Longs Jewelers

Introduction

Bob Longs of Longs Jewelers returned to his store in the spring of 20×5 angry and depressed. “We just lost our lease; I don’t see how we can make it now.” It had
been seven years since Bob and his wife, Bonnie, moved their business to Spartanburg, South Carolina. They had struggled, and sometimes excelled. But primarily,
through sheer determination, they just survived in the jewelry business to this point. The loss of their lease and prime location could be the final blow that would
destroy their business. Bob needed to decide, and quickly, either to fold the tent or give it one more shot.

York Operations

Longs Jewelers originally started in 1978 as Able Jewelry and Music—a pawnshop in York, South Carolina, purchased by Bob’s parents from other family members. Bob
helped his mom in the business after his graduation from the University of South Carolina with a major in business in 1989. Wanting to gain more business experience,
Bob earned his MBA from Regent University in 1993 and, with Bonnie, assumed ownership of the store on July 1, 1993.

Bob and Bonnie met at the University of South Carolina. She graduated in three years with a major in foreign politics and a minor in Spanish. After college she was
also able to get a Para-legal degree in business and real estate law and bankruptcy. Her legal training made it easy for her to find work with a law firm while Bob
completed his MBA.

Even though the store was a well-recognized landmark in York, it initially had trouble earning a reasonable profit. After about three years, Bob saw the 80-20 rule in
action. The pawnshop generated 80% of the headaches and 20% of the revenue. Bob wanted the store to be more upscale; he eliminated the electronics and musical
equipment inventory associated with the pawnshop and changed the name of the store to Longs Jewelers. Over the next four years, sales and profits grew.

Bob and Bonnie lived in Spartanburg where Bonnie grew up, about 30 miles west of York on I-85. Through their associations and church activities, they established a
loyal clientele in their hometown who would travel to York to shop at Longs Jewelers. Many of these customers often encouraged Bob and Bonnie to open a store in
Spartanburg.

In York, however, Bob had the only jewelry store that catered to a middle-class market. Unlike in Spartanburg, where there were several similar jewelry stores already
established, he did not have to worry about competition. The store’s roots were in York with a long history and a devoted following. Even though the drive to work
sometimes seemed long, the York site was doing well.

This situation changed about ten years ago. Video poker was the new craze, and numerous people in the York seemed addicted to it. While illegal in South Carolina, it
was legal in North Carolina. Many York citizens frequently drove north a mere 10 miles to the next state to spend their discretionary income on these games. Bob saw
a change in his customer spending habits as they bought less jewelry, and some even said they or their spouse used the money instead to gamble and “hit it big.”

At the same time, York’s Main Street was going the way of many small towns without a strong economic base. Downtown businesses were shutting their doors as shoppers
drove to new malls or superstores like Wal-Mart. The only stores that seemed to be opening on Main Street were loan companies, which offered high interest rate loans
to consumers and businesses. Within two years, this combination of events took Bob’s operation from being profitable to barely surviving.

Relocating to Spartanburg

Bob and Bonnie had to decide if it was worthwhile to continue their jewelry business. They had two young children and roots in Spartanburg. With Bob’s MBA and
business experience, the possibility of a job at a company in Spartanburg was attractive. Bonnie could stay home and raise the kids, and they would be free of the
pressure of ownership and the worry over cash flow.

It was evident that Longs Jewelers in York would not survive. Persuaded by friends and motivated by his entrepreneurial spirit, Bob developed a business plan and
sought financial assistance to move his operation to Spartanburg. To his surprise, local banks were not as supportive as Bob thought they would be. Longs Jewelers’
current financial condition did not help to qualify for a loan; it seemed too risky. The financial institutions denied funding.

Bob liked the idea of being his own boss, enjoyed the jewelry business, and felt he had some expertise in the area. So he kept looking for financial assistance.
Eventually, he returned to his old bank in York. Even though he was leaving town, based on the relationship he had established with the bank and with their
assistance, he qualified for a Small Business Administration loan of $60,000. Bob and Bonnie sold their house in Spartanburg and used the equity to add another
$20,000 to start over in Spartanburg. Upon the sale of their house in Spartanburg, Bob and Bonnie and their two children, Hannah and Jonathan, moved from a 3,200-
square-foot home into a 1,200-square-foot apartment.

Spartanburg Operations

Bob secured a lease for almost 3,000 square feet in a prime location in west Spartanburg on a busy main street across from a large shopping center. This section of
Spartanburg was experiencing sustained consumer consumption since it had easy access to I-85, and new upper-income home developments were opening on a regular basis.
The rent for the store was $3,000 per month. The strip shopping center included some other fine stores, including an upscale women’s fashion store and a quality shoe
store.

Unexpectedly, Bob learned that the landlord charged him an additional $40,000 to “up fit” the store before the first sale was even made. In some of the other lease
contracts they considered, “up fitting” was already provided, and he wrongly assumed those lease stipulations were included in this current lease. Bob learned the
importance of “buyer beware.” He regretted not getting professional guidance before signing the lease, but he was trying to save money and time. On top of that, Bob
later learned that his share of the property tax for the facility was also charged to him at the end of the year as an additional expense versus being part of the
monthly rent. Already cash poor, Bob used his remaining $40,000 in funds to acquire inventory.

With limited working capital, a discretionary income type product with low turnover, and a seasonal business, Bob continually had cash flow problems. Jewelry was
expensive, and the store needed significant inventory to display in showcases in order to attract customers. He bought lots of silver, which was relatively
inexpensive, to supplement gold and diamonds.

Bob maintained a credit purchasing relationship with many of his suppliers, but when sales did not achieve anticipated levels, Bob quickly found himself past due on
many accounts. It was not long before some of these suppliers wanted cash up front for purchases. Conditions seemed to go from bad to worse as debt mounted. In the
first year, the business lost over $108,000.

Bonnie and Bob both needed to work in the store because at least two people had to be around to prevent theft. With their responsibilities as parents, family
activities, commitments at church, working six days a week at the store was demanding and there was little down time. They even had to give up attending or watching
the games of their beloved University of South Carolina football team—an activity that in the past often gave them much-needed relaxation from the stress of running
your own business.

Fortunately, the clientele from Spartanburg remained loyal and frequented the store even more now that the business was more conveniently located in Spartanburg.
Store hours were 10:00 a.m. to 5:30 p.m., Monday through Saturday. Bob believed that the customers he was trying to reach, primarily non-working women who enjoyed
shopping and socializing would shop during the day. These women generally entertained, wanted quality family time, and had other obligations in the evening. Also,
this was more of a destination location as opposed to a mall location where there would be more walk by traffic in the evening.

Bob and Bonnie practiced a high moral and ethical standard and understood the importance of trust and honesty. They were fair in valuing stones for both buying and
selling purposes, which was often a concern by less knowledgeable customers. They were also friendly and got to know their customers on a first-name basis. Customer
service was highly regarded in all of their business dealings. As it turned out, many customers bought jewelry exclusively from Longs Jewelers. With over 15 years of
experience, plus his educational training, Bob felt he knew the jewelry business and how to make it successful.

Additionally, Bonnie, who was completely self-taught in the jewelry business, had a knack for picking the right products. She had always had an interest in colors and
texture and was good at determining what looked good on fashion conscious women. As a teenager, Bonnie was paid commercial art work for the Governor of New Jersey.
Since their market was primarily women in a middle- to upper-middle income bracket, it was important for Bonnie to recognize trends and styles when purchasing
inventory. She believed in her products and her enthusiasm translated into sales to satisfied customers. Bonnie also learned to make jewelry. She bought older
jewelry from estate sales and other secondary sources at a discounted price and used the materials to make new and more appealing jewelry items. Customers adored
these unique items.

Even though competition from other jewelry stores in the immediate vicinity was fierce, Longs Jewelers effectively used good marketing strategy with ads in popular
publications, radio, store specials, and especially word of mouth primarily catered to middle-income earners. They became active in the community and supported
charitable events, which helped to give the business credibility. Also their products were more fashion forward and seemed to have a unique appeal to their customers.
Their target customers were women who looked for something better than a run-of-the-mill Kmart or Wal-Mart type of product, but not the exorbitantly priced products
found at the really upscale jewelry stores. Of course, many of the other individually-owned stores were trying to capture the same market.

As with many owner-run businesses, Bob and Bonnie focused on little, but significant, services. They did engraving, cleaning, and elaborate gift-wrapping at no extra
charge. Their best promotion was word of mouth and personal friendly service.

Still with all the positive factors that Bob and Bonnie had going for them, maintaining the financial viability of the business was still a struggle in a very
competitive market. There were any number of factors that seemed to impact their potential for success including the seasonal nature of sales, high carrying cost of
inventory, high overhead costs, low sales volume, and even sometimes surprisingly low margins on items sold.

At times Bob had trouble making the monthly lease payment on the store. This last year he was four months behind. Like many businesses, the jewelry business was
seasonal. The majority of sales were made during the Christmas season with other peaks in February, May, and June. Months like July and August were extremely slow. In
the past, Bob caught up on the rent payments in December when he had a better cash flow.

Over the years, Bob and Bonnie had no choice but to rely on credit card debt, which had amounted to over $50,000. Once they were unable to make even the minimum
payment, their credit scores tumbled—and they no longer qualified for any personal loans or other credit cards. Nevertheless, they worked hard to repay suppliers and
establish a better relationship with those companies to hopefully get more favorable terms for future purchases.

Even with their best efforts, the Spartanburg store did not live up to their expectations. It had been seven years. What did Bob and Bonnie have to show for their
effort? They had already worked nine years in York with limited success and now another seven years in Spartanburg. There were good days, but then there were also
days when Bob wished just to sell a watch battery. With a $3,000-plus monthly rent, it was easy for Bob to determine that he needed over $200 in sales (assuming a 100%
markup) every day just to pay the rent. Sometimes Bob felt he was working for his landlord.

However, Bob and Bonnie both gained much joy selling a quality product, like an engagement ring to a satisfied customer, knowing they played a role in a special event.
Bob and Bonnie enjoyed working the store together and had complementary skills and a strong marriage even though they were together almost 24-7.

Bob surveyed what he had. His $100,000 of inventory could neatly fit into a couple of shoeboxes! There was the large safe, showcases, fixtures and some office
furniture. Of course, there also was the $250,000 debt. He felt fortunate that some of the debt was still interest-free and that his average cost of debt was around
11%. He had worked very hard to reduce the level of debt over the past few years. While the total company debt had decreased, his interest expenses increased as his
credit rating went down and his perceived riskiness by creditors went up.

If he left the store he asked himself: how was he going to make good on this debt? Because of their high ethical values and integrity, Bob and Bonnie felt badly that
they had created such a bad debt situation, and they felt morally obligated to make good on all of the outstanding debt. Suppliers and others had placed faith in them
and given the store favorable credit terms and assumed they would fulfill these obligations.

Future Operations

If Bob wanted to begin again, could he, especially now that his lease was terminated by his landlord? Seven years ago, he had a house with some equity that he sold to
raise capital for the business. Now, he did not even have that. It was doubtful that he could arrange for debt financing, given his history. If he brought in a
partner, that partner would probably want 51% ownership or more of the business, and he would lose control. Furthermore, could he even find a suitable location for
his store close to where he had become established?

He was aware of another location that had recently become available. It was just three blocks away, but it was only 1,250 square feet, 40% of the size of his current
store. Bob surmised that the monthly lease rate would be about half of his current rate. What kind of other lease terms would he face with a new landlord? Bob did
not want to be surprised again with hidden charges in another lease agreement. Also, could he afford the cost of a move, especially transporting the large and very
heavy safe?

There was also the issue of employees. Because of the need to always have at least two employees on site, Bob had often hired extra help at various times during the
year. Currently, two additional employees had come to depend on Bob and the job for their source of income. They too, would have to seek other employment. And there
were his loyal customers. Many had stuck with him since his early days back in York. He had spent years developing this relationship and market. Did he want to give
up this valuable but intangible resource?

If he folded the business, what would he do? For 20 years he had been in the jewelry business. Working for another company in jewelry, like a competitor, seemed like
such a step down. He wanted to stay in Spartanburg, and he had plenty of connections. But after being an entrepreneur, could he work for someone else? What would
Bonnie do? Their children were now 12 and 16. How would they react to this situation? They had already been through a lot.

Bob pulled out his last three years of financial data to try to determine if they even had resources or the financial viability available to make the store viable at a
new location. From Bob’s understanding of the jewelry business, successful operations have a gross margin of around 50 percent and a profit margin of at least five to
ten percent.

Maybe it was time to consider another direction. He had an MBA and years of retail experience, surely he could find a job in the Spartanburg area in the $50,000 to
$60,000 range. Plus Bonnie, with her talents and skills in the jewelry business, could easily find a part-time or maybe full time job and earn up to $30,000. Also,
with some catching up on the latest laws in the legal field, she could probably get a much higher paying job as a Para-legal with a law firm in the area. The thought
of using her legal bankruptcy training on their own store was not amusing. But was it or should it be just about the money? They really enjoyed the jewelry business
and the relationships established with their clientele. Their faith had remained strong, but this was going to be a test, or was it an opportunity?

Longs Jewelers
Income Statement
For the Years Ending June 30, 20×2, 20×3 and 20×4

20×2 20×3 20×4

Sales $419,779 $419,667 $432,206
Cost of Goods Sold 232,869 297,161 228,743
Gross Margin 186,910 122,506 203,463
Operating Expenses
Salaries and Wages 50,374 31,909 44,891
Rent 36,284 38,639 40,523
Taxes and Licenses 19,772 18,804 26,391
Advertising 13,875 13,515 11,599
Insurance 7,829 7,683 7,658
Utilities 6,506 7,412 6,504
Depreciation 19,047 18,672 16,738
Other General and Administration 3,087 11,767 19,762
Total Operating Expenses 156,774 148,401 174,066
Interest Expense 7,670 3,812 11,696
Total Expenses 164,444 152,213 185,762
Net Income Before Tax* $22,466 $-29,707 $17,701

*Due to significant losses from prior years, no taxes have been paid over the
three years because of net operating loss carryforwards. The marginal federal plus state tax rate, if taxes had been paid, would be 15%.
Longs Jewelers
Balance Sheet
For the Years Ending June 30, 20×1, 20×2, 20×3 and 20×4

20×1 20×2 20×3 20×4

Current Assets
Cash $-4,824 $433 $-2,130 $9,657
Accounts Receivable 7,886 6,100 5,000 4,368
Inventory 186,450 188,237 111,455 99,351
Total Current Assets 189,512 194,770 114,325 113,376
Long-Term Assets
Equipment 139,497 150,790 149,332 152,942
Less Accumulated Depreciation -63,592 -82,639 -101,311 -118,049
Equipment (net) 75,905 68,151 48,021 34,893
Other Assets 1,458 1,458
Total Long-Term Assets 75,905 68,151 49,479 36,351

Total Assets $265,417 $262,921 $163,804 $149,727

Current Liabilities
Accounts Payable $151,743 $140,000 $140,000 $141,328
Long-Term Liabilities
Loans from Shareholders 19,471 18,200 16,200 44,177
Notes Payable 206,377 200,846 133,436 70,684
Total Long-Term Liabilities 225,848 219,046 149,636 114,861

Total Liabilities 377,591 359,046 289,636 256,189
Common Equity
Common Stock 1,000 1,000 1,000 1,000
Retained Earnings* -113,174 -97,125 -126,832 -107,462
Total Equity -112,174 -96,125 -125,832 -106,462

Total Liabilities and Equity $265,417 $262,921 $163,804 $149,727

*Prior period adjustments made
to balance in retained earnings -6,417 1,669

Period 3 Quiz

Daniel’s Auto Factory manufactures an extensive line of premium auto parts for sale throughout the United States. Its balance sheet for the first quarter of a recent
year is presented along with an analysis of selected accounts and transactions:

Daniel’s Auto Factory March 31 January 1
Assets
Current Assets
Cash $ 921,505 $ 528,787
Accounts Receivable 1,602,582 1,463,901
Inventories 2,748,788 2,504,908
Supplies 581,508 224,001
Other 59,219 59,219
Total Current Assets 5,913,602 4,780,816
Long-Term Assets
Equipment 14,010,796 12,929,675
Accumulated Depreciation -2,744,388 -2,468,084
Equipment (Net) 11,266,408 10,461,591
Land 574,130 624,185
Intangible Assets Net of Amortization $259,641 3/31 & $253,740 1/1 330,359 336,260
Other 100,206 111,588
Total Long-Term Assets 12,271,103 11,533,624
Total Assets $18,184,705 $16,314,440
Liabilities and Equity
Current Liabilities
Accounts Payable 1,279,455 998,520
Accrued Liabilities 714,473 550,386
Income Tax Payable 11,198 54,229
Short-Term Debt 0 1,000,000
Current Maturities of Long-Term Debt 429,562 134,538
Total Current Liabilities 2,434,688 2,737,673
Long-Term Liabilities
Long-Term Debt 4,193,290 2,183,877
Deferred Income Tax 275,508 275,508
Total Long-Term Liabilities 4,468,798 2,459,385
Total Liabilities 6,903,486 5,197,058
Stockholders’ Equity
Common Stock 91,029 91,029
Additional Paid-in Capital 9,703,985 9,703,985
Treasury Stock -1,015,899 -1,015,899
Retained Earnings 2,502,104 2,338,267
Total Equity 11,281,219 11,117,382
Total Liabilities & Equity $18,184,705 $16,314,440
Analysis of Selected Accounts and Transactions:

a. Net income was $163,837
b. Depreciation and amortization totaled $282,205
c. No equipment was sold during the period.
d. No intangible assets were acquired or sold.
e. Proceeds from issuance of long-term debt were $4,659,466, and principal payments were $2,355,029
f. No dividends were declared or paid

Required

1. Prepare a statement of cash flows using the indirect method for the three month period.
2. Discuss the strengths and weaknesses Daniel’s Auto Factory based on the statement of cash flows.