Financial Management - Problems with Repaying the Loan on Time - Assignment Example

Financial Management 1. Problems with repaying the loan on time The actual sales or shipment figures from March 2013 to May were significantly lower that the forecasted sales or shipment figures. This was the main reason why a profitable company like Jackson was not being able to repay its loan on time. There was an interruption in shipments during this period. This was because Jackson had to wait for the installation of some key electronic components for the newly designed air conditioning systems that brought about a delay in Jackson’s order fulfillment. The drop in sales led to a lack of cash-in-hand for Jackson. Sources and uses of funds statement   2012 August 2012 September 2012 October 2012 November 2012 December 2013 January 2013 February Sources of Cash       Net sales 6,321 5,969 6,421 6,302 6,009 6,170 6,006 Interest income 13 14 6 6 8 7 8 Notes payable, bank 0 5,000 0 0 0 0 0 Total 6,334 10,983 6,427 6,308 6,017 6,177 6,014         Uses of Cash       COGS 4,994 4,727 5,003 4,914 4,695 4,815 4,692 Operating expenses 773 763 777 788 733 728 744 Interest expense 0 0 25 25 25 25 25 Income taxes 152 127 171 157 151 166 147 Dividends 0 200 0 0 0 0 0 Total 5,919 5,817 5,975 5,884 5,604 5,734 5,608   2013 March 2013 April 2013 May Sources of Cash   Net sales 5,197 4,165 3,744 Interest income 9 7 10 Notes payable, bank 0 0 0 Total 5,206 4,172 3,754     Uses of Cash   COGS 4,087 3,215 2,876 Operating expenses 685 587 566 Interest expense 25 25 25 Income taxes 98 76 57 Dividends 0 0 0 Total 4895 3,903 3,524 2. The need for a new loan The company needs an additional loan of $ 2.4 million for financing the purchase of a new equipment. Given the circumstances, need for the additional borrowing is quite urgent for Jackson. As it was mentioned, some very important parts of the existing equipment were worn out and it was very urgent that they are replace as quickly as possible for avoiding any disruptions in production in the near future. As a result, to keep the company’s productions smooth and running, the purchase of a new equipment was needed, and since the company did not have enough cash to fund the purchase, so it needed this additional borrowing urgently. 3. Pro forma financial statements Monthly Cash Budget 2013 June July August September Cash Inflow A/R Collections 3744 10881 6474 7201 Interest Income 8.32 2.71 10.89 11.72 Additional Loan 0 2400 0 0 Total 3752 13284 6485 7213 Cash Outflow Capital Expenditure 2400 Tax 375 375 Accounts Payable 5969 5200 5200 5200 Interest Expense 25 25 37 37 Operating Expense 750 750 750 750 Dividends 1200 Loan Repayment 7400 Total 7119 8375 5987 14962 Beginning Balance 4994 1627 6536 7034 Ending Balance 1627 6536 7034 -715 Pro Forma Income Statement 2013 June July August September Net Sales 12681 7374 7201 7394 COGS 10850 5810 5810 5810 Gross Profit 1831 1564 1391 1584 Operating Expense 750 750 750 750 Interest Expense 25 25 37 37 Dep. & Amortization 120 120 130 130 Interest Income 8.32 2.71 10.89 11.72 Profit (loss) before Tax 944.32 671.71 484.89 678.72 Net Income 623.25 443.33 320.03 447.96 Dividends 1200 Pro Forma Balance Sheet 2013 June July August September Cash 1627 6536 7034 -715 Inventory 6513 5903 5293 4683 A/R 10881 6474 7201 7394 Total Current Assets 19021 18913 19528 11362 Gross PP&E 47900 47900 47900 47900 Accumulated Dep. 31568 31688 31818 31948 Net PP&E 16332 16212 16082 15092 Prepaid Expenses 54 54 54 54 Total Assets 35407 35179 35664 27368 Bank Loan 5000 7400 7400 0 A/P 5200 5200 5200 5200 Accrued Taxes 219 448 612 468 Other accrued expenses 1142 1142 1142 1142 Advance payments by customers 900 0 0 0 Total Current Liabilities 12461 14190 14354 6810 Stockholders’ Equity 20546 20990 21310 20558 Total Liabilities & Equity 35407 35179 35664 27368 4. Probability of repaying the loan Based on the forecasts shown above and the analysis of Jackson’s credit, it can be said that the company will not be able to repay its loans (one $ 5 million and one $ 2.4 million = $ 7.4 million in total) at the end of the fiscal year if it pays the dividend. The monthly cash budget (cash inflow & outflow) shows that at the end of Sep’ 13, Jackson will not have enough money to pay these loans back. Due to a negative cash balance at the end of September 2013 resulted by the dividend payout, the company will not be able to pay both loans. As a result, the bank will be at high risk when it comes to the second loan of $ 2.4 million. 5. Evaluation and sensitivity analysis The forecasts above were done based on the following assumptions: Monthly interest payment for both loans is 0.5% of the principal amount, The new purchased equipment would work for 20 years with zero salvage value at the end of its life time, straight-line depreciation method would be used, Work-in-progress would be reduced by $ 5,040,000 in June 2013, Advance payment of $ 2.7 million made by a customer, Accumulated inventories are $ 2,440,000 above the normal inventory level, Raw material purchases would be down by $ 5,200,000 starting from June 2013, Dividend payment of $ 1,200,000 in September 2013, Operating expenses would be $ 750,000 from June 2013 to September 2013, and The company’s corporate tax rate is 34 percent. From the analysis provided by Jackson, we can say that some of the assumptions are accurate and realistic. On the other hand, some of them seem a little over optimistic (such as the inflated sales figures). And the rest seem unrealistic (the dividend payment of $ 1,200,000 in September 2013). Sensitivity Analysis The Account Receivables amounts depend on the Sales volume. As a result, we will change the year-end A/R Collections by +/-5% and hold the other receipt and disbursement amounts constant to see its effect on the year-end cash balance- Forecasted Optimistic (+5%) Pessimistic (-5%) September’13 September’13 September’13 Cash Inflow A/R Collections 7201 7561.05 6840.95 Interest Income 11.72 11.72 11.72 Additional Loan 0 0 0 Total 7213 7572.77 6852.67 Cash Outflow Capital Expenditure Tax 375 375 375 Accounts Payable 5200 5200 5200 Interest Expense 37 37 37 Operating Expense 750 750 750 Dividends 1200 1200 1200 Loan Repayment 7400 7400 7400 Total 14962 14962 14962 Beginning Balance 7034 7034 7034 Ending Balance -715 -355.23 -1075.33 6. Decisions regarding the loan Yes, the bank should extend the maturity of the current loan and approve the additional loan. It was seen that in June 2013 the company did not have enough cash to repay the loan. But, the industry predictions, and Jackson’s assumptions along with its good collection and payment records, and its conservative financial policies make sure that the company will be able to repay the loans by the end of September 2013, given that the company does not payout $ 1200 thousand as dividend payment. All the forecasts and discussions above also support this notion. In addition to that, Jackson has managed to pay its interest payments regularly, and it never got behind its interest payments. Finally, the company badly needs to purchase a new equipment in order to keep its production operations running smoothly. If this happens, then this will be beneficial for the bank as well, since nonstop productions will lead to increased sales and more cash, which in turn will guarantee the loan repayment by the company. So, if the bank extends the current loan and approves the additional loan, it will be able to earn more as interest payments. But, the bank can impose the following terms and conditions in order to reduce the risks of these loans- Dividend payment should not be more than $ 400 thousand (maintain a conservative dividend policy). Monthly interest payment will be 0.5%, or Implement a ‘Discounted Inventory Sale’ strategy for the excessive inventories, or Divide the total loan amount into four equal repayments of $ 1850 thousand starting from July 2013. 7. Repurchasing of the outstanding common stocks There could be a number of reasons why Jackson bought back a substantial fraction of its outstanding common stocks ($ 9954 thousand), for example improving the financial ratios, undervaluation, ownership consolidation etc. A company issues shares for raising funds for expanding the business. However, if there is no probable growth potentials at present or in the future then the extra funds raised by issuing shares will lead to sharing ownership equity without any reason. In addition, these shareholders will demand dividends as well, which will eventually increase the company’s ‘cost of capital’ (Ginglinger and Hamon, n.d.). As a result, repurchasing some or all of the additional stocks will bring down the company’s cost of capital. Undervaluation is another important reason why companies buy back their own shares. When the company’s share price goes down, the company can buy back its own shares at the reduced price in order to capitalize on the undervaluation and then sell the stocks again when the share price goes up. This can generate a lot of cash for the company without having to issue any new shares, or taking any substantial loan. Finally, many companies repurchase their own share for making their companies look like more lucrative investment options to the investors. Repurchasing reduces a company’s number of outstanding shares and increase the company’s EPS (earning per share). Moreover, it is often seen that short-term investors usually invest in companies just before their planned repurchase. This actually boosts the share price at least momentarily and increases the company’s P/E Ratio (Ginglinger and Hamon, n.d.). Now considering all these reasons, let us see why Jackson bought back a substantial fraction of its outstanding common stocks in September 2012. The monthly balance sheets of the company shows that Jackson had been buying and selling its stocks regularly since September 2012. From this action, it can be assumed that the company could be taking advantage of the undervaluation of its share price, and selling them back once price goes up. And the impact of this action was discussed above. 8. Jackson’s dividend payout plan The company planned to pay $ 1200 thousand as dividend in September 2013. The amount of dividend is much greater than the dividend payment of the previous year. In 2012, Jackson incurred a net profit of $ 2546 thousand and paid a total of $ 400 thousand as dividends. During the first 8 months of the 2012-2013 financial year, the company had a net profit of $ 1986 thousand already. And the net income forecast above shows that the company will have a year-end net income of $ 3820.57 in 2013. However, due to a negative cash balance at the end of September 2013 resulted by the dividend payout of $ 1200 thousand, the company will not be able to repay its loans. As a result, the bank should not agree with the payout, as it will put both the bank and the company at risk. In such a scenario, $ 400 thousand (just like the previous year) seems like an appropriate amount for dividend payment, because this will ensure the repayment of both loans. References Dai, J. (n.d.). Heterogeneous Banks, Loan Decisions, and their Informational Externality. SSRN Electronic Journal. DeFond, M. and Hung, M. (n.d.). An Empirical Analysis of Analysts' Cash Flow Forecasts. SSRN Electronic Journal. Ginglinger, E. and Hamon, J. (n.d.). Ownership, Control and Market Liquidity. SSRN Electronic Journal. Manisha B, R. (2012). Financial Performance Analysis. GRA, 3(5), pp.9-10. Read More