In January, I established a $300,000 line of credit with the Harris Bank. We expected to have some cash flow difficulties, and I thought this would help us cope with them. Now I’m not sure $300,000 is enough!
In mid July 2001, Dr. Mark Amsted, Chair of the Department of Obstetrics and Gynecology at Brookstone Medical School, Chief of Ob-Gyn at Brookstone Medical Center, and President of Brookstone Ob-Gyn Associates (BOGA), was concerned about his upcoming meeting with the Harris National Bank. He planned to present a request for an increase in BOGA’s line of credit. As had happened in the past, the bank’s approval of his request was critical to BOGA’s continued operations. Although the Dean of the Medical School had approved his request to approach the bank again, Dr. Amsted was uncertain about the bank’s reaction. The Brookstone Ob-Gyn Associates (A) case contains background information on BOGA, and discusses the details of Dr. Amsted’s January request to the bank for a $300,000 line of credit.
In conjunction with Dr. Amsted’s January request, the bank had asked him to prepare some projections for the 2001 operating year. He had done this, indicating that he expected 2001 revenue to be 30 percent greater than 2000 revenue. After switching to an accrual system of accounting, Dr. Amsted had been pleased to learn that 2000 had been a profitable year for the group. His projections indicated that 2001 also would be profitable.
Despite the growth in revenues and the group’s profitability, BOGA’s cash flow was once again becoming an issue. Indeed, as he began to prepare for the meeting with the bank, Dr. Amsted realized that he faced a problem related to BOGA’s cash flows. He commented:
Until 2000, we kept our financial records on what the accountants called a modified cash basis. That was pretty simple. Revenues were recorded when we received a cash payment from a patient or third party payer. Expenses were recorded when the cash was paid out. The only exception was plant and equipment purchases, where the accountants said we needed to use depreciation instead of cash as the expense.
When I applied to the Harris Bank for the line of credit, Ms. Tanshel [the bank’s loan officer] told me that a modified cash basis was not an acceptable way to present our financial statements. The bank required us to submit our statements on an accrual basis. According to our accountants, the most significant change needed to satisfy the bank’s requirement was to record our revenue when a patient received services, rather than when we actually received the related cash payment.
An operating statement for calendar year 2000, prepared on an accrual basis, is contained in Exhibit 1. The balance sheet as of 31 December 2000 is contained in Exhibit 2. Exhibit 1 also contains a projected operating statement for calendar year 2001 (prepared by Mr. Weber, BOGA’s business manager, and Dr. Amsted in January 2001), and actual operating statements for each of the first six months of 2001. The projected operating statement reflects Dr. Amsted’s expectation that 2001 revenue would grow by 30 percent over the 2000 level. Exhibit 2 contains actual balance sheets as of the end of each month for the first six months of 2001. . . .
- Using the data in Exhibit 3 and the worksheet in Exhibit 4, project the changes in the line of credit during July - December 2001. Note that the line of credit effectively is negative cash. It will increase in any given month by the same amount that cash otherwise would decrease for that month.
- What is causing the decline in cash? How big does the line of credit need to be to accommodate the cash shortfalls? When will BOGA be able to repay the line of credit to the bank? Would a return to a modified cash system eliminate the problem?
- What should Dr. Amsted do?