Ritter Dairy and Fruits Case Study

CHAPTER 6

Case Study Project – 6-32

Answer to Question A

Ritter Dairy and Fruits had grown from one store to three locations by 1994, which required additional capital for continued growth and maintain the existing business locations. Since the financing being requested from the bank was from a Company still in its early stages of expansion, the bank may have offered to provide a credit facility with a relatively not too significant borrowing base. Because the Company may have been perceived to be still in infancy / early stages of growth, the bank may have agreed to provide the loan at a higher rate of interest and requiring the Company to submit at least quarterly reviewed financial statements. In order to derive reasonable level of comfort in the financial statements, the bank may have stipulated a clause of requiring the Company to select a CPA firm approved by the bank.

The risk of losing the capital provided by the bank in wake of the Company’s inability to sustain its continued growth and expansion plans, hence, these strict clauses may have been incorporated by the bank in the loan document. The reviewed financial statements from a CPA firm approved by the bank would provide comfort to the bank that the Company is generating enough operating profits and it would be able to service its debt on a timely basis in form of interest payments along with repayment of the money borrowed under the credit facility. The prospect of losing a potential business, the bank may have agreed to start with reviewed financial statements at the minimum as a condition to extend the loan instead of requiring an audit of the financial statements. Moreover, the bank may have adopted an approach to start low and continue to grow as the Company grows in future.

Answer to Question B

With the business expansion plans requiring additional capital, Rene decided to add two business partners who both had considerable capital and some expertise in the convenience store business. She decided to have an additional annual audit done, even though the additional cost was almost $25,000 annually. Introduction of two new partners and continued growth in form of ten additional stores to be opened in near future would have prompted the Company do an audit of the financial statements.

Prior to adding two business partners, Rene had managed the business on her own and had taken all the business decisions. The introduction of the partners would require a greater level of transparency in both financial and operational aspects of the business. As such, an audit of the financial statements by an outside independent CPA firm would ensure the two partners and Rene that the company’s financial position and results of operations have been prepared in accordance with accounting principles generally accepted in USA. The audited financial statements, which are the top most level of assurance provided by an independent CPA on the Company’s financial statements, could also help in future to secure any additional capital in form of loans from the bank. The advantages of going through an audit right now may have been a far-sighted decision taken by Rene even though it involved additional costs.