Commercial Equipment Financing Division - Case Study Example

Case: GE Capital Canada: Commercial Equipment Financing Division Financial Decision Executive Summary Steve Rendl is an accountant in the commercial Equipment division of GE. He is approached by a company called Clark Carriers Ltd (CCL) with a loan request of $270,000. He has to evaluate CCL loan application and to recommend his higher office based on the certain criteria of GE. One of the important criteria is the company’s capacity to pay for the loan taken based on the projected cash generated from the operations. He is also hard pressed for the business in the difficult market condition and does not want to lose this customer as per GE’s philosophy of “Find, Win, Keep.” Rendl decides to recommend this loan application such that it gets approval from his higher-ups. Problem Statement Steve Rendl’s main issue is to know, given all the pros and cons, whether the CCL will be able to repay the loan if his company sanctions CCL loan application. Other Issues a. The freight market is highly competitive. There is no chance of upward freight revision in the short run. b. Rendl needs to complete his yearly target of loan disbursement and does not want to let go this important customer in this difficult market conditions. Analysis CEF division of GE capital has listed certain criteria in order to grant loans to new businesses and they are found as per the following. Operational Parameter GE’s first criterion of loan application is that the company applying for loan should have minimum three years’ operational working. The CCL has more than three years’ existence starting from 1987 until the year ending December 31, 2002. Thus, CCL clearly passes the first criterion. Repayment Capacity Second criterion laid down by GE is of paramount importance as it ascertains whether the applicant would have enough cash generation in his or her business to repay the loan. It is necessary to do a complete analysis related to this aspect. Projected Financial Statement CCL’s income statement for the year ended 2003 can be generated with the given details as per the following. 2002 2003 (Projected) (From Exhibit 1of the case) Revenue $835,295 $1336, 472 (60% likely increase) Cost of sales 518,845(62.1% of sales) 829,949 (taken as 62.1% of sales) Gross margin $316,490 $506,523 Operating expenses: Salaries & Wages $120,259 $180,259 General & administration 8,512 21,512 Telephone and fax 8,924 (1.1% of sales) 14,701 (taken as 1.1% of sales) Legal & accounting 1,491 1,491 (Same as last year) Travel & auto 9,430 (1.1% of sales) 14,701 (taken as 1.1% of sales) Rent & utilities 10,075 (1.2% of sales) 16,038 (taken as 1.2% of sales) Bank charges and Interest 18,505 35,805 (Increase by 17,300) Bad debts 1,302 (0.2% of sales) 2,673 (taken as 0.2% of sales) Depreciation Expense 42,795 72,795 (additional 30,000) Advertising & Promotion 1,235 (0.1% of sales) 1,336 (taken as 0.1% of sales) Meals & Entertainment 1,042 (0.1% of sales) 1,336 (taken as 0.1% of sales) Total operating expenses $233,570 $362,947 Net Earnings before Taxes 82,920 143,876 Provision for Income taxes 34,246 64,744 (at the rate of 45%) Net Earnings after taxes $48,674 $79,132 Rendl wants to know about the cash generated from the operations so as to be assured of the loan repayment by CCL. This can be given by net earnings after tax plus depreciation charged ($72,795+$79,132 = $151,927). Depreciation is not a cash outgo and remains with the company and hence counted in the cash generated. During the year 2003, Cash generation after the expansion will be $151,927. CCL’s previous loans have been disbursed for the repayment period of 48 months. Assuming same repayment period of 48 months for the loan of 270,000, CCL will have monthly installment of 270,000/48 = $5,625/month. Thus, in a year CCL would need to pay 5625×12 = $67,500 toward its new loan; however, for its two old loans CCL has been already paying 7000+800 = $7800 per month. Thus, the outgo per annum for these two old loans would be $93,600. Added a new loan repayment, total repayment comes out to be $161,100 per year. Cash likely to be generated in the year ended 2003 (as calculated above) at $151,927 is marginally short of this repayment requirements. Ratio Analysis CCL financials are strong when viewed from the view point of industry average. The liquidity ratios as on December 31, 2002 are reported as per the following. CCL Industry Average Current ratio - 2.3:1 1.1:1 Acid test ratio - 1.7:1 0.9:1 (Source: Exhibit 3 of the case) The liquidity ratios indicate the strength of CCL to repay its debts and have been much superior to the industry average. While Rendl reviewing CCL application for $270,000 on April 15 2003 for likely new loan disbursement from May 1 2003, the CCL would have reduced debt in the first four months by 7800×4= $31,200 and net long term liability at the time of new loan disbursement would be 225,000(from balance sheet year ended 2002) – 31200 + 227000(new debt) = $420,800. The owner’s equity in CCL is $116,845 (as on year ended 2002, Exhibit 2). Thus, debt/equity ratio as on May 1 2003 comes out to be 420,800/116,845=3.6 As per the norms of GE, debt/equity ratio has to be less than 4:1 so this criterion of GE is fulfilled. 4 C’s of Credit CCL’s condition to repay is certainly better in the sense that the company is likely to secure a contract, which will keep its fleet 100% occupied. Moreover, the company has been doing business for the automobile giant Ford Motors where payments are more or less secured. The past record of company toward repayments is very good and the company has been consistently paying installment toward old loans without default. The company can also give necessary collateral as its balance sheet as on year ended 2002 shows fixed asset of $307,424. The owner is working hard as his past history reveals and has built up good reputation in the business. From the analysis it is clear that though CCL fulfills all major norms of GE to become eligible for the loan except one where cash flow projections show some shortfall to pay for the company’s new loan. Alternatives In the above perspective, Rendl has the following alternative. The important insight that is available from Exhibit 3 is that the company’s age of receivables is 18 days while age of payables is 19 days. This indicates that the company’s working capital of $34,421 is simply not being used efficiently. This money is idle with the company and can be used to reduce the loan requirement by at least $30,000. Further, using full line of credit up to $50,000 (instead proposed $30,000) available to CCL, the real loan requirement would come down to $220,000. Thus, the issue of repayment is sorted out and risk of rejection of loan application from Rendl’s higher office is eliminated. Recommendation It is essential for Rendl to arrive at the viable solution sitting with the CCL in above lines so that the company does not lose the client as he is hard pressed for the business to meet his yearly target and that is important for his own survival. He decides to make a strong case for this loan application such that it gets approval from his higher office. Works Cited Grasby, Elizabeth; Michael Pearce, John Haywood-Farmer, Mary Crossan, Ann Frost, and Lyn Purdy. Business Decision Making: Text and Cases. Seventh Edition, 2004. Print. Read More