Financial Management

2016
Case Analysis
Jones Electrical Distribution
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Team 11
Alexandra Stute
Jasurbek Djamalov
Michelle Rodriguez
Paul Leeflang
Sonia De Cia
Waqar Zaheer

Case Analysis
Jones Electrical Distribution
Jones Electrical Distribution is a company which has several years increasing
their sales and making good profits. At 2006, the business was in a shortage
of cash; therefore, they needed to increase the borrowings from The
Metropolitan Bank to $250,000 dollars, which was the maximum loan
permitted by the bank. Since the company was growing significantly fast,
Jones was in the urgency of increasing their borrowings to pay their assets
and cover their operating expenses. In this moment, Jones decides to make
relationships with The Southern Bank, a new bank that allowed them to
extend their loan to $350,000. In order to make the approval of the line of
credit, the bank will proceed to investigate the company.

Jones Electrical Overall Health

Performan
ce
Measures
Leverage
Liquidity
Use of
Resources

Ratio

Calculations

2004 2005

2006

Debt to Asset (%)

Debt to Equity (%)
Current Times
Quick Times

TL/TA
TL/Equity
CA/CL
(CA - Inventory)/CL

0.69
2.20
2.14
1.05

0.68
2.12
1.91
0.97

0.69
2.23
1.64
0.71

42
4
10
4

44
5
10
4

43
6
24
5

1.8
8%
2%

2.5
14%
4%

2.5
12%
4%

DSO (Days)
Credit Sales (Days)
Payable Period (Days)
Credit Purchases (Days)
EBIT Interest Coverage
Times
ROE %
ROA %

AR/Credit Sales
Sales/365
AP/Credit Purchases
COGS/365
EBIT/Interest
payment
NI/Equity
NI/TA
EBIT(1-T)/Invested
ROIC %
Capital
Sustainable Growth (g* %) Retention* ROE
Retention

8.5% 13.0% 13.3%

1%
0%
0%
0.07
1-Dividends/NI
1
0.034 0.033
EBIT
$48
$74
$77
Invested Capital (TA$36 $371
$377

CL)
6
Initially, in order to analyze Jones company, it should be considered all the
performance measures to conclude if the Southern Bank will decide to
approve the loan. Below, the ratios to take in consideration.

Leverage
Debt to Asset
From 2004 to 2006, for every 1 dollar of the company assets, 69 cents were
funded through liabilities and 31 cents were financed by equity. In 2005, it
was almost the same, which means Jones business is mainly funded by bank
loans which are almost 69% of the finances and just his personal capital
investment. It is fine for a growing business to get funded by loans but in the
future it has to be funded through Equity as well because this has increased
Jones liabilities which leads to larger interest payments.
Debt to Equity
In 2004, for every 1 dollar of Jones equity, 2.20 dollars were raised through
liabilities and this fell to 2.12 in 2005 but increased to 2.23 in 2006. This
means the company is running on bank loans mainly as 220% of equity is
being contributed by liabilities. It is suggested that, in order to expand the
business and to get more finances for Jones Electrical, the company should
go for equity financing to get instant cash without incurring interest
expenses.

Liquidity
Jones Electrical has been reducing its liquidity through the last years. From
ratios 2.14 in 2004 to 1.64 in 2006, which is current liquidity. It happens
similarly when only analyzing the most liquid assets; the ratio lows down
from 1,05 in 2004 to 0,71 in 2006. This is due to the higher level and
indebtedness and the progress of their increasing liabilities.

Use of Resources
DSO
The collection period in 2004 was 42 days which shows that Jones electrical
allows its customers to pay them in 42 days after getting their products and
it did not change a lot as in 2005 and 2006 it was 44 days and 43 days,
respectively. This is almost a month and a half time period which is more

than enough for a growing company like Jones. In order to grow, a company
needs cash for operating activities and to buy more of the raw materials. In
this matter, the company can give added value to its customers so as to
make a long term relationship. It is suggested that the company should lower
its Collection Period in order to meet the cash requirements.

Payable Period
The payable period in 2004 and 2005 was 10 days whereas has increased to
24 days in 2006. Which shows that during the first two years, Jones was
more towards availing the purchase discounts and saving that money. Nor
as, in 2006, when it was more towards borrowing money from the suppliers
to invest in order to make cash available for operating activities. It is
suggested that Jones should choose wisely which is better for the company
but for a growing company the longer time period for payable would be good
but not very long.
EBIT interest Coverage Times
Earnings before interest and taxes, or EBIT, takes a companys revenue, or
earnings, and subtracts its cost of goods sold and operating expenses. The
Earnings before interest and taxes, if the company can pay its interest costs.
Jones received a loan of $250.000, in 2006 from the Metropolitan bank. The
EBIT increased from 2004 till 2005 and stayed the same from 2005 till 2006.
This has to do with the shortage of cash in 2006.
Return on Equity (ROE)
To know the amount of net income that is returned to the shareholders
equity, it would be needed to analyze the Return on Equity ratio. For 2006,
this ratio is 12.3%, which means that, for every dollar of the shareholders
equity, the company is making more than 12 dollars. The current
ratio,12.3%, is lower than 2005, but still very good. We should need to make
a forecast in order to see how the ratio is going to behave in the next year.
Return on Assets (ROA)
This ratio indicates how profitable the company is related to its assets, or
how effectively they are managing their assets in order to make profits. The
return on assets, or return on the investments for Jones Electrical in the year
2006 is 3,82%, which is lower than the year before (ROA 2005 4,36%). On
2005, the business is managing its assets less effectively than in 2005.

Return on Invested Capital (ROIC)

ROIC is an overall profitability for the Company, no matter how it is funded.
The Return on Invested Capital is used to give an impression about how
well a company is using its money to generate returns. The calculation helps
to determine a companys efficiency to allocate its capital under its control to
profitable investments. A high ROIC rewards companies that are able to
produce the most net operating profit with the least amount of invested
capital. Due to this we can see that Jones ROIC is increasing every year;
therefore, the company is rentable.

Sustainable Growth Ratio

No company should grow faster than their sustainable growth rate (g*).
Otherwise, they would run out of funds and would their borrowing will
increase significantly. In this case, as Nelson Jones is the only shareholder of
the company, the retention rate would be 1. Therefore, the sustainable
growth would be same as the return on equity ratio. For 2005, the g* was
14%, although the growth rate was 107%; for 2006, the g* was 12,3%, but
actually grew only 3,4%. This explains that Jones Electrical is now in a huge
need of more funds.

EBIT
$74

$48

$77

Short-term Financing Requirements Trade

Discounts
If the company foregoes trade discounts they will be having a higher liquidity
for a certain amount of time which could be used for his short-term financing
requirements. On the other hand, the business will not be able to grow as
fast as it is wanted without an additional loan or further financial support
from the bank.

Suggestions to the Bank

To decide whether giving Jones Electrical a loan, the bank should be
skeptical. We suggest they could require a very strict business plan to the
company. We believe that the company has a great future, but at the same
time, it is observed that its management has not been accurate and it is also
expected that the managers should be stricter about the sustainable growth
and all the liabilities they are taking. We agree with the conditions presettled by Rachel Montrose, that limit the provision of the credit, limiting
both the quantity (limit of $350k, which would be also limited to the 75% of
the accounts receivable and 50% of the inventory), but also its qualification,
as Jones would not be able to invest on fixed assets without previous
permission of the bank, and other withdrawal limitations. Also, we believe,
that in order to have a better knowledge of the accounting of the company,
we would require Jones Electrical to report twice a year, once per semester.
Indeed, the bank could approve the loan, with some requirements to be
asked before-hand, since the significant growth the company has had in the
last years. Also, should do a revision of the business financial statements,
observing every year the sustainable growth of the company and its
performance measures.