Rick Anderson
Carlos Aparicio
Edlyn Tjhatra
Sarah Yoon
Executive Summary of Recommendation
Nelson Jones is the founder and sole owner of Jones Electrical, a company that supplies
electricians and general contractors with electrical components and tools. At present, the
company is facing a solvency crisis as the availability of cash has been decreasing. As the supply
of cash has not kept up with rising expenses, Jones Electrical has needed to rely on a line of
credit at the local bank. However the cash needs have surpassed the current supply as the needed
line of credit continues to rise. So far, Jones Electrical’s financial needs have been met by
Metropolitan Bank; however, this growing company is considering shifting to Southern Bank
and Trust in order to gain access to a larger line of credit. While Metropolitan Bank offers a
$250,000 line of credit, Southern Bank and Trust may be willing to extend a $350,000 line of
credit.
There are several recommendations that Jones Electrical should take action on in order to
remain solvent and continue their company growth. Jones Electrical will need to increase its line
of credit. Therefore, we would first have Jones Electrical move forward with acquiring the new
line of credit from Southern Bank and Trust. We also recommend that Jones Electrical keep the
current growth and momentum of the company, reform the compensation model for his
salespeople, forgo supplier discounts to retain cash for a longer period, refrain from re-paying
long term debt until the company regains stability, and reconsider the rapid growth as the current
pace is not sustainable. In order to stabilize the company and be seen as an attractive investment
by Southern Bank and Trust, we therefore have these recommendations. By taking these steps,
we believe Jones Electrical will improve.
Situation Analysis
Nelson Jones has a desire to continue growing the Jones Electrical as aggressively as
possible. With an emphasis on personal selling and having a commission driven sales force, the
sales figures for the company have grown rapidly. Unfortunately, Jones Electrical has
experienced a cash flow crisis and needs to find a way to increase the availability of cash. The
company’s cash needs have outpaced its inflow of cash. Because of this, the company is now
considering changing banks to increase their available line of credit.
For many years, Jones Electrical has paid their product suppliers early to gain an
additional 2% discount of purchases. Although this provided a lower cost of goods sold in the
early stages, the company extended their payment periods in order to retain cash for short term
liability payments, as cash became tight. This action has kept the company going, but it only
treated a symptom, not the cause.
Jones Electrical has seen its inventory and accounts receivable grow faster than its sales,
which is partially responsible for the shortage of cash. It’s great for the customers that he has a
big inventory because it means that he’s prepared to supply what his customers want. However,
it also shows that even though Jones projected high sales figures, he didn’t sell as much as what
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he was anticipating. In addition to the inventory issue, he also has an issue with his accounts
receivable. There is a 13 day gap between when Jones pays his suppliers and when the clients
pay the company, which has contributed to Jones Electrical outgrowing the current line of credit.
This has contributed to the company’s dilemma as to whether or not they should take on a larger
line of credit or not. Thus, Jones need to re-evaluate and gain a better perspective on his business
plan to better forecast the current and future needs and priorities.
Company Analysis
How well is Jones performing? What must Jones do well to succeed?
With regards to growth, Jones Electrical has been doing very well. With a commission
driven sales force, the company continues to drive sales volume higher and higher. In spite of
this rapid growth, the cash flow situation is troubling. Although they have high sales figures, the
company finds itself borrowing on a line of credit at a local bank in order to pay the bills. In
order to succeed, Jones Electrical needs to do four things.
First, Jones Electrical needs to continue their current momentum. While the growth has
not been managed well so far, the corporate culture will be best served by continuing forward in
a more responsible way, rather than halting their growth and momentum as a company. Halting
or slowing down the sales growth rate will hurt the sales force, current customers, and potential
customers. If you slow the sales growth, the sales force will be focusing solely on existing
customers who currently fall into the accounts receivable category. This would exclude potential
new customers who may have the financial stability to pay within a short period of time.
The second move that the company must do is reform the compensation model for the
salesmen. The culture of the company is informed by the highly commission based sales force.
This is likely a major cause of the increasing growth of accounts receivable. Jones should change
the compensation to primarily salary based pay, with commission being a minor part of the
compensation. Also, we recommend Jones implement an additional incentive to salesmen to help
shrink the company’s accounts receivable. Be offering an additional 20% commission for sales
paid within 30 days, the company will be able to get salesmen interested in and committed to
decreasing the accounts receivable. By reforming the compensation to be largely salary based
with a small focus on commission, salesmen will be better motivated to find clients that can pay
within a reasonable pay period, rather than seeking any buyer for the sake of the commission.
We believe that this will improve the company’s culture and the cash flow situation
simultaneously.
The third area of action is for Jones Electrical to continue forgoing the 2% discount that
they receive from paying suppliers early. It will be better in the long term for Jones Electrical to
gain this discount, and while this would increase the income of the company, they simply cannot
afford to pay suppliers early at this time. The company should put repayment of long term debt
on hold for the time being. The company has been paying its long term debt off a small portion at
a time. However, as this cash issue is approaching crisis, the company needs to prioritize short
term debt over long term debt.
The final, and perhaps the most important step needed to be successful, is that Jones must
reconsider the rapid growth of the company’s sales. With the company’s current net income
margin and working capital figure, the company can only sustain 5.7% growth per year. The
above measures will help increase the company's sustainable growth rate; however, until the
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company’s performance is improved, they need to consider the possibility of slowing the rapid
sales growth.
Why does a business that has profit of $30,000 per year need a bank loan? Is
it attractive to take trade (Accounts Payable) discounts?
There are two likely reasons for the cash deficit that Jones Electrical is experiencing
despite having a profit of $30,000 per year. The first is that the inventory of the company has
risen disproportionately to the rise in sales. As Table A shows, the inventory has risen 1.94%
more when compared to sales growth. This shows that the company is spending too much to
stock its shelves, which is a part of the problem of low cash.
Table B
2004
Inventory
243
379
Net Sales
1624
$2,242
% of change
Accounts
Receivable
Net Sales
% of change
14.96%
2005
14.51%
2006
16.90%
187
264
1624
2242
11.51%
12.06%
11.78%
A second reason that a business may need a bank loan is because they are not being paid
in a timely way. This is also seen in Table A as accounts receivable has grown 0.27% more than
sales. The combination of an over inflated inventory and high accounts receivable are likely the
cause of Jones Electrical’s shortage of cash and their need for a bank loan.
Although it is attractive to take trade discounts, it is not attractive in our situation. The
company is in a cash crisis, as they aren’t receiving money that is owed and continuing to sell at
a high rate. In time, it will be a good idea to return to the 2% discount; however, for now, it is not
an attractive option.
What drove the increase in Jones's accounts receivable and inventory
balances in 2005 and 2006?
Nelson Jones’ has a desire to aggressively grow the company, and this is reflected in how
the company behaves. An aspect of the company’s corporate culture is a sales force whose
compensations is based on commissions. A commission based sales force will be more willing to
compromise on things such as the payment period, which is likely a cause of the high accounts
receivable. This trend of lengthening payment periods will likely continue unless the
aforementioned compensation reform is enacted.
Jones also had a strong assumption that his sales will continue to grow, and this
assumption is not without evidence, as his net sales have been steadily increasing over the past
few years. While Jones’ was dependant on net sales, it turned out that inventory was growing at a
higher percent than sales figures by 1.94%. Because of this the company was overspending on
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inventory, resulting in less cash on hand. In addition, Jones wants to remain competitive in the
market, which may have led him to purchase inventory that he is not selling or is sought out for
by his regular customers. His desire to be a one-stop shop has unintentionally reduced the
inventory turnover rate.
Is Nelson Jones's estimate that a $350,000 line of credit is sufficient for 2007
accurate? Forecast Jones financing needs.
Table D
Balance Sheet as of December
31, 2007
2%
Discount
No
Discount
23
23
A/R
318
318
Inventory
456
467
Total Current assets
797
808
PPE
252
252
($134)
-134
Total PPE, net
$118
118
Total assets
$915
926
60
184
$425
347
Accrued exp
$14
14
Long-term debt (current)
$24
24
Current liabilities
523
569
Long-term debt
$110
110
Total liab
633
679
Net worth
$282
247
Total liab and net worth
$915
$926
Cash
Depreciation
A/P
Line of credit payable
As Table D shows, without a
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2% discount on purchases, Jones Electrical will only need to borrow $347,000 of the line of
credit, seen with ‘Line of credit payable’. If Jones pays early and accepts the discount, the
available cash to repay the line of credit will decrease and $425,000 would be needed. In order to
get the discount, Jones would need to negotiate a larger line of credit. Following our
recommendation, Jones should accept a $350,000 line of credit and keep its current course,
forgoing the 2% savings.
Jones Electrical will be sufficiently financed with a $350,000 line of credit. In time, Jones
should move to accept the 2% discount, but they are not able to afford it at this time.
What needs to occur for borrowing to decline?
Jones’ borrowing and his line of credit needs to decline in order to avoid bankruptcy
because of a lack of cash. There are two changes that should take place: decrease inventory
growth rate and improve the accounts receivable account. These would both improve the cash
flows for the company. But the company should be careful to not decrease the inventory too
dramatically, as this could slow down his growth and net sales. Decreasing his accounts
receivable is a wise move as Jones Electrical would have more cash on hand. By improving the
inventory growth and shrinking the accounts receivable, Jones Electrical will be able to continue
to grow in a healthier manner. Additionally, it’s recommended that he continues to not pay early
and receive the 2% discount. Even though early payments give Jones a good standing with his
suppliers, he can allocate the money to his day-to-day operations instead. It will not likely hurt or
negatively impact his reputation with the suppliers if he pays on time rather than early.
Would you as Ms. Montrose agree to lend Jones the money?
If we were Ms. Montrose, we would agree to lend Jones the money only if he follows the
aforementioned recommendations. The historical path of the company is not sustainable and at
the current rate of growth, the $350,000 line of credit will be outgrown. If Jones refuses to
change course, then Ms. Montrose shouldn’t agree to do business with the company. However,
there are factors beyond history to consider. First is that Jones is referred to Southern Bank and
Trust by Mr. Lyons, a relationship that has been valued by the bank for many years. He has
vouched for Jones as a businessman “of the highest integrity and sharp acumen” and as a person
who “lives a modest lifestyle.” Additionally, Jones will be following the above recommendations
that will alter the course of the company into a more sustainable path. These changes will include
decreasing his accounts receivable and improving his inventory growth. Therefore, we believe
that if we were Ms. Montrose, we would agree to extend Jones Electrical new line of credit.
What are the implications for Jones's lifestyle of accepting the new larger line
of credit? What would you do as Mr. Jones?
There are several implications to Jones’ lifestyle if he accepts the new larger line of
credit. First, an improved cash flow will allow the company to continue growing. This is in line
with Jones’ desire to grow the company rapidly, which will lead to continued satisfaction and
confidence for Jones as the leader of the company. Additionally, accepting the larger line of
credit will increase expenses and decrease the income of the company as higher interest charges
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will be paid throughout the year. This will force Jones to reevaluate himself and his leadership
styles.
As Mr. Jones, we recognize the need to direct and lead the company in a responsibly
viable way. Therefore, we would take the new line of credit, reform the compensation of our
staff members, and reconsider the present aggressive growth rate. We recognize that out of
control growth is not sustainable and taking a more balanced approach is necessary. Also, we
will seek better cash management strategies and seek counsel in making responsible future
decisions of the company.
Faith Integration
As we worked through the various issues with Jones Electrical Company, we realized the
importance of planning. Proverbs 24:27 clearly states, “Prepare your work outside; get
everything ready for yourself in the field, and after that build your house.” This verse talks about
how planning is crucial to be successful in both building a house and a business. Following this
principle, Jones will need to have a plan in place to improve his company. In order to keep
growing, Jones needs to take time to prepare a business plan that will allow him to retain more
cash for his company. There are different ways Jones can improve his business but the first step
is to lay out a plan. Without a plan, the company will keep making short sighted decisions that
will bring the company to ruin. The way of wisdom focuses on the long term and is the way to
build a house and business that lasts.
As Jones Electrical moves forward they will need to seek out a better balance in how they
do business. A passage that speaks to this is Ecclesiastes 7:12, “Wisdom is a shelter as money is
a shelter, but the advantage of knowledge is this: that wisdom preserves the life of its possessor.”
Our advice gives a double shelter to Jones, in both wisdom and money. It gives wise course
corrections for the company to take, giving Jones the tools of wisdom with which to shelter his
company. The money will not last, but wisdom can. We believe that our recommendations
provide the wisdom needed to guide the company through this difficult season.
Future Projections
Table A
Cash Flow Statement for 2005
Cash Flow Statement for 2006
Cash Flow from Operating Activities
Cash Flow from Operating Activities
Net Income
29
Net Income
Depreciation
25
Depreciation
Inventory
35
Inventory
-1
6
Accounts Payable
6
Accounts Payable
Accrued wages and tax
1
Accrued wages and tax
Accounts Receivable
44
A/R
SUM
18
SUM
Cash Flow from Investing Activities
Cash Flow from Investing Activities
15
Gross PP&E
Long Term Assets
0
15
SUM
Cash Flow from Financing Activities
Gross PP&E
SUM
Long Term Debt
Line of Credit
65
Line of Credit
SUM
41
SUM
Net Change in Cash & Market.
Securities
$8
Net Change in Cash & Market.
Securities
Table B
2004
Inventory
243
379
Net Sales
1624
$2,242
Accounts
Receivable
187
-
Cash Flow from Financing Activities
24
14.96%
-
Long Term Assets
Long Term Debt
% of change
-
2005
14.51%
-
($3
2006
16.90%
264
7
Net Sales
% of change
1624
11.51%
2242
12.06%
11.78%
Table C
Income Statement for Year Ending December 31,
2007
2%
Discount
Net sales
No discount
2700
2700
Less: COGS
-2190
-2244
Gross profits
510
456
-419
-419
91
37
-31
-31
EBT
60
6
Less: Taxes
21
2
Net Income
39
4
Less: other operating expenses
EBIT
Less: Interest
Table D
Balance Sheet as of December 31,
2007
2%
Discount
Cash
No
Discount
23
23
A/R
318
318
Inventory
456
467
Total Current assets
797
808
PPE
252
252
($134)
-134
$118
118
Depreciation
Total PPE, net
8
Total assets
$915
926
60
184
$425
347
Accrued exp
$14
14
Long-term debt (current)
$24
24
Current liabilities
523
569
Long-term debt
$110
110
Total liab
633
679
Net worth
$282
247
Total liab and net worth
$915
$926
A/P
Line of credit payable
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