Case studies in working capital management and short-term financial planning

0. Dell’s working capital

Dell Computer Corp. manufactures, sells, and services personal computers. The
company markets its computers directly to its customers and builds computers after
receiving a customer order. This build-to-order model enables Dell to have much
smaller investment in working capital than its competitors. It also enables Dell to
more fully enjoy the benefits of reduction in component prices and to introduce new
products more quickly. Dell has grown quickly and has been able to finance that
growth internally by its efficient use of working capital and its profitability. This case
highlights the importance of working capital management in a rapidly growing firm.
Suggested questions:
Q1: How was Dell’s working capital policy a competitive advantage?
Q2: How did Dell fund its 52% growth in 1996?
Q3: Assuming Dell sales will grow 50% in 1997, how might the company fund this
growth internally? How much would working capital need to be reduced and/or profit
margin increased? What steps do you recommend the company take.
Q4: how would your answers to Question 3 change if Dell also repurchased $500
million of common stock in 1997 and repaid its long-term debt?
1. BBC PVT. LTD and working capital challenges
BBC Pvt. Ltd. (BBC), a chemical manufacturing company, was in urgent need of
funds in order to secure an important contract. BBC was able to manufacture a
product that involved low investment in the form of fixed assets. Although the
product was of an inferior quality due to its cost-effective production, the company
was able to pass on that cost advantage to its end customers, enabling BBC to
maintain its position in the market. In addition, the company sold the product
primarily on credit and was therefore a preferable option for buyers. BBC followed a
traditional approach to working capital management. Its assets were much greater
than its liabilities. The company repaid its creditors promptly before the credit period.
However, in terms of credit management, the company followed a casual approach. It
extended credit sales for large periods and its large inventory in the form of raw
material and finished goods resulted in excessive blockage of working capital. In this
case, BBC had the opportunity to pursue a promising contract that would require
significant investment immediately. The company's managing director needed to
make a decision about how to obtain and manage adequate funds for the upgrade that
BBC needed in order to secure its contract.
Suggested questions:
Q1: Was BBC’s working capital policy successful? Why or why not?
Q2: BBC’s inventory turnover ratio (ITR) decreases from 2009 - 2011. Calculate ITR
and analyze the efficiency of the company’s inventory management.
Q3: Evaluate the company’s cash position with focus on its credit policy towards
receivables and payables.
Q4: Is BBC a growing company? Which areas should be improved in the company for
future growth?
2. Signet Jewelers: Assessing customer financing risk
Marc Cohodes, a renowned short-seller, has identified weaknesses in Signet's business
strategy, which he argues is heavily reliant on providing loans to customers with
subprime credit score. He believes that the company accounts for its receivables
portfolio using recently accounting to hide the problem. The case presents Cohodes'
thesis, the response by Signet's management team, as well as the reactions by sell-side
analysts.
Suggested questions:
Q1: Consider the business model of Signet, Tiffany’s and Blue Nile. How are the
business models reflected in the financial statements of each company? Use financial
ratio analysis to identify the business model differences.
Q2: In your assessment, which of the three firms is performing better and why?
Q3: What risks and opportunities does in-house customer financing create for Signet?
How can we identify and assess the extent of this risk using financial statement
information?
Q4: How do you assess the performance of Signet’s in-house financing program?
Q5: Do you agree with Cohodes’s critique of Signet’s financing risk and its financial
reporting.
3. Coromandel: Enhancement of short-term finance
In April 2015, Coromandel International Limited (CIL), a manufacturer of fertilizers
based in Chennai, India, requested that the National Bank of India increase CIL's
existing short-term finance arrangement. CIL operated 14 state-of-the-art
manufacturing facilities across India with a combined installed capacity of four
million tonnes per annum and over 2,000 employees. It sold its products through a
countrywide dealer network as well as in its own 800 retail chain stores, with plans
for aggressive expansion both at home and to various countries in Southeast Asia,
Latin America, and Africa. However, CIL was dependent on government subsidies
and, because many of its raw materials had to be imported, was also dependent on a
positive foreign exchange rate. Over the previous three years, CIL had acquired four
fertilizer companies as part of its growth strategy in inorganics. With extended short-
term financing, CIL could integrate these companies and take advantage of the
resulting synergy. The country head of the Wholesale Banking Group was concerned
that CIL's request would exceed the bank's exposure norms on the fertilizer industry
as well as the bank's prudential exposure limits on a single borrower. Should the bank
accept CIL's request for enhanced short-term borrowing?
Suggested questions
Q1: Evaluate the strengths of CIL based on its past financial statements.
Q2: Assess CIL’s working capital requirement in respect of cash credit (CC), buyers’
credit (BC), and letter of credit (LC) limits from its financial projections.
Q3: Identify and discuss possible mitigation strategies for the risks embedded in the
case.
Q4: Comment on CIL’s liquidity position after it extended credit to its trade channel
partners, invested heavily in its group companies, and received substantial subsidy
receivables from the government.
Q5: Identify the strategic moves of CIL to position itself as a leading market player in
the fertilizer industry.
Q6: As Garg, would you make the loan to CIL?
4. LP Laboratories LTD.: Financing working capital
This case sets the context of a fast growing company; it is financing and working
capital requirements and important aspects the banker should consider while
extending the facilities and how the banker can structure working capital solutions.
The case is intended to challenge the students and practising executives to understand
the financial statements of a corporate entity from a banker's perspective, working
capital loan decision process, and assessment of working capital requirements. It
provides a comprehensive understanding about the types of financial products being
extended by banks to a large corporate entity, especially in working capital finance.
These include a demand loan of working capital, overdraft/cash credit pre- and post-
sales finance against exports, and finance against instruments such as bills discounting
and extending financial support on the basis of letter of credit (LC) mechanism.
Students are expected to assume the position of the banker and raise various questions
to the borrowing firm and utilize effectively the credit monitoring tools such as review
of current account transactions, funds flow statement, financial statement analysis,
and so on. This case helps in understanding the intriguing relationship between
accounting profits, cash flows, operating cycle, and working capital of the company.
Finally, the case concludes with structuring a working capital finance solution.
Suggested questions
Q1: What are the various financial instruments offered by banks for working capital
finance?
Q2: How has the company utilized existing working capital facilities?
Q3: What issues does the banker have to consider in renewal and extension of loan
facilities?
Q4: How should the financial statements be analyzed from the banker’s perspective,
both historical and projected?
Q5: How do we analyze operating cycle, inventory norms, and estimate working
capital requirements?
Q6: How do we structure the overall working capital financial solution?
5. J.C. Penney Company
The case examines the liquidity issues that J. C. Penney (JCP) experienced in 2012
and 2013 following a decline in sales and profits over several years. Despite once
being a highly profitable and growing company, the increasing pressures of
competition led to changes in strategy and in management that were insufficient to
return the company to the consistent financial results it had previously enjoyed. While
sales and profits waned, the cash balance also suffered, and Wall Street analysts began
expressing liquidity concerns as the company wrestled with having enough cash on
hand to cover daily operating needs. Students are asked to calculate a time series of
quarterly liquidity and leverage ratios to illustrate the declining financial condition of
the company. They are further challenged to weigh the benefits and drawbacks of
raising equity versus debt as a solution for the company's lack of liquidity. To assess
the amount of external capital required, students are asked to use a sources and uses
analysis that provides intuition for the cash flow challenges facing the company. Set
against the background of an iconic retailer, the case provides an engaging context in
which to discuss the need for a major capital structure decision due to operational
challenges.
Suggested questions
Q1: What do the liquidity ratios - Current, Quick, and Cash-to-Sales - reveal about
JCP’s financial position for the eight quarters spanning Q1 2011 to Q4 2012?
Q2: What do the leverage ratios - Debt-to-Capital, Interest Coverage, and Cash-to-
Debt - reveal about JCP’s financial position for the eight quarters Q1 2011 to Q4
2012?
Q3: How has JCP managed its working capital accounts over the past eight quarters?
Is there an opportunity to squeeze more cash from any of these accounts?
Q4: Assume that JCP will experience a $1.5 billion net income loss for 2013 and that
a cash balance of $1.0 billion is required for JCP to operate efficiently. Create a pro
forma sources and uses statement to estimate JCP’s external funding required by year-
end 2013. Be prepared to recommend whether the debt or equity issuance is the better
choice as the source for external funding. How will the stock price react to the
announcement of a debt offering? An equity issuance?
Q5: What effect did Bill Ackman have on the company? Were his interests
appropriately aligned with those of shareholders? How do assess the board’s decisions
regarding CEO appointments? Was Ron Johnson the right choice as the CEO?
6. Primo Benzina AG
Primo Benzina AG was a retail chain of petrol stations offering petrol, snacks,
restaurant meals, and high-quality service in central Europe. The company began
operations with four outlets and sales of €2.4 million in 2006, and grew to 24 outlets
and sales of €38.1 million in 2009. The company's rapid growth in revenues was
accompanied by declining profitability. Dresdner Bank reluctantly increased the
maximum amount available to the company to €12 million from €10 million. In early
2010, Otto Schroder, Chief Executive Officer, and Annegret Heuermann, the
company's chief financial officer, completed a review of the company's financial
situation. The company's executives were unsure whether the new credit limit would
permit the company to implement its growth strategy, since the company now had a
limited amount of cash available to finance additional outlays for working capital and
capital expenditures.
Suggested questions
Q1: What are the key elements of Primo Benzina’s business strategy? What are the
implications of this strategy for its financial performance?
Q2: Prepare an economic balance sheet showing the major classes of investments
(cash, net working capital, net fixed assets) and major sources of financing (short-
term debt, long-term debt, and equity) for 2007-2009. Explain the changes over time.
Prepare cash flow statements for 2007 through 2009. What is your assessment of the
company’s generation and use of cash?
Q3: What is your assessment of the company’s recent financial performance?
Q4: How much cash will the company need next year if the planned capital
expenditures on new retail outlets are undertaken and sales increase by 25 percent in
2010? How would the company’s cash requirements be impacted by changes in the
company’s operating, investment, and financing decisions?
7. Joneja Bright Steels: The cash discount decision
Joneja Bright Steels Private Limited (JBS) was one of many major players in India's
bright steel industry, serving almost every automobile manufacturer in Northern India.
After the business launched in 2002, the automobile market expanded, leading JBS to
an early strong position. But in fiscal year 2014/15, the company experienced working
capital management issues. JBS considered using credit policies as a way of
improving profitability-shifting from a strict credit policy of net 45 days to a flexible
credit policy with a 2 per cent discount for accounts paid within 10 days (2/10 net 45
days). Should JBS implement a cash discount for fiscal year 2016/17? The discount
could potentially increase the burden caused by already declining sales, but could also
improve the company's cash position.
Suggested questions
Q1: Define the elements of working capital in an organization such as JBS, describing
the importance of each element.
Q2: Calculate the various ratios used to quantify working capital in an organization.
Q3: Create a study comparing JBS’s working capital with that of its competitors.
Q4: Should management implement the proposed cash discount for its accounts
receivable?
8. Toffee Inc.: Demand planning for chocolate bars
The inventory manager of sales and distribution for Toffee Inc., a confectionery
company, had just concluded a meeting with all relevant personnel. The meeting had
not been entirely positive. The words of the production manager still echoed in his
ears: "If the ingredient inventory is not re-examined and reworked to the firm's
advantage then [soon] the final products based on these ingredients will cease to yield
the kind of profits that the firm expects." The inventory manager needed to prepare a
comprehensive forecasting and inventory management plan with a view to minimize
the cost of managing the supply chain by judicious use of resources, better
forecasting, and improvement in the ingredient inventory purchasing and management
systems.
Suggested questions
Q1: What kind of sales demand is Toffee Inc. looking at? Which forecasting method
is best suited to the situation that the company is in?
Q2: How are seasonal forecasting factors computed?
Q3: How can regression be used for quarterly forecasting for 2011, and then
extrapolated to monthly forecasts?
Q4: What is the safety stock to be maintained by the sales and distribution division for
a service level of 95 percent?
Q5: What are the replenishment trigger (re-order level) for the sales and distribution
division with the given lead time and expected service levels?
Q6: What is the most economic order quantity for the sales and distribution division?
Compute the number of orders per year and the order cycle as well.
Q7: What is the total annual inventory cost?
Q8: What is the production quantity for Seven Star (assuming zero losses in
production) and hence, what is the annual requirement for primary ingredients in
terms of quantity needed?
Q9: What is the best quantity bargain for the firm for various primary ingredients?
how are the purchase quantity levels decided and what is the total cost outlay for the
same?
9. Manish Enterprises: A growth versus profitability dilemma
In 2012, Manish Enterprises, a leading coal supplier firm located in Ludhiana, India,
was facing a decline in growth. A year later, a business graduate was appointed as the
chief executive officer of the company. He managed to reduce the cash cycle from six
months to three months by running the operations of the firm efficiently. Sales
increased by 127 per cent, and the firm began financing its growth by taking advances
from customers. The firm was thus able to reduce its investment in current assets.
However, despite adopting best practices, the profitability of the business was
declining. The challenges then faced by Manish Enterprises were to manage growth
and liquidity while retaining profitability.
Suggested questions
Q1: What was the gearing ratio of the firm and how did the firm manage it?
Q2: Why did the profitability of the firm decrease despite an increase in sales?
Q3: How did Manish Enterprises fund a 127 percent growth in sales in the year 2013?
Q4: Should Manish Enterprises scale up its business in the coming year?
Q5: Prepare the projected balance sheet of Manish Enterprises for the year 2014
considering a growth of 100 percent.
10. Horniman Horticulture
This case captures the cash-flow and working-capital management problems typical
of small, growing businesses. At the end of 2015, Bob and Maggie Brown have
completed their third year of operating Horniman Horticulture, a $1-million-revenue
woody-shrub grower in central Virginia. While experiencing booming demand and
improving margins, the couple is puzzled by their plummeting cash balance. The case
highlights the difference between cash flow and accounting profits, as well as the
common negative effects of growth on cash flow. The case provides a forum for
establishing appreciation for the relevance of free cash flow to business owners and
managers, introducing financial ratio analysis, developing the concept of the cash
cycle and working-capital management, and motivating the use of financial models.
Suggested questions:
Q1: What is your assessment of the financial performance of Horniman Horticulture?
Q2: Do you agree with Maggie Brown’s accounts-payable policy?
Q3: What explains the erosion of the cash balance?
Q4: What do you expect the financial position of the business to be in 2016? Extend
the financial statements through 2016, assuming that Bob Brown grows revenue by
30%. Note: To make the balance sheet balance, define cash as equal to (Current
Liabilities + Net Worth) - (Accounts Receivable + Inventory + OCA + Net Fixed
Assets).
11. Shenzhen JIT technology: Account receivable management issues
In March 2012, the president of Shenzhen JIT Technology Co., Ltd., a small
electronics manufacturing company in Shenzhen, China, was facing a problem with
the company's uncollected accounts receivables (AR). The company had a high level
of AR, and the time it was taking to settle these accounts was much longer than the
industry average, which had led to financial difficulties. The company had formalized
its sales commission structure to include a system of rewards and penalties related to
the collection of outstanding AR payments, but these new rules had not solved the AR
problem. The president needed answers: What was the main reason for the company's
high AR and receivable turnover? What was wrong with its AR policy? What specific
approach for quantity management of AR would resolve these issues?
Suggested questions
Q1: Why did Li become distressed when he read the figures describing the company’s
increased profit and increased AR?
Q2: How did JIT Technology manage its AR before revisiting the policies and
procedures for the marketing staff at the end of 2009? What is wrong with the
company’s AR management?
Q3: What problems did JIT Technology face in revisiting the policies and procedures
for the marketing staff?
Q4: What kind of quantitative analysis approach do you think should be used by JIT
Technology to assess its marketing staff’s AR collection performance?
Q5: What measures can JIT Technology take to speed up the collection of AR? What
should JIT Technology do in the future?
12. Home Store, Inc.
Home Store, Inc. is a retail chain of home improvement stores catering primarily to
middle income female homemakers interested in undertaking do-it-yourself (DIY) and
do-it-for-me (DIFM) projects. The company grew rapidly from a single store with
sales revenue of $8.8 million in 2001 to 20 stores with total sales of $11.334 million
in 2003. Yet, the company's rapid growth in revenues has been accompanied by
declining profits and a substantial increase in receivables, inventories, and capital
investments in new stores. The resulting cash outflows have been financed by
increased borrowing from Bank of America as well as stretching the company's
payables, i.e., taking longer to pay suppliers. Bank of America reluctantly increased
the maximum amount available to the company under its term loan to $5 million from
$2.6 million. In early January 2004, Hermione Granger, President and Chief
Executive Officer of Home Store, Inc., and Ron Weasley, the company's chief
financial officer, completed a review of the company's financial situation. The
company's executives are unsure whether the new credit limit will permit the
company to implement its growth strategy since there is only $1.464 million
remaining under the term loan at the beginning of 2004.
Suggested questions:
Q1: What are the key elements of Home Store’s business strategy? Does Home Store
have a sustainable competitive advantage?
Q2: How has the company financed its growth in the past? Why have they adopted
that particular financial strategy?
Q3: What is your assessment of the company’s recent financial performance?
Q4: How much cash will the company need next year if sales do grow 20% in 2004?
Q5: Does this company have any problems? What are they? How should they be
fixed?