Corporate Finance (Theory and Practice)

CASE 1: Jones Electrical Distribution

Vikas Khandelwal (2011D39)

Tejasvi Vijayaraghavan (2011D40)

Pranay jain (2011D41)

Taha Lanewala (2011D46)

Vikas Gupta (2011D49)

Jones Electrical distribution CASE

Jones Electrical Distribution is involved in wholesales of electrical devices and appliances. Even though Jones Electrical has been profitable, they have noticed a shortage of cash when attempting to take advantage of trade discounts. Their current bank is unable to extend financing over $250,000, and Jones believes they will need considerably more to finance their operations.

Even in an extremely competitive market environment the business has been able to show profits (competing on the basis of competitive pricing, effective inventory management, and aggressive sales force). But its ineffective collections policy has drained the company’s cash leaving it in need of additional financing. In order to afford to continue taking advantage of trade discounts Jones Electrical Distribution needs to tighten its cash collection procedures. 

PROBLEM STATEMENT

What is the right long term growth plan of the company? Should the company avail the increased line of credit from the new bank at the floating rate of interest or stick to Metropolitan Bank? If yes, should they avail the trade discount from the suppliers at the 2%? or pay the suppliers a little after due date?

To evaluate the case we will forecast the 2007 financial statement of the company with and without trade discount.

We assume that sales of the company increases to 2.7 million. In case of no growth the financial statements will not have much effect so we don’t

forecast.

Income Statement

Profit and Loss Account200

4200

5200

6Q1

2006Q1

20072007

E2007 E (with trade discount)

Net Sales 1624

1916

2242

514 608 27002700

COGS 1304

1535

1818

499 21892145.596789

Gross Profit 320 381 424 109 511 554Operating Expenses 272 307 347 94 418 418Interest Expenses 27 30 31 8 37 37

Net Income before taxes 21 44 46 7 55 99Provision for Income Taxes 7 15 16 2 19 34

Net Income 14 29 30 4 5 36 65Balance sheet

2004 2005 2006 2007 E(with trade discount)

2007 E

Cash 45 53 23 32 32Accounts Receivable 187 231 264 317.9304193 317.9304193

Inventory 243 278 379 429.1193577 437.8768956Total Current Assets 475 562 666 779.049777 787.8073149

Property and Equipment 187 202 252 303.4790366 303.4790366

Accumulated Depreciation-74 -99 -134 -173.4522748

-173.4522748

Total PP&E 113 103 118 130.0267618 130.0267618

Total Assets 588 665 784 909.0765388 917.8340767

Accounts Payable 36 42 120 58.78347366 179.9494092Line of Credit Payable 149 214 249 395 310

Accrued Expenses 13 14 14 14 14Long Term Debt, Current

Position 24 24 24 24 24Current Liabilities 222 294 407 491.7834737 527.9494092

Long term debt 182 158 134 110 110Total Liabilities 404 452 541 601.7834737 637.9494092

Net Worth 184 213 243 308 279Total Liabilities and Net Worth 588 665 784 909 917

Cash flow statement

Cash Flow Statement200

5200

6

CFO

PAT 29 30Depreciation 25 35

Increase in Account Receivable -44 -33Increase in Inventory -35 -101

Increase in Accounts payable 6 78Increase in Lines of Credit 65 35

Increase in Accrued Expenses 1 00 0

CFO

Debt Repaid-24 -24

CFI Investment in Fixed Asset -15 -50Change in Cash Balance 8 -30

Ratio Analysis

Ratio Analysis2004 2005 2006

Current Ratio 2.14 1.91 1.64Quick Ratio 1.05 0.97 0.71

Inventory Turnover 5.37 5.52 4.80Days Of Inventory 68.02 66.10 76.09

Days Sales Outstanding 42.03 44.01 42.98Days Payables 10.08 9.99 24.5

Fixed Asset Tunover Ratio 14.37 18.60 19.00ROA 2.38% 4.36% 3.83%ROE 7.61% 13.62% 12.35%

Cash Conversion Cycle 99.97 100.12 95

Conclusions

Inventory turnover ratio for 2005 is (1535/278=5.89) and for 2006 is (1818/379=4.8). It shows that Jones has been overconfident in their predictions. Increasing the inventory is a reason that the company is facing cash money shortage. All of these have dramatically increased day’s payable outstanding.

In past history Jones took advantage of a 2% discount if supplies were fully paid off ten days upon purchase. With the growth of business and the decrease in Cash Flows, payments for supplies exceed the discount period. The discount that is disregarded only increases the accounts payable and further decreases cash flow. In 2006 Metropolitan Branch Bank issued a loan of $250,000 to Jones in order to finance its growth in sales. Heavy credit dependency on suppliers will continue to draw request for larger loans and Jones must keep its line of credit at a lower rate to increase cash flows. The risk in issuing a $350,000 loan with a company of Jones size could be decreased in hope of creating a long term relationship.

Also, the company has lowered the Cash Conversion Cycle from 100.12 days (during 2005) to 95 days(during 2006) thus by increasing the days payable the company can reduce the c2c cycle.

We observe that with trade discount the company’s line of credit has to increased its line of credit to $395 assuming it has year ending cash balance of$ 32 and without cash discount the company needs to maintain a line of credit of $ 310. We know that the company can get a maximum line of credit of $350, thus the option of trade discount is not feasible.

One area that we feel that the company could improve in is in its purchasing of inventory. There seems to be a huge influx of additions to its inventory, and based on the decrease in its inventory turnover ratio, the increase of inventory seems to be a bit unnecessary. Looking at the financial statements we feel that the company could improve your cash flows by buying the appropriate amount of inventory. Although the company is expected to continually grow, we feel that if the company purchased inventory in proportion to the growth that the company expects, it would improve its inventory turnover rate. Doing this would help it be more profitable.

Another area of concern for the company is its collections policy. We feel that if it enforced a more strict collections policy it would improve other areas of its finances. By the looks of it, it appears that the lack of enforcement has deducted the company’s available cash which has forced an inhibition of payment during the discount period on its credit line. We feel that it needs to take the necessary steps to collect its Accounts Receivables in a timely manner, so that it may take advantage of the discount period.