Jones Electrical Distribution

Jones Electrical DistributionDr. C. Bulent AybarProfessor of International Finance1Context 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 Aybar2Impact of Growth on Jones: Investment RequirementsInventories + Accounts Receivables

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 periodFixed Assets

Growth in fixed assets is moderate!

200420052006$430 $509 $643 200420052006Net Fixed Assets$113 $103 $118 Acquisitions$15$50 Dr. C. Bulent Aybar3Working Capital and Sales Growth200420052006WC/Sales26.47%26.54%28.67%FA/Sales6.96%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 Inv.Turnover 5.37 5.53 4.80 DSI 68 66 76 APP 10 10 24 CCC 100 100 95 WCR$381 $453 $509 WCR/Sales23.47%23.63%22.70%What is the impact of slowing inventory turnover and collection period on Joness investment requirements? ?4WC Investment is Growing Faster than Sales! 20042006ChangeAccounts receivable$187 $264 $77.3 Sales$1,624 $2,242 Change in accounts receivable as pct of sales11.51%11.78%0.27%12/31/06 Accounts Receivable at 12/31/04 pct of Sales$258.0 Actual 12/31/06 Accounts Receivable$264.1 Accounts Receivable due to increased receivables as % of sales$6.1 20042006ChangeInventory$243 $379 $135.7 Sales$1,624 $2,242 Change in Inventory as % of sales14.96%16.89%1.93%12/31/06 Inventory at 12/31/04 pct of Sales$335.4 Actual 12/31/06 Inventory$378.6 Inventory due to increased Inventory as % of sales$43.2 Combined $$429.8 $642.8 $212.9 Combined % of sales26.47%28.67%2.20%$ of A/R and Inventory at 12/31/06 due to slower turnover$49.3 Combined $ due to sales growth$163.6 5Contribution of Declining Efficiency: 23.2%Change in companys working capital is $212.9 (~213K)The companys 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 Aybar6Does Jones Generate Sufficient Cash Flows? 200520062005-06Net Income$29 $30 $59 Depreciation$25 $35 $60 Inventory($35)($101)($136)Accounts receivable($44)($33)($77)Trade credit (Accounts payable)$6 $77 $84 Accrued expenses$1 $1 $1 Cash flows from operations($18)$9 ($9)Capital expenditures($15)($50)($65)Cash flows from investing activities($15)($50)($65)Bank borrowing (Line of credit)$65 $35 $100 Reduce long-term debt($24)($24)($48)Cash flow from financing activities$41 $11 $52 Increase / (decrease) in cash$8 ($30)($22)7Is 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 yearsProbably 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 Aybar8Before we move on to assessment of funding need..What is the cost of not taking the discount for Jones? Assume $1000 purchaseTake discount pay $980 on day 10Do not take discount pay $1,000 on day 30Not taking the discount costs $20 for 20 days of $1,000 purchase, or 2% per 20 daysAnnualized cost 2% x (365/20)=36.5%If APP is stretched to 40 days cost s ~24%

Dr. C. Bulent Aybar9Assumptions for Forecasting Funding NeedSales 2,700,000Operating Expenses15.46%Interest Expense31,000ACP43DSI76Principal Paid24,000Cash32,000Net PPE110,000COGS/Sales with discount81.11%COGS/Sales without discount83.11%Tax Rate35%10Income Statement20072007Net sales 2,700,000 2,700,000 Cost of goods sold 2,189,970 2,243,970 Gross profit on sales 510,030 456,030 Operating expense b 417,310 417,310 Interest expense31,000 31,000 Net income before taxes61,720 7,720 Provision for income taxes 21,602 2,702 Net income 40,118 5,018 11Pro Forma Balance Sheet Take DiscountNo DiscountCash 23,000 23,000 Accounts receivable 318,082 318,082 Inventory 455,994 467,238 Total current assets 797,076 808,320 Property & equipmentAccumulated depreciationTotal PP&E, net 118,000 118,000 Total assets 915,076 926,320 Accounts payable 59,999 184,436 Line of credit payable 249,183 249,183 Accrued expenses 14,000 14,000 Long term debt, current portion 24,000 24,000 Current liabiliities 347,183 471,619 Long-term debt 110,000 110,000 Total liabilities 457,183 581,619 Net worth 282,790 247,690 Total liabilities and net worth 739,973 829,310 Funding Need (Excess) 175,103 97,010 Line of Credit after Adjustment 424,286 346,193 12