Jones Electrical Distribution

Dr. C. Bulent Aybar

Professor of International Finance

Context
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 Aybar

Impact of Growth on Jones: Investment Requirements

Inventories + Accounts Receivables
2004

2005

2006

$430

$509

$643

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 period
Fixed Assets

Net Fixed
Assets
Acquisitions

2004

2005

2006

$113

$103

$118

Growth in fixed assets is moderate!

$15

$50

Dr. C. Bulent Aybar

Working Capital and Sales Growth

2004

2005

2006

WC/Sales

26.47%

26.54%

28.67%

FA/Sales

6.96%

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

5.37

5.53

4.80

DSI

68

66

76

APP

10

10

24

CCC

100

100

95

WCR

$381

$453

$509

23.47%

23.63%

22.70%

Inv.Turnover

WCR/Sales

What is the impact of

slowing inventory
turnover and collection
period on Joness
investment requirements?

WC Investment is Growing Faster than Sales!

Accounts receivable
Sales
Change in accounts receivable as pct of sales

2004
$187

2006
$264

Change
$77.3

$1,624
11.51%

$2,242
11.78%

0.27%

12/31/06 Accounts Receivable at 12/31/04 pct of Sales

$258.0

Actual 12/31/06 Accounts Receivable

Accounts Receivable due to increased receivables as % of sales

$264.1
$6.1

Inventory
Sales
Change in Inventory as % of sales

2004
$243

2006
$379

Change
$135.7

$1,624
14.96%

$2,242
16.89%

1.93%

12/31/06 Inventory at 12/31/04 pct of Sales

$335.4

Actual 12/31/06 Inventory

$378.6

Contribution 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 Aybar

Does Jones Generate Sufficient Cash Flows?

2005

2006

2005-06

Net Income
Depreciation
Inventory
Accounts receivable
Trade credit (Accounts payable)
Accrued expenses
Cash flows from operations

$29
$25
($35)
($44)
$6
$1
($18)

$30
$35
($101)
($33)
$77
$1
$9

$59
$60
($136)
($77)
$84
$1
($9)

Capital expenditures
Cash flows from investing activities

($15)
($15)

($50)
($50)

($65)
($65)

Bank borrowing (Line of credit)

Reduce long-term debt
Cash flow from financing activities

$65
($24)
$41

$35
($24)
$11

$100
($48)
$52

Is 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 years
Probably 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 Aybar

Before we move on to assessment of funding need..

What is the cost of not taking the discount for Jones?
Assume $1000 purchase
Take discount pay $980 on day 10
Do not take discount pay $1,000 on day 30

Not taking the discount costs $20 for 20 days of $1,000

purchase, or 2% per 20 days
Annualized cost 2% x (365/20)=36.5%
If APP is stretched to 40 days cost s ~24%

Dr. C. Bulent Aybar

Assumptions for Forecasting Funding Need

Sales
Operating Expenses
Interest Expense

2,700,000
15.46%
31,000

ACP

43

DSI

76

Principal Paid

24,000

Cash

32,000

Net PPE
COGS/Sales with discount
COGS/Sales without
discount
Tax Rate

110,000
81.11%
83.11%
35%

Income Statement

Net sales
Cost of goods sold

2007
2,700,000
2,189,970

2007
2,700,000
2,243,970

Gross profit on sales

510,030

456,030

Operating expense b

417,310

417,310

Interest expense

31,000

31,000

Net income before taxes

61,720

7,720

Provision for income taxes

21,602

2,702

Net income

40,118

5,018

Pro Forma Balance Sheet

Take Discount
23,000
318,082
455,994
797,076

No Discount
23,000
318,082
467,238
808,320

Accumulated depreciation
Total PP&E, net

118,000

118,000

Total assets

915,076

926,320

Accounts payable
Line of credit payable
Accrued expenses
Long term debt, current portion
Current liabiliities

59,999
249,183
14,000
24,000
347,183

184,436
249,183
14,000
24,000
471,619

Long-term debt
Total liabilities

110,000
457,183

110,000
581,619

Cash
Accounts receivable
Inventory
Total current assets

Property & equipment