Finance - Expanding Business and Increasing Income - Case Study Example

?Executive Summary CCL is a growing business; however, increasing level of debt may create more risk in future. The explosive growth in profitabilityof the firm, therefore, is one of the key indicators of how firm may perform in future. Higher level of profitability as well as growth prospects indicate that firm should be given the credit and GE Capital should grow as the business of the firm increases. Problem Statement The changes in the economic conditions as well as the business requirements of the customers of CCL; it may not be able to sustain its profitability for longer period of time and, hence, may default due to constrained cash flows. Problems/Sub-Problems/Issues Following issues have been observed: 1. Relatively tough economic environment. Economic conditions do not seem to be favorable as the overall industry dynamics may not allow the firm to expand at a rapid pace. With overall low prices, it may seem difficult for the firms to actually maintain their margins and effectively generate sufficient cash flows to service their debts. 2. Higher volume of business with limited capacity to meet the demand. It is also critical to note that though business is expanding, the overall capacity to meet this demand is limited. In order to expand meeting the demand, firm, however, has to borrow indicating that its own equity may be low; therefore, the firm’s own internal stake will be limited. It is critical that the capacity should be expanded with higher contribution from the owners with less reliance on debt. 3. Not professionally managed as firm is still a family business. Business does not seem to be run professionally as despite growing, firm has not been able to expand professionally. The legal character of the firm is still same to be managed by the two individuals with little hiring except drivers. In order to manage the business, marketing side of the business must be delegated to professionals who can better run the firm and let the owners focus on the expansion of business. Analysis Ratio Analysis A closer look at the return on equity would indicate that for year 2002, ROE is higher than the industry average. However, it was lot lesser than the industry average in 2000 and 2001 suggesting that the firm has been able to increase its ROE. However, owners’ capital has remained constant during the period with increasing long term liabilities. ROE can increase due to higher level of debts and it seems that this large increase in ROE during 2002 is also the result of higher level of debt. Overall debt to equity is higher than the industry; however, interest coverage has increased too during last few years. Firm seems to be liquid as its current and acid test ratios are higher than the industry average, however, higher liquidity position can be due to higher accumulation of accounts receivables on the balance sheet of the firm. Firm needs to improve its collection policy because higher investment into working capital is also a cost and it is a non-productive asset. Efficiency seems to have improved over the period of time as firm’s receivables in days have consistently been reduced. It is, however, important to note that account receivables are on rise which has basically inflated the liquidity position of the firm. Sales and assets growth has been high too, however, asset growth seems to be due to higher cost of the capital expenditure done. Sales have increased too but this increase has been mainly due to business given by one customer. Sales growth in 2001-2002 has been 29.5% down from 219%, however profit has shown an explosive growth. Statement of Changes Sources of Cash Short term Long Term Other Receivables 51.00 Prepaid Expenses 935.00 Accounts Payable 17,322.57 Loan 30,000.00 Loan 270,000.00 Retained Earnings 58,750.96 Tota Sources 18,308.57 358,750.96 377,059.53 Uses of Cash Accounts Receivables 17,719.31 Net Fixed Assets 270,000.00 Total Uses 17,719.31 270,000.00 287,719.31 89,340.22 Cash Dec 2002 4,230.00 Cash Dec 2003 93,570.22 4Cs of Credit The loan will be collateralized against the trucks having good market value, therefore collateral seems to be sufficient enough to cover the loan. Secondly, it will be covered only up to the 90% of the value of the vehicle, thus GE has a cushion of 10% against the collateral covering any substantial decrease in the value of the collateral. Overall conditions may not be suitable with focus on generating volume business rather than generating profits. The need to expand every time volume expands is being met by the increased expansion of the fleet, however, such expansion seems to erode the margin. Higher costs with low margins, therefore, can make the overall conditions for operations relatively difficult. It is also critical to understand that firm is not managed professionally with most of the management belonging to the family. In the absence of a mature and skilled management, expansion of the business may not generate the required result. It is also critical to understand that there is only one customer on which all reliance is being built, therefore, lack of diversification of the business in terms of customers can also limit the potential and increase the down-side risk for the business. A cancellation of contract of the customer would end everything for CCL, therefore, in order to expand, it is critical that the firm must diversify and expand its customer base as reliance on one customer can increase the risk significantly. Borrowers seem to be of credit worthiness as their repayment history has remained good and has always paid for their obligations on time. It is, therefore, one of their stronger points, however, with the reduced margins and increasing competition, cash flows of the firm may not be high, therefore, firm may not be able to service its debts quite satisfactorily in future. Projected Financial Statements Projected Balance Sheet Assets Current Assets 2000 2001 2002 2003E Cash 8,107.00 2,605.00 4,230.00 93,570.22 Account Receivables 21,912.00 28,230.00 42,004.00 59,723.31 Other Receivables 482.00 478.00 429.00 480.00 Prepaid Expenses 16,237.00 12,820.00 15,065.00 16,000.00 Total Current Assets 46,738.00 44,133.00 61,728.00 169,773.53 Fixed Assets Truck & Trailers 95,000.00 426,500.00 463,800.00 716,500.00 Fixture 5,480.00 5,480.00 5,480.00 5,480.00 Company Vehicle 21,500.00 21,500.00 21,500.00 21,500.00 Computer - 3,200.00 3,200.00 3,200.00 Acc. Depreciation 95,196.00 143,761.00 186,556.00 259,351.00 Total Fixed Assets 26,784.00 312,919.00 307,428.00 487,329.00 Total Assets 73,522.00 357,052.00 369,156.00 657,102.53 Liabilities Current Liabilities Accounts Payable 13,676.00 15,881.00 27,307.00 44,629.57 Bank Line of Credit - - - 30,000.00 Total Current Liabilities 13,676.00 15,881.00 27,307.00 74,629.57 Long Term Liabilities Loan (New Court Credit) - 273,000.00 189,000.00 105,000.00 Loan (GE Capital) - - 36,000.00 296,400.00 Total Long Term Liabilities 0.00 273,000.00 36,000.00 401,400.00 Owner's Equity Share Capital 60,000.00 60,000.00 60,000.00 60,000.00 Retained Earnings -154.00 8,171.00 56,845.00 115,595.96 Total Owner's Equity 59,846.00 68,171.00 116,845.00 175,595.96 Total Liabilities & Owner's Equity 73,522.00 357,052.00 180,152.00 651,625.53 Projected Income Statement 2000 2001 2002 2003 Revenue 202,232.00 645,118.00 835,295.00 1,211,177.75 Cost of Sales 147,238.00 407,432.00 518,805.00 752,141.38 Gross Margin 54,993.00 237,686.00 316,490.00 459,036.37 Operating Expenses Salaries & Wages 26,362.00 116,757.00 120,259.00 180,259.00 General & Admin 2,058.00 15,556.00 8,512.00 21,512.00 Telephone & Fax 1,091.00 6,858.00 8,924.00 13,322.96 Legal & Accounting 800.00 1,500.00 1,491.00 1,491.00 Travel & Auto 0.00 6,734.00 9,430.00 13,322.96 Rent & Utilities 7,140.00 8,142.00 10,075.00 10,075.00 Bank Charges & Interest 3,227.00 17,127.00 18,505.00 35,805.00 Bad Debts 0.00 2,841.00 1,302.00 1,211.18 Depreciation Expense 14,348.00 48,565.00 42,795.00 72,795.00 Advertising & Promotion 0.00 1,330.00 1,235.00 1,211.18 Meals & Entertainment 0.00 867.00 1,042.00 1,211.18 Total Operating Expense 55,026.00 226,277.00 233,570.00 352,216.44 Net Earnings Before Tax (33.00) 11,409.00 82,920.00 106,819.92 Provision for Income Tax 0.00 3,084.00 34,246.00 48,068.97 Net Earnings After Tax (33.00) 8,325.00 48,674.00 58,750.96 Alternative Analysis Firm can be either refused the credit because of the potentially higher risk associated. This decision will actually not allow GE Capital to book new loans and expand and potentially lose income. Firm should be granted the credit based on strong growth in profitability. This decision will allow GE Capital to earn income and expand its business. Decision & Recommendations Considering the above situation, it seems that the firm must accept this request from CCL because the firm seems to have high probability of expand its business and increase income. GE Capital therefore should accept this credit application and grow its business as the business of the client also grows. The overall long term plans may include giving more working capital to the firm as it grows in future. Read More