Good Case Study About Paper Due Date
While considering the different nuances of the business environment in regards to Jones Electrical distribution , the following case issues will be investigated as follows:
Issue 1: Jones electrical has been trying to keep its operating expenses at a minimum; one of the methods is by taking advantage of the 2% early payment discounts to vendors. Management will have to determine if it is worth borrowing to take advantage of the above discount. To do this with growing sales, Jones electrical requires a bigger line of credit than what it is getting now.
Issue 2: While investigating new credit line options with Southern Bank & Trust, it is clear that there will be a number of restrictions on future borrowings
Issue 3: Joes electrical faces uncertainty of future sales, i.e. after the 1st quarter of 2007. This will help with all decision making in terms of where to take the company.
The above mentioned issues although specific are interrelated as it will allow Nelson Jones to figure out whether to seek financing through debt financing or raise new equity.
Cost of funds:
While considering Issue 1, we have to take into consideration the cost of borrowing. Please refer to Appendix 1 while going through this section. Considering the example above assuming the material value is for $10,000 the discount benefit on paying of the invoice in 10 days is $200 and the cost of borrowing at from Southern Bank & Trust for one month is $62.5 . As per the case payments are expected to be paid in 30 days but will usually extend further credit possibly up to 5 to 10 days after the due date. From a purely quantitative standpoint Jones is better off by taking advantage of the early payment discount but has to understand that as business’s grow, management has to consider the big picture and us funds available to them wisely. I would recommend that Jones electrical consider using its credit line for streamlining its business operations rather than to pay off bills which would mean foregoing trade discounts. The reason for foregoing the trade discount is two fold a) Jones cannot tell for certain when the items purchased from the vendor can be distributed, which means the credit line is not only being used but also the interest at 7.5%.
b) Since direct sales has been a big part of success for Jones’s sales growth, a more ambitious option would be to dedicate the same funds to hiring more sales people and motivating current marketing representatives, which can be done with more cash available at any given time. To elaborate on this point , assuming that Jones has an option of using $10000 towards a 2% discount which is $200 or using the same funds towards spending on marketing expenses which could result on more coverage of new customers to distribute too, e.g. assuming the $10,000 used in magazine ads and promotions for sales people could result in $1 Million in sales this would allow for a profit of $15,791 in 2007 (Note that 2007 forecast is expected to yield a 1.579% profit margin as seen in Appendix 6). Therefore it is important that management consider using their funds available towards promoting the product line of the company.
Negotiating on Banking terms:
In terms of Issue #2, Southern Bank & Trust protecting their interests have put a number of restrictions on future borrowings, prior permission to be given to Jones electrical before investing in fixed assets and borrowings at any given time should not exceed 75% of accounts receivable and 50% of inventory. Under the current scenario this would pose an issue for Jones. As per Appendix 2 as per the 1st quarter of 2007 data the maximum Jones could use of its credit line is only $216 K. Jones current banker Metropolitan allows Jones to borrow $250k without any stipulations. The restriction on AR and inventory during the low quarters would restrict Jones electrical buying capacity. While negotiating with Southern Bank and trust, this point should be waved. However the rule on asking permission on fixed investments is common in the banking sector and will not affect Jones to a great extent since as per the 1st quarter of 2007 , property plant and equipment is the same as 2006, Increasing sales is not likely to drastically increase this number. Another important point is the restriction on the amount of money Nelson can draw from the company, this is a healthy precaution which is advisable for both the company as well as the bank. Overall Jones should stipulate flexibility on the % of receivables and inventory rule when negotiating with the bank on terms. As per the balance sheet below the Bank is paying attention to Jones cash position which us decreasing the worst decline seen was in 2006. This is also reflective in the increase of accounts payable. As seen in Appendix 4 the liquidity of the company is will be questioned by the bank. As seem the current ratio falling year on year which means Jones has to keep a close watch to make sure it does not fall further . I recommend that Jones electrical should agree to the terms with the following stipulations
The stipulation on accounts receivable should be removed as it does not allow a company of Jones’s size to borrow more than $220 K
The stipulation on inventory should be increased from 50% to 80% which will help Jone’s get closer to borrowing upto $350K.
Request for temporary increases in credit for an additional 50 k to 100 k on a case by case basis. For example if Jones has fully borrowed on his credit line but needs an additional 10 K , management should provide the bank with where the goods purchased are going to be sold and a report on the credit worthiness of the customer being distributed too.
Forecast and decision making:
Issue #3: The biggest issue after analyzing that Jones should not focus on attaining small early payment discounts and should negotiate with the Southern Bank and trusts on the terms of the financial revolver is whether to seek equity from private funding or whether to seek funds via the banking route. The following table covers the assumptions employed to forecast sales for 2007. The forecasting methodology used is based on historical yearly data as well as rules on taxes etc.
The assumptions as stated in Appendix 3 have been employed to come up with the forecast for 2007 in the last column as per the table in Appendix 5.
As seen above sales is expected to increase to $2.7 Million and net income is expected to increase by $13,000 when compared to 2006. In terms of the electrical industry January through September are heavy sales periods and should be consistent with the estimate of $2.6 Million for 2007. When considering outside investment from private funding, the profit margin of a company is the first always considered and investors tend to look at opportunities over 15 % to 20%. As seen in Appendix 6 Jones is at a much lower position. Although it is always good to have options of Private funding, in the current situation the chances are slim at best. Hence it is best that Jones electrical only consider a line of credit from banking institutions and keep working towards improving the financial stability of the company.
As per the forecast and analysis of the issues above it is clear that Jones electrical will be facing moderate growth at over to $2.7 Million and should seek funding for stabilizing its cash situation allowing them flexibility with getting more business. Jones should sign with Southern only if it is willing to have more flexibility on the terms of AR and inventory, as they already have a credit line with Metropolitan and Nelson himself should exercise caution and discipline on how much is drawn from the company i.e. like any employee he should restrict his requirements to a particular number with an increase year on year if the company is profitable ,e.g. if nelson is drawing 100K in the 1st year he would be eligible for a 5% increase year on year if the company is making money. This will overall help the company’s financial situation, and shows that Nelson is committed to putting money back into the business rather than taking it out. Stability is the key to the long term growth of any organization.