Short-Term Sources of Funds
Subject:O.M. Scott & Sons Company
Problem:Should the O.M.Scott company keep with its Trust Receipt Plan in order to maintain 25% growth rate.
Options: 1. Sell receivables to a third party at a discount rate to receive cash.
2. Issue preferred equity to help finance retailers in holding higher Inventory levels
3. Reduce growth rate to a sustainable
Recommendation: In order to maintain the 25% growth, we need to first of all, abandon the trust receipt plan which causes sales growth rate to drop ever since implementation. we need to adopt alternative 1 (selling receivables) in order to reduce the cash cycle and free up some cash to meet our short term liabilities. Our external fund needed exceeds the maximum allowed line of credit of 12.5 million according to the performa for March 1962, which means that we have to also incorporate alternative 2 which is to issue equity to cover for extra fund outside of the limit.
O.M. Scott & Sons (Scott) is a lawn-care company that has its operations centered in Ohio. The company has successful established a customer base and has a positive outlook for future operations. Their goal for future years is to maintain a growth of 25% for sales and income, however, we believe that this is not plausible because receivables are not being collected at a rate that supports the growth in sales. This is the main source of the problem for the company is not getting paid for its inventory until they have been sold by the dealers. This places significant financial strain on the company, as it is responsible for obtaining the finances necessary in order to maintain the inventory levels at each of its 10,000 dealers.
Starting with an analysis of the inventory period, we see a poor trend. Logically, the inventory period has also gone from bad to worst. Also alarming are the company’s accounts receivable turnover ratios, decreasing by 72% and its accounts receivable period going up by 253% from 1957 to 1961. What is most interesting is that these numbers were fairly stable prior to 1960, the year the O.M. Scott & Sons Co. started implementing its Trust Receipt Plan. Pushing further, the ROA reflects a poor corporate ability to extract value from its assets, as the numbers are getting worst from year to year.The operating cycle was 106.7 days in 1957, growing by 126% to 241.3 days by 1961, demonstrating poor management efficiency. The cash cycle was extended by 100 days during the same period, which is not the direction in which you want cash flow to go. The cash cycle needs to be shorter in order to allow cash to flow into the company sooner, easing the financial strain on the company.
Regarding profitability, the company’s net income over sales ratio was in an upward trend from ‘57 till ‘59 but dropped as soon as Scott implemented the Trust Receipt Plan. Higher operating expenses as well as interest expenses have had a non negligible impact on bottom line results. The ROE in 1961 is of 13.53%, down from 19.98% in 1959, demonstrating that the shareholder’s return is alarmingly going down.
To dig deeper into the recent ROE results, we did a Dupont analysis and were able to relate the drop in return to the longer receivables collection and higher inventory levels. In turn, higher inventory levels grossed up total assets and dropped the ROA.
A free cash flow model was constructed to further prove our point that the Trust Receipt Plan is not successfully claiming receivables from Scott’s dealers. By looking at the numbers in 1959 and 1960, we see that free cash flow in the company decreased by 72% after the implementation of the Trust Receipt Plan. This further proves our idea that the Trust Receipt Plan is not successful in bringing cash into the company.
Despite these negative outcomes from the trust...