MBA770 Corporate Finance
Case “Jones Electrical Distribution”
Jones Electrical Distribution (“JED”), which sells electrical components and tools to general contractors and electricians, is experiencing rapid growth in a highly-fragmented, highly competitive industry and despite profits, experiencing a cash shortfall, resulting in increased borrowing from Metropolitan Bank (the “Bank”) to $250K, the max loan amount the Bank will make to any one client. JED has been able to remain within this amount through 2006, relying heavily on trade credit from suppliers. As a result, Nelson Jones, owner and president, is seeking a new banking relationship. Nelson’s friend introduced him to a new bank where he felt he might qualify for a loan up to $350K. The new loan would provide him with the much need credit availability now, but carry customary covenants causing JED to be more deliberate about future growth: (i) continue on aggressive growth path; or (ii) moderate/slow.
Tactical Approach to Growth - Facing competition from national distributors, home centers, and other supply houses, JED grew sales competing on price and aggressive direct sales, resulting in YoY growth in excess of 17%.. Maintaining tight control over operating expenses (commissioned sales force, paying suppliers within 10 days of invoice to take advantage of the 2% discount, adept at forecasting, maintaining modest inventory levels) promoted profitability, but growth was increasing the overall operating cycle, resulting in greater borrowing needs.
Rapid or Slowing Sales Growth Options – Should JED elect to continue the rapid sales growth and continue to take advantage of trade discounts, the borrowing need increases significantly. Forgoing trade discounts, the need for financing remains, but not to quite the same extent. Taking the alternative “slower growth” path moderates the need for capital.
Financial Metrics – (see Appendix) Financial calculations and ratios support the Bank’s diligence findings that JED has done well controlling expenses and that the cash need is in fact due to sales growth. There is no indication that financial mismanagement is a root cause. When assessing JED’s matching strategy, we do find that the WCR could be considered permanent and, therefore, consider long-term financing. When calculating the self-sustaining growth rate for JED, it’s approximately 12% in FY06 versus the expected 20% in FY07, the result of which confirms the cash crunch. With regards to REO, JED is beginning to see a reduction, going from 13% in FY05 to 12% in FY06, the result of the operating profitability decreasing.
Debt Service Coverage – JED does have sufficient cash flow to support the requested debt levels, as well as capacity to layer in a portion of term debt. Customary DSC Ratio requirement is 1.25:1.
|Debt Service Coverage Analysis | | | | | | |Net A/R |$187 | |$231 | |$264 | |Inventory |$243 | |$278 | |$379 | | | | | | | | |Total Gross Asset Base |$430 | |$509 | |$643 | | | | | | | | |A/R @ 75% |$140 | |$173 | |$198 | |Inventory @ 50% |$122 | |$139 | |$190 | |...
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