Running Head: JONES CASE ANALYSIS 1

Finance Case Study:

Jones Electrical Distribution

Adam Brown, Edwin Aguilar, and Todd Cary

Professor J. McHugh
BUSN 370-03
10 December 2015
Executive Summary
Running Head: JONES CASE ANALYSIS 2

Nelson Jones, the sole owner of Jones Electrical Distribution, is facing

tough decisions about how to improve his company. Jones has the option to
pursue rapid sales growth, or minimal sales growth with subsequent
implications. If Jones pursues rapid sales growth, he must decide whether to
forego or accept trade discounts, and whether debt or equity would be
adequate for financing. On the other hand, if Jones decides to pursue
minimal sales growth, he will have the option to forego or accept the
discount, and whether or not to accept any form of financing. If Jones opts for
debt financing, he must choose whether to continue relations with a new
bank, Southern Bank & Trust, or through long-term debt.

Situation Analysis

For the past few years Jones Electrical has increased its sales consistently. In
fact, they were performing well enough that they began increasing their
inventory as a part of an aggressive inventory forecasting strategy. However,
due to poor cash management, their cash on hand has suffered significantly
in the process. This cash shortage has forced Jones Electrical to dip into a
line of credit to conduct their operations. Their credit limit is approaching,
and Jones has the option to extend a line of credit by $100,000 with a new
bank, or consider other financing options. Based on an analysis of the
companys financial statements, business environment, and related
assumptions, we will provide a recommendation for how Jones Electric can
improve its financial situation in the years to come.

Case Analysis Questions

1. How well is Jones Electrical performing?

Overall, Jones Electrical is performing moderately well due to

consistent growth and increasing sales. However, the business is still
struggling with cash flow due to ineffective inventory management and
collecting payments from customers as of late. We can see the growth of
Jones Electrical through increases in Net Income. However, the cash flow
needs to be more consistent with the amount of money received and the
amount of money being distributed to inventory, projects, and paying back
debt financing. Nelson Jones should have a positive outlook on the position
his company is in, but will require more financing if he expects to grow his
business.

2. What must Jones Electrical do well to succeed?

There are three main needs for Jones Electrical to accomplish in order
for them to be a successful, competitive company in their market
environment.
Running Head: JONES CASE ANALYSIS 3

a. Jones Electric needs to better manage their inventory and inventory

forecasting. Jones Electric has too much inventory on hand resulting
from a higher demand in previous years. However, since they have not
forecasted correctly, the additional inventory has inhibited cash flow
significantly.

Account Change per

Yr ($) 2005 2006 2007
$15,000. $9,641.6
Net Income 00 $1,000.00 0
$35,000. $101,000. $76,937.
Inventory 00 00 53

b. Jones Electric needs to forego the trade discount. In theory, the 2%

discount should always be taken because Jones Electrical would be
saving money. However, if you take into consideration the cash flow
statement and the money that should be kept on hand to pay off loans,
Jones Electrical should not pay the 2% discount rate. Taking discount
dramatically alters how much funding the company needs. By
constantly monitoring these numbers, they can change their payment
methods to fit the most profitable and efficient scenario. Long Term
Debt plays a major role in this decision.

Line of Credit Payable

with and without $424,381 $346,411
discount .35 .26

c. Jones Electric needs to improve collection from customers. Accounts

Receivable has increased considerably from 2005 to 2007, and their
inability to collect has inhibited their cash flow. Jones has a good sales
model, and strong customer relations, yet he will need to request
customers to pay sooner.

Turnover Ratios Avera

(days) 2005 2006 2007 ge
Accounts Receivable 44.01 42.98 43.00 43.33
Accounts Payable 9.99 24.09 10.00 14.69

3. Why does a business that has net income of $30,000 per year in
2006 need a major bank loan?

Net Income does not always represent the financial needs of a

company. Jones Electrical has an increasing amount of Gross Profit, but they
also have an increasing amount of Inventory and Accounts Receivable. Jones
Electrical is not receiving the money of the supplies that they are selling.
Running Head: JONES CASE ANALYSIS 4

Jones Electrical has a Gross Profit percentage increase of 17%, but they also
have a 12% increase in Accounts Receivable and a 36% increase in
Inventory.

Considering these circumstances, it is no surprise that Jones Electrical

is considering more financing because they are not matching the products
and materials bought from suppliers to the products and materials they are
selling. The 36% increase in Inventory and the 12% increase of Accounts
Receivable far outweigh the percentage shift of Gross Profit. The financing
may allow Jones Electrical to continue purchasing supplies although there
may be a decline of sales in the marketplace or there may be an increase of
a purchase on credit.

4. What drove the increase in Joness accounts receivable and

inventory balances in 2005 and 2006?

From 2004 to 2006, there was a rapid increase of demand for Jones
Electrical products. This requires an increase in supply in order to keep up
with the competitive market. The increase of supply/inventory was the right
decision, but it affected the time that it takes the company to receive
payment. This brings a negative impact on the cash flow of the company.
Another reason that Joness accounts receivable and inventory balances
increased in 2005 and 2006 has to do with the commission basis sales force.
Employees paid on commission will offer products that must be bought from
a supplier because they are out of stock. This can drive up the inventory of
certain products. If an employee is making money from commission, they are
also more likely to change the payment periods allowed in order to close a
sale. This affects the accounts receivable drastically.

5. Is Nelson Joness estimate that a $350,000 line of credit sufficient

for 2007 accurate? Answer by using the excel spreadsheet and
assumptions provided to forecast Jones Income Statement and
Balance Sheet in 2007.

The estimated $350,000 line of credit could or could not be sufficient

depending on the payment approach of Jones Electrical. If Nelson Jones
decides to pay his suppliers the 2% discount allotted to him within 10 days,
the line of credit will be about $75,000 short. On the other hand, Nelson
Jones could take the full amount of time to pay back his suppliers and would
only need $346,411 of the total amount of the line of credit. In taking the 2%
discount, the line of credit would be insufficient, but by not taking the 2%
discount the line of credit would be sufficient (Appendix B).

6. What needs to change to reduce the borrowing needs for the

Jones company?
Running Head: JONES CASE ANALYSIS 5

Jones needs to increase in their cash flows. In 2006 alone, more than
50% of their cash flow dropped, forcing them to consider increasing their
borrowing limit. Jones line of credit needs to decline if he is to avoid
bankruptcy. A cause of their thirst for cash is their inability to sell off their
inventory. Still, he must be careful to not decrease the inventory too much,
for this could slow up growth and net sales. Jones should not take the
discount, for they need cash more. They are increasing each year, causing
them to lose cash and build more assets.

7. Do you think Jones should pay his suppliers early to obtain the
2% discount or pay his suppliers in 30 days and forego the 2%
discount?

Jones Electrical should forego the 2% discount and opt to pay his
suppliers back in 30 days. Taking the 2% discount may alter the Net Income
more positively for 2007 (Appendix A), but it will not help his cash flow
situation. Jones Electrical has paid back its suppliers with an average close to
10 days, with the exception of 2006, but has consistently failed to receive
payments on Accounts Receivable until 40 days out or more on average. The
money saved from the discount does not outweigh the benefit of having a
balance between Accounts Payable and Accounts Receivable Turnover ratios.
Delaying to pay suppliers will help Jones Electrical manage its cash flow more
efficiently.

8. Would you as Ms. Montrose agree to lend Jones the money?

I would only agree to lend Jones the money if he opted to forego the
trade discount of 2%. If Jones Electric decided to take the trade discount,
their cash flows would be much more restricted, thus hindering their ability
to pay back the loan. The forecasted Balance Sheets illustrate the clear
difference between the two options in terms of how much of the loan would
be required. With the discount, Jones Electrical would need a line of credit
over $400,000 which exceeds the amount of the loan offered. However, if
Jones Electric rejects the discount, their line of credit payable would decrease
to just under 350,000. Still, Jones must consider whether taking any further
line of credit at all would really improve his business.

9. Jones has been thinking about investing $200,000 in an inventory

management software system. His sales rep has guaranteed free
cash flows of $60,000 per year for 5 years as a return on the
investment. The $60,000 would be a combination of reduced
inventory carrying costs, admin charges from his freight carriers
and the reduction of one person in his customer service
department. Calculate the NPV assuming a 10% discount rate and
the IRR. Does the $200,000 software system seem like a good
investment?
Running Head: JONES CASE ANALYSIS 6

According to NPV calculations, this would be a good investment to

decrease the high levels of inventory, and yield profit. This project would
have an NPV of $27,447.21, and an IRR of 15.24%.

10. What would you do as Mr. Jones? Come up with your top 3
options and then pick one as your final and best recommendation to
ensure his company is successful into the foreseeable future.

1. Jones Electrical could opt for the line of credit for the full $350,000.
However, the discount would not be feasible considering this option as
illustrated in the projected Balance Sheets for 2007. This option would
be very risky for Jones Electrical if he could not keep enough cash on
hand to pay the interest expenses on the loan. Additionally, the bank
would probably require some sort of collateral, which could cause Jones
to lose a considerable portion of his company should he default on the
loans.

2. Jones Electrical could renounce any form of investment from the bank,
forego the trade discounts, and address his current issues with cash
flow. This is not the most feasible option if Jones is expecting to grow
rapidly. Jones may be able to address some issues with collections,
inventory, and cash flows on his own, but without much ambition to
expand.

3. Jones Electrical could refuse a line of credit from the bank, and choose
to raise financing through receiving equity investments.

Our Recommendation

Jones Electrical could refuse a line of credit from the bank, and
choose to raise financing through receiving equity investments. This
is the most feasible option because it allows Jones to raise capital without
paying interest, therefore providing an opportunity to address his cash flows.
Investors would be concerned about current Cash Flow issues, an area in
which Jones is weak. However, Jones would be able to invest the money into
a new inventory management software system, which would yield a positive
Net Present Value, and improve Inventory management into the future. Jones
has a good credit rating and is trustworthy with his personal finances
according to Lyons, and this is the character that would attract angel
investors. Additionally, Jones could use advising as he continues to grow his
business, a key benefit of equity investors.

Faith and Integration

Running Head: JONES CASE ANALYSIS 7

Contentment is not only the key to a thriving Christian life, but also
incredibly helpful in making financial decisions. Jones has many different
options before him, but he must remember to be content with how much
progress he has already made. This will help him to be patient, and
thoughtful in making the best decision rather than hasty, greedily, or with
prideful disposition. Indeed, Paul reminds us that, if we have food and
clothing, with these we will be content. But those who desire to be rich fall
into temptation, into a snare, into many senseless and harmful desires that
plunge people into ruin and destruction (1 Tim 6:8-9, emphasis mine). If
Jones does not first consider what he has already accomplished, and how
much he already possesses, he could easily stray into tempting thoughts
that would cause him to pursue wealth aggressively and hastily. In this
decision, Jones needs to make a patient and thoughtful position that will
improve his overall financial position, and cannot be distracted by mere
short-term gains.

Appendices

Appendix A: Projected 2007 Income Statement with and without

trade discount

Income Statement 2007A 2007B

$2,700,000. $2,700,000.
Net Sales 00 00
$2,189,700. $2,243,700.
COGS 00 00
Gross Profit on Sales $510,300.00 $456,300.00
Operating Expenses $418,500.00 $418,500.00
Interest Expense $31,000.00 $31,000.00
Running Head: JONES CASE ANALYSIS 8

Net Income Before

Taxes $60,800.00 $6,800.00
Provision for Income
Taxes $21,158.40 $2,366.40
Net Income $39,641.60 $4,433.60

Appendix B: Projected 2007 Balance Sheet with and without trade

discount

Balance Sheet 2006 2007 A 2007 B

$23,000.0 $23,000.0
Cash $23,000.00 0 0
$264,000.0 $318,082. $318,082.
A/R 0 19 19
$378,612.0 $455,937. $467,181.
Inventory 0 53 37
$665,750.0 $797,019. $808,263.
Total Current Assets 0 73 56

$252,000.0 $252,000. $252,000.

PPE 0 00 00
$(134,000. $(134,000. $(134,000.
A/D 00) 00) 00)
$118,000.0 $118,000. $118,000.
Total PPE, net 0 00 00
$783,750. $915,019 $926,263
Total Assets 00 .73 .56

$119,562.0 $59,991.7 $184,413.

A/P 0 8 70
$249,183.0 $424,381 $346,411
Line of Credit Payable 0 .35 .26
$14,333.0 $14,333.0
Accrued Expenses $14,333.00 0 0
LT Debt, Current $24,000.0 $24,000.0
Portion $24,000.00 0 0
Total Current $407,078.0 $522,706. $569,157.
Liabilities 0 13 96
$134,000.0 $110,000. $110,000.
LT Debt 0 00 00
$541,078.0 $632,706 $679,157
Total Liabilities 0 .13 .96
Running Head: JONES CASE ANALYSIS 9

$242,672.0 $282,313. $247,105.

Net Worth 0 60 60
Total Liabilities and $783,750. $915,019 $926,263
Net Worth 00 .73 .56