1. Jones Electrical Distribution
Dr. C. Bulent Aybar
Professor of International Finance

2. 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.

3. Impact of Growth on Jones: Investment Requirements
Inventories + 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 period
Fixed Assets
Growth in fixed assets is moderate!
2004
2005
2006
$430
$509
$643
2004
2005
2006
Net Fixed Assets
$113
$103
$118
Acquisitions
$15
$50

4. 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
Inv.Turnover
5.37
5.53
4.80
DSI 68 66 76
APP 10 24
CCC
100 95
WCR
$381
$453
$509
WCR/Sales
23.47%
23.63%
22.70%
What is the impact of slowing inventory turnover and collection period on Jones’s investment requirements? ?

5. WC Investment is Growing Faster than Sales!
2004
2006
Change
Accounts receivable
$187
$264
$77.3
Sales
$1,624
$2,242
Change in accounts receivable as pct of sales
11.51%
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
Inventory
$243
$379
$135.7
Change in Inventory as % of sales
14.96%
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 sales
26.47%
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

6. Contribution of Declining Efficiency: 23.2%
Change in company’s working capital is $212.9 (~213K)
The company’s 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.

7. Does Jones Generate Sufficient Cash Flows?
2005
2006
Net 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
Cash flows from operations
($18) $9
($9)
Capital expenditures
($15)
($50)
($65)
Cash flows from investing activities
Bank borrowing (Line of credit)
$65
$100
Reduce long-term debt
($24)
($48)
Cash flow from financing activities
$41
$11
$52
Increase / (decrease) in cash $8
($30)
($22)

8. 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?

9. 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%

10. Assumptions for Forecasting Funding Need
Sales
2,700,000
Operating Expenses
15.46%
Interest Expense
31,000
ACP 43
DSI 76
Principal Paid
24,000
Cash
32,000
Net PPE
110,000
COGS/Sales with discount
81.11%
COGS/Sales without discount
83.11%
Tax Rate
35%

11. Income Statement 2007 Net sales 2,700,000 Cost of goods sold 2,189,970
2,243,970
Gross profit on sales
510,030
456,030
Operating expenses
417,310
Interest expenses
31,000
Net income before taxes
61,720
7,720
Provision for income taxes
21,602
2,702
Net income
40,118
5,018

12. Pro Forma Balance Sheet
Take Discount
No Discount
Cash
23,000
Accounts receivable
318,082
Inventory
455,994
467,238
Total current assets
797,076
808,320
Property & equipment
Accumulated depreciation
Total PP&E, net
118,000
Total assets
915,076
926,320
Accounts payable
59,999
184,436
Line of credit payable
249,183
Accrued expenses
14,000
Long term debt, current portion
24,000
Current liabiliities
347,183
471,619
Long-term debt
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