Q 1, How well is “Jones Electrical Distribution” performing? What must Jones do well to succeed?
Sustainable growth rate
From coverage ratio analysis we can see Jones electrical distribution’s business is stable business as a retailer. Sales increase 18% and 17% in 2006 and 2007 respectively, with estimation in 2007 will be 20.4%. Shareholder’s equity is around 30%. Jones sustainable growth rate: g*=RT*ROA, so compare with actual sales growth, we can make the conclusion Jones well managed its growth through year of 2004 to 2007. As Jones doing low margin business, so should avoid high financial leverage ratio as interest burden will be heavy. Q2, why does a business that has profit of $30,000 per year need a bank loan?
From above table we can find out Jones collection period increased step by step and this will need more cash support that, payables period exceed 10 days from 2006, this will lost 2% discount from suppliers. As Jones sales growth rate is high than sustainable rate, so its net earning could not support increased account receivable and inventory. Then the company need bank loan to finance the increase business.
Q3, What drove the increase in Jones’s accounts receivable and inventory balances in 2005 and 2006?
Sales growth drove the increase of accounts receivable and inventory balances in 2005 and 2006.
Q4, Is Nelson Jones’s estimate that a $350,000 line of credit is sufficient for 2007 accurate?
As Jones estimated growth rate in 2007 is 20% for sales, so account receivable and inventory will increase as a consequence. Total $129,000 is needed if collection period and inventory will not improve. As Jones accounts payable in first quarter exceed 37 days already, this will makes Jones loss 2% discount from suppliers, accumulated 24% against 7.5% interest rate. So this makes sense for Jones get loans build inventory within 10days payment. Total inventory change $129,000+$120.000=$249.000. So $350,000 line of credit is sufficient for 2007 even the bank set some limitations how to use the credit.
Q5, When will Jones be able to repay the line of credit?
As long term debt already $378,000 in first quarter of 2007, plus additional bank loan $350,000. So total credit will be $720,000 Net income for Jones is $30,000 and with stable growth rate, so Jones need around 25 years repay all the credit.
Q6, What could Jones do to reduce the size of the line of credit he needs?
Jones should manage closely reduce collection period and increase inventory turn over to reduce work capital.