Cash flow and credit risk

Taipei-based Tang Manufacturing has a $1.45 million bank loan that starts coming due in a year, and the loan officer at the local bank has asked for cash budgets to be reassured that the company can repay the debt on schedule. Management has prepared quarterly cash flow forecasts for each of the next six quarters, excerpts of which are produced in the table below. Also worth noting is that much of Tang’s equipment and machinery is dated, and therefore long overdue for replacement.

Q1

Q2

Q3

Q4

Q5

Q4

Scheduled loan payments

$725,000

$725,000

forecasted cash flows

Cash flow from operations

$290,000

$362,500

$435,000

$348,000

$290,000

Capital expenditures

217,500

217,500

253,750

$319,000

Dividends

72,500

Required

(a) Why might Tang’s loan officer be concerned about the company’s ability to repay the loan?

(b) What steps can Tang management take to reduce the bank’s risk on the loan?

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