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Y.Guess Jeans is currently one of the largest supplier to County Seat, a large retail business in the US. The company has over 630 stores in 46 states. Currently, the business has been underperforming, and its sales and profitability are not at the expected levels. The business has approached Y.Guess requesting for a 20% extension of credit. In order to sustain its business, the company is borrowing from various banks using preexisting Credit Agreement. If it fails to meet the terms of the agreement, it may incur various penalties.
The terms of the Credit Agreement are; current ratio 1.1-1.0, minimum interest coverage ratio of 0.9-1.0, minimum adjusted net worth of $30 million inclusive of preferential stock, minimum EBITDA OF $24 million, minimum fixed charge coverage of 1.15-1.0, as well as a credit agreement limit coverage. When analyzing whether to extend its credit with County Seat, the business should analyze these ratios. We also need to evaluate the company’s liquidity ratios such as quick ratio, interest coverage ratio, long-term debt to capital ratio, total liabilities to total assets, as well as its performance ratios, such as return on equity, and the profit margin ratio.
Current Ratio
Current Ratio = Current Assets / Current Liabilities
As of July 29th, 1995:
177754/130652=1.36
As of August 3rd, 1996
158371/154048= 1.035
The required minimum ratios are 1.1-1,0
Interest Coverage Ratio
Interest coverage ratio=EBIT/ Interest Expense
As of July 29th, 1995:
-733/5865= -0.125
As of August 3rd, 1996
-5180/5742=-0.902
Required ratios are 0.9-1.0
Adjusted Net Worth
Adjusted Net Worth = Total Shareholders’ Equity + Redeemable Preferred stock CSI + Minority Interest of Stores
As of July 29th, 1995:
Adjusted net worth (thousands): 22,193+ 2600-4973-78,804+40389+53637=35042
As of August 3rd, 1996
Adjusted net worth (thousands): 22193+ 2600-5139-181578+48521+64210= -44054
Required level is $30,000,000
Minimum EBITDA: $24,000,000
As of July 29th, 1995:
$279,800
As of August 3rd, 1996
$-2,224,000
The required minimum level is $24 million
Credit limit
As of July 29th, 1995:
$43,700,000
As of August 3rd, 1996
$81,800,000
The set limit is $ 4 million for 1996
Profit Margin
Profit Margin on Sales = Net Income / Revenues
As of July 29th, 1995:
-19825/130,110= -0.1524
As of August 3rd, 1996
-20110/121727= -0.1652
All the ratios indicate that County Seat is performing poorly. In addition, it is also violating the agreements that it has already made with banks. It is inappropriate for the business to extend credit to a failing business. In light of this, Y. Guess should not agree to the 20% credit extension to County Seat.