Jones Electrical Distribution.pptx

Jones Electrical Distribution

Dr. C. Bulent Aybar Professor of International Finance

Context • Jones Electrical Distribution has been expanding rapidly for the past several years. • Increases in working capital requirements have significantly outrun the capacity of the company to generate funds from internal sources. • The company has been forced to forgo taking discounts on accounts payable and to borrow in increasing amounts from its bank to maintain its expansion. • Jones must decide whether to continue to expand and, if so, how to finance the growth. © Dr. C. Bulent Aybar

Impact of Growth on Jones: Investment Requirements – Inventories + Accounts Receivables 2004

2005

2006

$430

$509

$643

– Investment in inventory and A/R has been growing at a rate of ~22% . (current assets has grown at 18.4%) > Sales growth of 17.49% for the same period – Fixed Assets Net Fixed Assets

2004

2005

2006

$113

$103

$118

$15

$50

Acquisitions

– Growth in fixed assets is moderate! © Dr. C. Bulent Aybar

Working Capital and Sales Growth 2004

2005

2006

WC/Sales

26.47%

26.54%

28.67%

FA/Sales

6.96%

5.37%

5.26%

Sales

$1,624

$1,916

$2,242

COGS

$1,304

$1,535

$1,818

A/R

$187

$231

$264

Inventory

$243

$278

$379

A/P

$36

$42

$120

ACP

42

44

43

5.37

5.53

4.80

DSI

68

66

76

APP

10

10

24

CCC

100

100

95

WCR

$381

$453

$509

23.47%

23.63%

22.70%

Inv.Turnover

WCR/Sales

What is the impact of slowing inventory turnover and collection period on Jones’s investment requirements?

?

WC Investment is Growing Faster than Sales! Accounts receivable Sales Change in accounts receivable as pct of sales

2004 $187 $1,624 11.51%

2006 $264 $2,242 11.78%

12/31/06 Accounts Receivable at 12/31/04 pct of Sales Actual 12/31/06 Accounts Receivable Accounts Receivable due to increased receivables as % of sales

Inventory Sales Change in Inventory as % of sales

$ of A/R and Inventory at 12/31/06 due to slower turnover Combined $ due to sales growth

0.27% $258.0 $264.1 $6.1

2004 $243 $1,624 14.96%

2006 $379 $2,242 16.89%

12/31/06 Inventory at 12/31/04 pct of Sales Actual 12/31/06 Inventory Inventory due to increased Inventory as % of sales

Combined $ Combined % of sales

Change $77.3

Change $135.7 1.93% $335.4 $378.6 $43.2

$429.8 26.47%

$642.8 28.67%

$212.9 2.20% $49.3 $163.6

Contribution of Declining Efficiency: 23.2% • Change in company’s working capital is $212.9 (~213K) • The company’s financing needs were increased by 2.20% of sales, or $49.3 thousand by the longer collection period and slower inventory turn in 2005 and 2006. • The figure of $49.3 thousand amounts to only 23.2% of the total increase in accounts receivable and inventories of $213 thousand between December 31, 2004 and December 31, 2006; • Therefore sales growth accounts for the a substantial majority of the additional funds invested in receivables and inventories. © Dr. C. Bulent Aybar

Does Jones Generate Sufficient Cash Flows? 2005

2006

2005-06

Net Income Depreciation Inventory Accounts receivable Trade credit (Accounts payable) Accrued expenses Cash flows from operations

$29 $25 ($35) ($44) $6 $1 ($18)

$30 $35 ($101) ($33) $77 $1 $9

$59 $60 ($136) ($77) $84 $1 ($9)

Capital expenditures Cash flows from investing activities

($15) ($15)

($50) ($50)

($65) ($65)

Bank borrowing (Line of credit) Reduce long-term debt Cash flow from financing activities

$65 ($24) $41

$35 ($24) $11

$100 ($48) $52

$8

($30)

($22)

Increase / (decrease) in cash

Is Jones’ Assessment of Funding Need Accurate? • Maybe if Jones continues to rely heavily on trade credit as a source of funds, as he has been during recent years • Probably no if he decides to pay his accounts payable promptly in order to take advantage of the 2% discount offered on payments made within 10 days of the date of invoice. •

How can we tell?

© Dr. C. Bulent Aybar

Before we move on to assessment of funding need.. • What is the cost of not taking the discount for Jones? • Assume $1000 purchase – Take discount pay $980 on day 10 – Do not take discount pay $1,000 on day 30

• Not taking the discount costs $20 for 20 days of $1,000 purchase, or 2% per 20 days – Annualized cost 2% x (365/20)=36.5%

– If APP is stretched to 40 days cost s ~24%

© Dr. C. Bulent Aybar

Assumptions for Forecasting Funding Need Sales

2,700,000

Operating Expenses

15.46%

Interest Expense

31,000

ACP

43

DSI

76

Principal Paid

24,000

Cash

32,000

Net PPE

110,000

COGS/Sales with discount

81.11%

COGS/Sales without discount

83.11%

Tax Rate

35%

Income Statement

Net sales Cost of goods sold Gross profit on sales Operating expense b Interest expense Net income before taxes Provision for income taxes Net income

2007 2,700,000 2,189,970 510,030

2007 2,700,000 2,243,970 456,030

417,310 31,000 61,720

417,310 31,000 7,720

21,602 40,118

2,702 5,018

Pro Forma Balance Sheet Take Discount 23,000 318,082 455,994 797,076

No Discount 23,000 318,082 467,238 808,320

Property & equipment Accumulated depreciation Total PP&E, net

118,000

118,000

Total assets

915,076

926,320

Accounts payable Line of credit payable Accrued expenses Long term debt, current portion Current liabiliities

59,999 249,183 14,000 24,000 347,183

184,436 249,183 14,000 24,000 471,619

Long-term debt Total liabilities

110,000 457,183

110,000 581,619

Net worth Total liabilities and net worth Funding Need (Excess)

282,790 739,973 175,103

247,690 829,310 97,010

Line of Credit after Adjustment

424,286

346,193

Cash Accounts receivable Inventory Total current assets