Anthony Larson, proprietor of Charleston’s J. Prep Company stared aghast at the November bank statement that the store’s bookkeeper had just placed on his desk. Despite the rapid growth in the store’s sales over the last three months, and the prospect of brisk sales for the upcoming holiday season, the company was almost out of cash. He had just begun to hire part-time employees for the anticipated growth in sales during December. He realized that, unless something was done quickly to rectify the cash situation, he would not be able to pay them.
J. Prep was an upscale clothing store that catered to college students and young professionals. The store carried a wide line of casually-elegant sportswear, including sweaters, jeans, socks, all-weather shoes, tee-shirts, pajamas, and jackets. The name J. Prep was well known throughout the country, and was synonymous with style at reasonable prices. Each J. Prep store was operated by an independent manager who paid a franchise fee to the national organization in exchange for the right to use the J. Prep name and to purchase the company’s products at wholesale prices for resale. The J. Prep Company did careful background checks on applicants for franchises, and put its franchisees through a one-week training pro-gram to acquaint them with the company’s merchandising policies, general operating systems, and other administrative matters that would assure a customer of receiving similar service in any J. Prep store regardless of the city.
In May, Mr. Larson had been attracted to the J. Prep Company after reading an advertisement for a franchise opening in Charleston. Several months later, he had signed an agreement with the company and attended the company’s training program. In September, he raised the funds necessary to invest in a store, completed his negotiations with the landlord and signed a rental agreement, added the necessary equipment and furnishings, purchased his initial inventory, and hired a small sales staff. J. Prep Charleston opened officially for business in early October.
The First Two Months
The first two months had gone much better than Mr. Larson had anticipated. Sales were brisk and profits were good. Most of his sales were either for cash or on credit. Customers who bought on credit used a national credit card. The national credit card companies charged about 4 percent of the sales price as a fee, but they paid the store in cash immediately via electronic transfer.
In an effort to maintain good relations with the national office of J. Prep Company, Mr. Larson had adopted a policy of paying the company immediately for the merchandise he received, even though the terms of the agreement permitted him to defer payment for 30 days. He did the same with his other suppliers, mainly utility companies, paying immediately upon receipt of a statement. He always paid his rent on the first of the month. Exhibit 1 contains a summary of the store’s transactions for its first three months. . . .
- Prepare a balance sheet for J. Prep as of November 30. To do so, draw up a basic balance sheet format, and make entries to the appropriate accounts for each event de-scribed in Exhibit 1. Leave sufficient space below each asset, liability, and equity account (especially the cash and retained earnings accounts) to make several entries.
- By how much did the company's retained earnings increase during its first two months of operations? Why?
- How well has Mr. Larson managing the operating cycle? What changes, if any, would you recommend to his management of the operating cycle?