Jones Electrical Distribution Case – Introduction Over the past several years, Jones Electrical has become a very profit
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Jones Electrical Distribution Case – Introduction Over the past several years, Jones Electrical has become a very profitable electric component dealer. Despite these great results, they have discovered a cash shortage and with sales expecting to rise in 2007, the firm needs to take up more debt in order to support its development. Jones Electrical’s current bank is unable to increase their financing to over $250,000 however they have been given an offer by Southern Bank & Trust who may extend this line of credit to $350,000. Problem Nelson needs to choose whether he should switch from Metropolitan Bank to Southern Bank & Trust in order to extend his line of credit. Furthermore, he needs to consider whether or not to continue with the trade discount from the suppliers at 2% or if he should instead pay them after the due date. Analysis Jones Electrical has grown very steadily over the years. Sales have grown every year and between 2004 to 2006 they rose by 38.1% from $1,624,000 to $2,242,000. Furthermore, sales are projected to increase to $2,700,000 for 2007. Although profit has been growing along with sales, the profit margin of Jones Electrical is relativity small for the amount of revenue it creates. In 2006, the profit margin was at 1.3% and in 2004, the margin was as low as 0.9%. This represents the firm’s profitability is not very secure. A single economic downturn could possibility lead to a negative profit margin for Jones Electrical. Furthermore, the 41.2% increase in accounts receivable between 2004 and 2006 are some of the reasons behind the decrease in cash, as fewer clients want to pay cash for the goods. Because of these receivables, the discount for quick payments has become very hard which has led to the 233.3% increase in accounts payable between 2004 and 2006. The decrease in cash is also attributed to using it to fund the higher amounts of inventory. In 2005, the inventory turnover ratio was 5.53 and there was a reduction in the ratio in 2006 to 4.80. This shows that Jones Electrical has overestimated their sales for the future and this has led to a shortage in cash due to unnecessary purchase of inventory. The return on assets for Jones Electrical in 2004 was 2.3%, 4.3% in 2005 and 3.8% in 2006. These low values represent the profit per
dollar of assets and these figures mean that Jones does not use the assets very efficiency. Moreover, return on equity in 2004 was 7.6%, 13.62% in 2005 and 12.35% in 2006. Although the ROE has risen over the years indicating they have performed better for their shareholders, a ROE below 15% is still considered low. To decide Nelson’s best course of action, we shall project the financials of Jones Electricals with and without the use of a trade discount (Appendix A&B). It was mentioned on page two that sales are expected to reach $2,700,000 so that will be our assumption of sales. Recommendations Based on the income statement and balance sheet created, it is seen that with the trade discount, Jones Electrical’s line of credit increases to $395,000. Without the trade discount, the company has a line of credit of $310,000 that is significantly less than the $350,000. Therefore Jones should skip the trade discount and create a relationship with Southern Bank. Areas of improvement for Jones Electrical include better purchasing of their inventory. They have purchased way too much and this is reflected in the lower inventory turnover ratio. Jones Electrical needs to purchase inventory in proportion to the increase in sales to raise its inventory turnover ratio. Furthermore, Jones Electrical needs to reduce its high levels of accounts receivable by introducing a stricter credit policy as increase in accounts receivable is one cause of the decrease in cash.
Appendix A Income Statement
200 4
200 5
200 6
Cost of goods sold
162 4 130 4
191 6 153 5
224 2 181 8
Gross Profit on sales
320
381
424
109
Operating expenses
272
307
347
94
27
30
31
8
21
44
46
7
Provision for income taxes
7
15
16
2
Net income
14
29
30
5
Year
Sales
Interest expense Net Income before taxes
Q1 2007
Assumpti on
608 499
% of sales
% of sales % of sales
34% tax
2007 (No trade discount)
2007 (with trade discount)
2700
2700
2190
2145
510
555
418
418
35
35
57
102
19
35
38
75
Appendix B Balance Sheet Year
2004
2005
2006
Q1 2007
Cash Accounts Receivable Inventory Total current assets
45 187
53 231
23 264
32 290
243 475
278 562
379 666
432 755
Property and equipment Accumulated depreciation Total PP&E, net
187
202
252
252
-74
-99
-134
113
103
Total Assets
588
Accounts payable Line of credit payable Accrued Expenses Long term debt, current portion Current liabiliites
Assumption
2007 (no trade discount) 32 318.06
2007 (with trade discount) 32 318.06
% of sales
438 788.06
430 780.06
% of sales
302.4
302.4
-142
-174
-174
118
110
128.4
128.4
665
784
865
916.46
908.46
36
42
120
203
180
58
149
214
249
250
310
395
13
14
14
12
constant
14
14
24
24
24
24
constant
24
24
222
294
407
489
528
491
Long-term debt Total Liabilities
182
158
134
128
110
110
404
452
541
617
638
601
Net Worth
184
213
243
248
278.46
307.46
% of sales
Total Liabilities and net worth
588
665
784
865
916.46
908.46
Jones electrical offer competitive pricing and they need to keep their costs low. Always do a source and application of funds or cash flow statement. Show where he is getting money and where he is paying money Growth has brought the need to have higher levels of inventory. Calculate days sales outstanding Calculate cost of discount and compare to cost he is going to pay.
Midterm
Will be a case Hard copy Use laptop Can use the internet Have to submit it before 9:20 or can email to professor Tyre City and Jones – about a company where you analyse how businsess is doing. Target – capital budgeting process. How to manage approval of capital investment requests. Alligator Deutsche – Dividends. Do the shareholders rely on it. Hill country – capital structure problem. Case may be related to AFN(projections), capital structure or capital budgeting(capital expenditure). Check out alliagator