Question

Please read the facts of the case and prepare answers for the following questions :

1 – What is the relevance of the $2,000 monthly payment to Dave Verden on the analysis of Jones’ financing needs?
2 – What metrics could you use to compare the historical financial results for Jones with the projected financial results under the four defined scenarios?
3 – Other than financing needs, what other issues should Jones address as he considers the different growth scenarios?

Jones Electrical Distribution After several years of rapid growth, in the spring of 2007 Jones Electrical Distribution anticipated a further substantial increase in sales. Despite good profits, the company had experienced a shortage of cash and had found it necessary to increase its borrowing from Metropolitan Bank-a local one- branch bank—to $250,000 in 2006. The maximum loan that Metropolitan would make to any one borrower was $250,000, and Jones had been able to stay within the limit only by relying very heavily on trade credit from the manufacturers from whom Jones purchased the electrical products it sold to its customers. Nelson Jones, sole owner and president of the company, was therefore looking elsewhere for a new banking relationship that would allow him to negotiate a larger loan. Jim Lyons, a homebuilder who was a friend of Jones, introduced Jones to Rachel Montrose, Lyons's relationship officer at the local branch of Southern Bank & Trust—a large, regional bank. Southern had a 7-year relationship with Lyons, including a current loan balance of over $3 million. Jones and Montrose tentatively discussed the possibility that Southern might extend a line of credit to Jones up to a maximum amount of $350,000. Jones thought that a loan of this size would more than meet his needs for at least the next year, and he was eager for the flexibility that a line of credit of this size would provide. After discussion, Montrose had arranged for the credit department of Southern Bank & Trust to investigate Nelson Jones and his company. Background of Jones Electrical Distribution Jones Electrical Distribution was founded in 1999 as a partnership between Nelson Jones and his college roommate, Dave Verden. In 2003, Jones and Verden had a disagreement on how aggressively they should grow the business, and Jones ultimately bought Verden out for $250,000. They agreed that Jones would pay Verden the $250,000 in installments of $2,000 per month plus interest of 8% per year. The business sold electrical components and tools to general contractors and electricians. The products, which included items such as controllers, breakers, signal devices and fuses, were purchased from nearly 100 different suppliers. Jones's customers used the products in the

This case is designed to demonstrate the Impact of sales growth on the required investment of cash flow in Net Operating Working Capital. It also allows us to look at the impact on profitability of trade discounts and develop a framework for a value added approach to deciding on growth plans.

Answer 1

1. The burden of 2000$ pm (comparable to an EMI) for repayment of 250000$ + interest @8% will require this cost to go on for 22.5 yrs! Given the fact that the bottom line is only 30,000$ in 2006, it presents a risk that any fall to growth will adversely impact profitablity. Also the rate of interest of 8% is higher than the bank rate of 7.5%. So it makes sense to repay the balance amount from 250K  via a bank loan and start an emi of lower rate.

2.Metrics - Histroic as well as projections

a - GP ratio change (Which is fallen by a 1% in 2006 & 2% in 2007)
b - Net Income to Sales margin (need to be higher to maintain the buffer)

c - Interest coverage ratio (as extra interest fro loan should be bearable to bottom line)

d - Inventory Level to sales (as it will impact funding & show how much is turnaround time)

e - Receivable to sale (Debtors days) - to show how much time it takes to collect viz a viz creditor days

f - Long term Debt to equity ratio (to decide whether the gearing is sustainable if funding is taken on long term basis)

3 - The owners need to factor -

a - Debt servicnig is costly and not subject the cycles of biz.

b - Excessive Competition can lead to slimmer margins. Hence he will need to consistently need to keep a tight leash on margin and expenses

c - The take home cash needs to be maintained to fund the propoerty mortgage

d- long term debt paid on lower rate will be preferable to 8% payable to ex -partner

e - While suppliers and work force are giving good comments , suppliers can shift business for better prices & workfore for better remunerations.

f- The owner can however cash on the loyalty of suppliers by asking for long term conntract of 3 -4 yrs speicifcing pricing etc to get stable sales.

g - No Growth or low growth will result in lesser scales and lower profitablity as costs will go up due to inflation.