Case Report Jones Electric Distribution

[pic 1]

Jones Electric Distribution

Case Analysis

Company 3

February 29, 2016

Summary

Jones Electric Distribution has experienced high growth rates between 2004 and 2006. Based on his increased sales, Jones is in need of a line of credit that exceeds $250,000. His current line of credit with Metropolitan Bank is the maximum loan, and he was doing his best to stay within its limit, however, my team’s projections for 2007 show that Jones needs a larger line of credit. Jones has an opportunity to take on a larger line of credit with Southern Bank & Trust of $350,000. Because Jones was able to take trade discounts he was able to stay within the bank loan, however, it has caused him to experience a shortage of cash. If Jones can take on a larger line of credit with Southern, along with forgoing his trade discount with suppliers, his company will not require eternal funds at the end of 2007. We will look at how well Jones Electric is currently performing after a short introduction.

Introducing Jones Electric Distribution

Jones Electric Distribution is a distributor of electrical components and tools for general contractors and electricians. With around 100 suppliers, Jones has many products at hand. The market in which Jones works is large and highly competitive. Jones has been successful by holding a modest amount of inventory to satisfy his customer’s needs, and takes full advantage of a 2% discount offered by his suppliers. Overall, his profit margins are low and his cash cycle is long, which leads to external funds needed in 2007.

Current Performance

Jones Electrical Distribution is experiencing high growth at 17.5% CAGR, between the years 2004 and 2006. In 2004 and 2005, Jones was taking trade discounts from his suppliers, by paying within 10 days to get a 2% discount. This discount helped Jones stay within his line of credit with Metropolitan Bank. In 2006, Jones ran into a shortage of cash, which can be shown by the decrease in the current ratio from 2.14, in 2004, to 1.54, in 2006. This reduced of the current ratio implies the shortage of cash that Jones faced in 2006.

In 2004 and 2005, Jones was paying his suppliers in 10 days to take full advantage of the 2% trade discount, which helped him stay within the limits of his $250,000 line of credit. While Jones is paying off his suppliers in 10 days, he is only receiving payments for account receivable every 40 days. Paying his suppliers faster than receiving payments caused the shortage of cash. In 2006, Jones began to forgo the trade discount, and resulted in a reduced, but still necessary, need of his line of credit. Between 2004 and 2005, his credit use increased by around 44%, whereas, between 2005 and 2006, he only used an additional 16%. With sales growth at 17% for both 2005 and 2006, the difference in increased credit use can be explained. By not taking the trade discount with his suppliers, Jones’s cash cycle decreased, allowing him to pay his suppliers with cash on hand, rather than using more credit that he would be required to pay interest on.

Jones net income at the end of 2005 and 2006 is approximately $30,000. We see that with a 17.5% growth in sales projected for 2007, we will have net income around $30,000 yet again, and increased net income in 2008 and 2009. With sales growing at a faster rate than net income, shown by low profit ratios, Jones needs to seek out more financing from outside sources. With the credit loan, he is able to pay off his account payable without dipping into his retained earnings, which can be found on the balance sheet labeled “Net Worth”.

In 2005 and 2006, we noticed an increase in Accounts Receivable and Inventory. Due to rapid sales growth, Jones took on more inventory in an attempt to push more product. He based his success on having a moderate amount of inventory on hand, but with low profit margin, and high cost of good sold taking away sales revenue, Jones is facing longer inventory turnover in 2005. Jones’s increased accounts receivable comes from increased sales. With more inventory on hand, and rapid growth, he faces larger credit sales. With his collection period ranging around 40 days, we see how he just barely is collecting two thirds of his collectables every quarter.

Forecasting for 2007

Based on the first quarter of 2007, we see that Jones has already reached his credit limit of $250,000. If we do not extend our line of credit we would need to seek external funds of $35,000 by the end of 2007. If Jones extends his line of credit to $350,000 with Southern Bank & Trust in 2007, and continues to forgo trade discounts with his suppliers as he did in 2006, he would only need to use $337,000 of the credit line to satisfy external funds needed. If we continue to see rapid growth in 2008 and 2009, we would need to seek more external financing.

My team and I calculated a three-year pro forma based on a 17.5% growth rate and percentage of sales. Assuming the market stays in a constant state and growth continues at 17.5%, we can reduce the line of credit from Southern Bank & Trust by $13,000. This can be accomplished if we continue to forgo the trade discount offered by our suppliers. Forgoing the trade discount allows Jones to extend his payable period, therefore decreasing his cash cycle, allowing him to pay off suppliers with more cash, rather than credit. However, forgoing the trade discount comes with the opportunity cost of a 2% discount. For every dollar, we could save $0.20. Dividing $0.20 by the amount we would pay, $0.98, and multiple that by the extra twenty days we have to pay in a given year, and we find that the opportunity cost of not taking the trade discount is 37.5%.

Conditions set by Southern Bank & Trust are as follows: additional investment in fixed assets must be approved by the bank, utilization of credit is limited to 75% of accounts payable and 50% of inventory at any given time, initial rate in 2007 for interest payments will be 7.5%, and Jones is required to sever his current relationship with Metropolitan Bank. If Jones takes on a $337,000 loan with Southern, at a 7.5% interest rate, he can pay $13,600 a year for 25 years. We use $13,600 as an assumption that his interest payments will be the same as that of Metropolitan’s.

Overall

Jones Electric is experiencing rapid growth that is causing a shortage in cash and low profit margins. In regards to short term fixes, a new line of credit with Southern Bank & Trust will help Jones in regards to his shortage of cash. By continuing to forgo his trade discount with suppliers, as he did in 2006, he will lose his 2% discount, however, his cash cycle will decrease, and he will be able to notice more cash on hand. Jones may want to look into reducing his payable periods or extending his pay periods slightly longer. If he can continue to reduce his cash cycle, Jones will gain liquidity and his current ratio will improve.