local market. John, the owner,
wants to expand to a neighboring city with higher potential but also higher competition. He is
unsure how to finance this expansion.
Expansion Costs:
Setting up a new store: $750,000 (includes rent deposit, renovations, furniture)
Initial inventory for the new store: $250,000
Financing Options:
Self-Funding: John could use the company's cash reserves of $1 million to cover all expansion costs. This
option offers complete ownership but limits cash flow for ongoing operations.
Loan: John can secure a loan of $1 million to finance the entire expansion. This offers access to significant
capital but increases debt and interest payments.
Line of Credit: John could establish a line of credit for $500,000, using a combination of cash on hand and
credit to cover expenses. This provides some flexibility but still involves debt.
Seeking an Investor: John could bring on an investor to provide the $1 million needed for expansion in
exchange for equity (ownership stake) in the company. This offers access to capital without additional debt, but
John would surrender some control and share future profits.
Solution:
Recommended Approach: A combination of options 2 and 3 seems most suitable.
Secure a loan of $750,000 to cover the new store setup costs. This provides the necessary capital for a strong launch without
depleting all cash reserves. Utilize a line of credit of $250,000 for initial inventory purchases. This allows John to manage
inventory based on demand without carrying unnecessary debt.
Justification:
This approach leverages debt strategically, providing the necessary capital for expansion while maintaining a healthy cash flow
for ongoing operations. The debt-to-equity ratio will increase, but it won't be excessive, especially considering the potential for
increased revenue from the new store. Maintaining a line of credit offers flexibility for future needs without incurring immediate
interest charges.
Additional Considerations:
John should develop a detailed financial plan for the new store, including projected sales, expenses, and profitability timelines.
He should negotiate favorable terms for the loan and line of credit, including interest rates and repayment schedules. John needs
to ensure his existing store remains profitable while managing the expansion.
Line of Credit (LOC):
A line of credit is a type of loan that works similarly to a credit card. A financial institution approves
you for a specific credit limit, and you can borrow against that limit as needed.
You only pay interest on the amount you actually borrow.
This offers flexibility compared to a traditional loan where you receive the entire amount upfront.
Bootstrapping:
Bootstrapping refers to financing a business or project using your own resources, primarily relying on minimal
startup capital.
Bootstrapping allows entrepreneurs to maintain full control of their business but can limit growth potential due to
restricted funding.
