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 Distribution Company participated in the field of electric appliances and electrical
appliances wholesale. The company was making profits, but there was a note that there was a
shortage of cash when Jones tried to take advantage of trade discounts. The current bank cannot
finance more than $ 250,000, so Jones believes he needs more funding.

Even in a highly competitive market environment, this company managed in a competitive

market environment to show profits (competition based on competitive pricing, effective
inventory management and strong sales force). But the inefficient collection policy has drained
the company's money and left it in need of additional funding. In order to continue to benefit
from trade discounts, this company needs to take extreme measures to collect funds

PROBLEM STATEMENT

Jones needs to decide whether to choose between the Metropolitan Bank, which can give him a
credit value of $ 350,000, and Southern Bank & Trust, which can only give him $ 250,000. In
addition, he must consider whether to continue to the trade discount from suppliers by 2% or not,
that leads him to make the payment after the due date.

To assess the situation,

1. we will expect the company's 2007 financial statement with or without a trade discount.
2. We assume that the company's sales rise to 2.7 million.
3. In the absence of growth, financial statements will not have a significant impact, so do
not expect.

ANALYSIS OF THE COMPANY

Jones Electric has grown steadily over the years. As sales increased year-on-year between
2004 and 2006, rising by 38.1% from $ 1,624,000 to $ 2242,000. Moreover, it is expected
that sales will rise to $ 2.7 million for 2007. Despite profit growth with sales, the
company's margin is relatively small compared to the amount of revenue it generates. In
2006, margin was 1.3% and in 2004, the margin was 0.9% lower. This shows that the
profitability of the company is not so good. The company's economic downturn could
lead to a negative profit margin.

Of the data we are studying, the increase of 41.2% (264 / 187-1) * in accounts receivable
between 2004 and 2006 is one of the reasons for the decline in cash, which indicates that
fewer customers wish to pay cash for goods . Due to these receivables, the discount for
quick payments became extremely difficult, resulting in an increase of 233.3% (120/36) /
* 100 in accounts payable between 2004 and 2006.

The decrease in cash was also due to its use to finance higher inventory amounts. In
2005, the stock turnover ratio was 5.53% and there was a decrease in the ratio in 2006 to
 4.80%. This is evidence that the company has over-estimated its sales for the future, and
this has led to a shortage of cash due to the improper purchase of the stock.

The company's ROA in 2004 was 2.3%, 4.3% in 2005 and 3.8% in 2006. These low
values mean that the company does not use highly efficient assets. In addition, the return
on equity in 2004 was 7.6%, 13.62% in 2005 and 12.35% in 2006. As ROE has increased
over these years, this indicates that the company has performed better for its
shareholders.

To determine the best working procedures of the company, we will show the financial
statements of the company with and without the use of a commercial discount

Income Statement

Profit and Loss Account

  Q1 2006 2007 Expected 2007

Q1 2007
Without discount trade Expected
2004

2005

2006

(with trade
discount)
Net Sales 1624 1916 2242 514 608 2700 2700
COGS 1304 1535 1818   499 (% of sales) 2189 2146
Gross Profit 320 381 424   109 511 554
Operating Expenses 272 307 347   94 (% of sales) 418 418
Interest Expenses 27 30 31   8 (% of sales) 37 37
Net Income before taxes 21 44 46   7 55 100
Provision for Income Taxes 7 15 16   2 19 34
Net Income 14 29 30 4 5 36 66
Balance Sheet
Year 2004 2005 2006 Q1 Assumption 2007 (no 2007 (with
2007 trade trade discount)
discount)
Cash 45 53 23 32 unchanged 32 32
Accounts 187 231 264 290 % of sales 318.06 318.06
Receivable
Inventory 243 278 379 432 % of sales 456.4 447.27
Total current 475 562 666 755 806.46 797.33
assets
Property and 187 202 252 252 unchanged 252 252
equipment
Accumulated -74 -99 -134 -142 -142 -142
depreciation
Total PP&E, net 113 103 118 110 110 110

Total Assets 588 665 784 865 916.46 907.33

Accounts payable 36 42 120 203 180 58

 Line of credit 149 214 249 250 310 395
payable
Accrued Expenses 13 14 14 12 unchanged 14 14
Long term debt, 24 24 24 24 unchanged 24 24
current portion
Current liabiliites 222 294 407 489 528 491

Long-term debt 182 158 134 128 110 110

Total Liabilities 404 452 541 617 638 601

equity 184 213 243 248 278.46 307.46

Total Liabilities 588 665 784 865 916.46 908.46
and equity

Cash flow statement

  Cash Flow Statement

200 200
   
5 6
PAT 29 30
Depreciation 25 35
Increase in Account Receivable -44 -33
CFO

Increase in Inventory -35 -101

Increase in Accounts payable 6 78
Increase in Lines of Credit 65 35
Increase in Accrued Expenses 1 0
    0 0
 CF
Debt Repaid
O -24 -24
CFI Investment in Fixed Asset -15 -50
  Change in Cash Balance 8 -30

Ratio Analysis

Ratio Analysis
  2004 2005 2006
Current Ratio 2.14 1.91 1.64
Quick Ratio 1.05 0.97 0.71
Inventory Turnover 5.37 5.52 4.80
Days Of Inventory 68.02 66.10 76.09
Days Sales Outstanding 42.03 44.01 42.98
Days Payables 10.08 9.99 24.5
Fixed Asset Tunover Ratio 14.37 18.60 19.00
ROA 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.