Managing cash flow an operational focus phần10 docx

The actual cash flow, by month, for the year is shown in Exhibit A.4.. 328 Case Study: Managing Cash Flow... Cash Forecast Information 333him, insisting that he zero out the line of cred

JACK B NIMBLE COMPANY

(formerly ABC Machining, Inc.)

Jack Nimble had been employed by ABC Machining for nearly 20 years, serving

in a variety of engineering and manufacturing positions for the company Thecompany owner decided to put the company up for sale, and Jack was eager tobuy it, since he knew he could do a better job of managing and running it thanwas presently being done There was potential for additional sales; and cost sav-ings through production efficiencies, superior customer service, and reducedadministrative expenses (the owner was quite generous to himself) would be easy

to accomplish Jack had no doubt that he could improve things dramatically

with-in a year, and growth possibilities after the first year were extremely attractive.Jack did not have strong financial skills, but he knew that he had to puttogether some kind of projected figures to set goals for the company and to satis-

fy his financial backers, who were members of his family and also not financiallysophisticated Exhibit A.1 shows the income statement projections that Jackprepared

Based on this projection, which he felt was realistic, Jack did not do any ther financial studies, nor did his financial supporters request any more data.Their feeling was that the combination of the sales growth and the attractiveimprovement in profitability would be enough to avoid any financial difficulties.Unfortunately, these projections proved insufficient Jack did not take intoconsideration three significant factors: (1) He would have to invest in excess of $2

fur-325

million in plant and equipment to gain all the efficiencies and throughput sion he required; (2) to gain the new customers required to achieve the sales tar-get, he would have to extend 30-day credit terms to all customers; and (3) it wouldtake time to ramp up to $1.5 million monthly sales necessary to attain the $18 mil-lion target figure.

expan-As ABC Machining, the company enjoyed a unique position—demand for itsproducts exceeded ability to supply The company was able to sell all of its month-

ly production of about $1 million on a continuing basis ABC required cash ment at time of delivery to virtually all customers, and was still able to sell 100percent of its output Jack, however, wanted to increase sales and net profits andrecognized the existence of increased competition and other changes in the mar-ketplace He not only saw the need to retain present customers but also to acquirenew customers To accomplish his goals, he knew he would have to offer creditterms for payment and would have to absorb the cost of carrying the significantincrease in accounts receivable investment

pay-Jack was fully aware of the plant and equipment investment and theaccounts receivable factors, but he did not understand the cash flow ramificationsthey would have on his fledgling business He simply assumed the profit gener-ated from the new sales would produce enough cash to cover any requirements

he would face He had not taken the ramping factor into consideration at all If hehad done a balance sheet projection, even without taking the ramping intoaccount, the pro forma balance sheet figures in Exhibit A.2 would have appeared,allowing him to plan for the cash shortage contingency

From the pro forma balance sheet, it is clear that Jack could have anticipated

a significant problem with cash Without that projection, however, Jack onlydiscovered the problem once in the middle of it Fortunately, because some of hisrelatives were willing to guarantee Jack’s loan, he was able to get a $1.5 million line

ABC Machining Jack B Nimble Co.12/31/x1 – actual 12/31/x2 – projected

Cost of goods sold 8,436.1 70.3 _11,900 66.1Manufacturing Profit 3,566.6 29.7 6,100 33.9Selling, gen & admin

expenses 2,474.4 20.6 _2,500 13.9

Taxes 395.1 3.3 _1,300 7.2Net Income $ 697.1 5.8% _ _$ 2,300 12.8%

December 31, 20x1 and 20x2 ($$ in 000s)

Jack B Nimble Company 327

of credit from his bank and to increase his long-term loan by $500,000 To completethe picture of his first year of operation, in Exhibit A.3 Nimble’s actual financialresults are shown compared to the projected figures and to the prior year numbers.Part of Jack’s problem (and the solution to his critical needs) was borrowing AtJanuary 1, 20x2, Jack assumed a loan of just over $1 million with a monthly pay-ment of $16,000 including interest at 81/2percent He added $500,000 to the loan onApril 1, 20x2, which increased the monthly payment to $25,000 but did not changethe interest rate He also negotiated a $1.5 million line of credit at a rate of 9 per-cent The actual cash flow, by month, for the year is shown in Exhibit A.4

From these figures, it is clear that Jack made good progress towards ing his goals During the year, however, his cash flow difficulties forced him todefer the purchase of certain equipment that he needed, and the impact on futureyears may be severe He did a good job controlling expenses and inventory, buthis accounts receivable went through the roof As a result, he is now dealing with

achiev-a significachiev-ant line of credit (achiev-and relachiev-ated interest chachiev-arges) He hachiev-as finachiev-anced the rest

of his requirements partly from the profits he was able to attain and from the tion to his bank loan, but also by not paying his vendors on time His accountspayable balance has increased dramatically, and is now about 85 percent higherthan it should be Jack’s phone is surely ringing off the hook with angry and frus-trated vendors who are looking for payment Additionally the bank is pressuring

Accts payable & accrued expenses $1,250 16.6Other current liabilities 400 _5.3

328 Case Study: Managing Cash Flow

Jack B Nimble Company 329

Cash Forecast Information 333

him, insisting that he zero out the line of credit for at least one month before theywill consider another year’s extension

Because of his cash flow problems, Jack got smart quickly He decided heneeds a reliable cash flow projection for next year, particularly since he wants tocatch up on his fixed asset expenditures as well as make additional investments.The assumptions and estimates that support the forecast in Exhibit A.5 are asreliable as can be expected in the circumstances

FINANCIAL FORECAST INFORMATION

• Sales—January 20x3—$1,600,000; increasing at the rate of 1% per montheach month thereafter

• Cost of goods sold

• Variable CGS @ 40 percent of sales

• Fixed CGS @ $425,000/month, increasing at $10,000 per month for eachfollowing month

• Selling, general and administrative expenses (including bad debt expense,but excluding interest expense)

• Variable @ 10 percent of sales

• Fixed @ $55,000/month for six months, then $65,000/month

• Taxes—40 percent of profit before taxes

CASH FORECAST INFORMATION

• Accounts receivable collections

• 10 percent of current month sales

• 55 percent of prior month sales

• 34.5 percent of second prior month sales

• 0.5 percent uncollectible

• Cost of goods sold

• 100 percent of variable costs are cash

• 70 percent of fixed costs are cash

• Current month expenses are used as basis for projecting cash flow,although they are actually paid for at a later date

• Selling, general and administrative expenses

• $5,000 of fixed costs are noncash; all others are cash

• Current month expenses are used as basis for projecting cash flow,although they are actually paid for at a later date

• Operating cash—maintain minimum balance of $10,000

• Line of credit—9 percent interest on the prior month end balance

• Loan payments

• Interest @ 8.5 percent of outstanding balance

• $25,000/month repayment (interest included)

• Balance outstanding @ January 1, 20x3 = $1,346,100

• Subsequent months $200,000/month

The preparation of this kind of a forecast is not difficult once the basicassumptions and estimates are developed The picture such a forecast providesthe management of the organization is invaluable The prospect of an excessamount of cash is an opportunity that should be used to the fullest advantage,while a cash shortfall needs to be recognized early and handled wisely to mini-mize the cost to the organization and to avoid the disaster of not being able to payoff obligations Either way, typical income statement projections and pro formabalance sheets are not enough Cash is the ultimate determinant of survival, suc-cess, or failure

TASK

Review the cash flow projection in conjunction with the financial statements andother data previously presented in this case study Identify opportunities, bothfinancial and operational, for improved cash management and be prepared tomake suggestions to Jack that can help him get through his cash crunch and meethis bank’s demands

JACK B NIMBLE COMPANY CASE STUDY

SUGGESTED SOLUTION

There are many different cash management and operational areas to discuss

relat-ed to this case study The company faces a cash flow crisis that has been causrelat-edessentially by four factors:

1 Growth in sales without proper attention having been paid to the factthat growth is an expensive proposition, requiring cash for the increase

in accounts receivable, inventory, staff, and possibly equipment and/orplant

Jack B Nimble Company Cash Flow Pr

Jack B Nimble Company Suggested Solution 337

2 The granting of credit terms of 30 days to customers, which means amonth’s worth of sales for which the company will not receive immediatecash In the meantime, it has to expend money ahead of time for the mate-rials and labor that go into the products to be sold

3 Debt service—loan repayment and interest payments—that have beenincurred to handle previous tight cash situation but were not adequatelyplanned for by Nimble in his projections

4 Investment in fixed assets—property, plant and equipment—that Jackfeels is necessary to achieve his goals These investments require payment(from cash or borrowed funds) when they are purchased but providereturns only over the lives of the assets acquired The timing differenceshave to be financed by the company, and Nimble has not taken this intoaccount

An examination of the Cash Flow Projection for 20X3 quickly shows that thecompany looks to be in very good shape by the end of that projection year Whileencouraging, this alone does not make the problem go away As of the beginning

of the projection year, Nimble Company is out of cash and has several months ofnegative cash flow to handle It is this immediate problem that needs to be han-dled Additionally, there are lots of opportunities that would make the cash flowsituation even better than it looks in the projection, and these should be consid-ered and implemented if feasible Finally, even with the favorable projection, thereare numbers of operational and financial problems that should be addressed toimprove the overall company financial performance

The suggested solution attempts to point out some of the key financial andoperational areas that should be addressed, but the reader should recognize thatthere are many other areas that deserve attention as well

Financial Issues

The company’s financial structure is seriously out of alignment The short-termline of credit has been used not only for working capital needs, but also for capi-tal investment requirements Using short-term money for long-term needs creates

a repayment problem since the benefits of those capital investments will accrueonly over the long-term Since repayment requirements are immediate havingadequate funds to make them is difficult and in the case of Nimble Company, vir-tually impossible That is the major reason the company has been unable to zeroout the line of credit as demanded by the bank

To solve this problem, it will be necessary to reshape the capital structure ofthe company and, more immediately, to take care of the line of credit problem.One quick and dirty, though temporary, way to deal with the line of credit issuewould be to ask the bank for a waiver of the requirement to zero out the loan Thebank might say, “No”, in which case the company is no worse off than before Or

338 Case Study: Managing Cash Flow

they might say, “Yes” to the request, in which case the problem goes away until amore permanent fix is devised In this particular case, given the very favorablepicture in the forecast for the end of year 20x3, it seems likely that the bank willhave little choice but to go along with the request for a limited period of time Torefuse the request and call for immediate repayment of the loan will put the com-pany into default and will thereby leave the bank as the owner/operator of thecompany, a position no bank wants to get into Since its best option for gettingrepaid is to help the company get out of its difficulty, an affirmative response tothe request is likely, unless there are other factors that cause the bank to feel theloan is a lost cause

Once the line of credit problem is handled, Nimble Company can then workwith the bank to create a more appropriate capital structure consisting of long-term loans, collateralized by the fixed assets it already owns This reduces imme-diate cash requirements by deferring the loan payments over a longer period oftime, albeit with greater interest payments But the goal is to get through theimmediate cash crunch, and anything that can be deferred is likely to be a goodthing Further, a more properly balanced capital structure is necessary and desir-able for the company As part of the refinancing structuring, the existing line ofcredit should be extinguished, solving the zero balance problem, and replacedwith a new line of credit to be used for working capital needs only Any new long-term assets should then be financed by appropriate long-term debt

Operational Issues

An immediate and obvious concern has to be the collection of existing accountsreceivable Sales for the last quarter of 20X2 were $4,426,100 or $48,100 per day.12/31/X2 accounts receivable were $2,029,600, making Jack’s collection period42.2 days – 12.2 days more than his terms That 12.2 days calculates out to be

$586,800 in unavailable cash Calculated on an annual basis, his sales were

$15,073,400 or $41,300 per day On that basis, his collection period is at 49.1 days,which represents $788,800 in overdue cash the company is owed Jack appears

to be doing little or nothing to collect his overdue accounts receivable, and heneeds to be pushed into going after the slow payers Failing to pay attention tothis type of behavior on the part of his customers will only cause them to takemore advantage of him and extend payment times still farther out A vigorousfollow-up program on the overdue accounts is likely to bring in a substantialsum of money

A second immediate issue is his planned expenditures for capital ments, which total $2,800,000 for the 20X3 projection period Of particular con-cern is the $700,000 projected for February This should be cancelled if possible,deferred if not cancelable, or financed if not deferrable After that Jack’s $200,000per month projection from April through December needs to be examined close-

invest-ly to eliminate those planned expenditures that are not essential to the basicgrowth and profitability of his business It is too easy for production/engineer-