Questions Covered

1. How well is Jones Electrical performing? What must Jones do well to succeed?
2. Why does a business that has profit of $30,000 per year need a bank loan?
3. What drove the increase in Joness accounts receivable and inventory balances in
2005 and 2006?
4. Is Nelson Joness estimate that $350,000 line of credit is sufficient for 2007
reasonable?
5. When will Jones be able to repay the line of credit?
6. What could Jones do to reduce the size of the line of credit he needs?
7. What are the implications for Joness lifestyle of accepting a new, larger line of
credit?

Keywords
Bank loans, Cash flow, Financial analysis, Financing Forecasting
http://www.papercamp.com/essay/75092/Jones-Electrical-Distribution-Case
Jones Electrical Distribution Case

Question A
How well is Jones Electrical Distribution Performing?

From the 2004-2006 data Jones Electrical Distribution is performing well, in that it is high growth
company with low profit margins and very low cash. In 2005 and 2006 he has seen 18% and 17% net
sales growth respectively and a return on equity of 13.5% and 12.3%, supporting a sustainable growth
rate of 14%. In addition to the claims of tight controls on accounts receivable, they are kept at a
constant rate of 12% of net sales throughout 2004-2006. Inventory significantly increased from 14% to
17% of net sales in 2006, presumably in anticipation of additional growth in 2007.
The high net sales and sustainable growth rate is highly contrasted with a 2006 profit margin of 1.3%,
and an internal growth rate of 4%. To maximize return off the companys growth, Electrical Jones
Distribution will need financing to get cash. In 2005 we can see that this financing was done through a
$65k increase in the line of credit payable and an attempt to do the same was done in 2006; however

there was only $35k left available in the $250k bank loan to draw from. The immediate solution was to
leverage one of the internal financing channels, namely account payable.
From 2005 to 2006 the accounts payable turnover ratio decreased from 45 to 18 or from 7.7 days to
18.8 days. While the increase in accounts payable allowed for $80k to be put into other areas of the
business, it forgoes the 2/10 n/30 payment discount to suppliers. This discount is extremely important
to the function of the business, with his low profit margins the elasticity of profit to COGS is a whopping
-40! While this translates to a very high price to pay for additional cash, it is only relevant as the
accounts payable turnover ratio moves from just 10 days to over 10 days. Now that it is above 10 days,
there is no additional direct cost for increasing it further to internally finance growth.

What must Jones do well to Succeed?

Depending on what is considered satisfactory growth pre-2008 financial meltdown, Jones 4% internal
growth rate may be sufficient. Should he want to maximize business growth in order to succeed, he
needs to find a source of cash to meet the 14% sustainable growth rate. This could be through
drastically increasing accounts payable, shaving a few dollars off accounts receivable, seeking external
financing, or some combination of those options. Given the choice to decrease the accounts payable
turnover ratio to 18, it seems unlikely that Jones will try to improve the profit margin.

Question B
Why does a business that has a profit of $30,000 per year need a bank loan?

Jones wants to increase his sales and expand his business. However despite a profit of $30,000 per year
his business needs a bank loan to take advantage of growth opportunities. There are three reasons;
firstly, as the tables below demonstrate, the increase in account receivables percentage and number of
receivable days are reducing the amount of working capital he has available. Secondly, Jones had not
taken advantage of purchase discounts 2/10 net/30 because he spent the cash for further investments
required for companys increased sales volume. Moreover, discounts for quick payments (within 10 days
of invoice date) historically had been helping him to better manage his expenses. In addition, having
control of expenses is very important for this business since the profit margin is very small and
profitability is mostly guaranteed by sales volume. Third, the current and quick ratios show that
company will not face any problem in short term although the ratios show a decreasing trend. This
company is able to pay its short-term debt.

Years

2004-2005

2005-2006

Changes in Account Receivables:

23.52 %increase

14.28%increase

Changes in Net Sales:

17.98%increase

17.01%increase

Year

2004

Days in Receivables

2005 2006

42

44

43

Question C
What drove AR and Inventory in 2005 and 2006?

Accounts Receivable Analyses

Parameter | 2005 | 2006 |
Growth | 24% | 14% |
Sales/AR | 12% | 12% |
AR Turnover ratio | 8,30 | 8,49 |
AR turnover in days | 44 | 43 |

To answer the question what drove AR in 2005 and 2006 we should look at income statement and
balance sheet. Average growth has a positive reducing trend dropping from 24% in 2005 to 14% in 2006
which is a good sign meaning that Jones is trying to stack his cash meaning he is fully aware of current
shortage of it and inability to fund further companys growth with internal recourses. If we divide AR by
net sales for each year we will see a positive correlation between AR and net sales totalling to 12% each
year starting from 2005. That means on every 12 products Jones company gets 1 unit of AR which is not
bad for a reseller company, however there is a room for improvement in this part to get to 5 10% ratio

and eventually infiltrate balance sheet with more cash so necessary for companys sustained growth.
Looking at Jones AR turnover ration of 8,3 in 2005 and 8,5 in 2006 resulting in average AR collection
period of 44 -43 days accordingly gives us a room for improvement in this part of his business eventually
increasing his cash generation by a lot.
Inventory Analyses
Parameter | 2005 | 2006 |
Inventory growth | 14% | 36% |
Sales/Inventory | 14% | 17% |
Inventory Turnover ratio | 5,53 | 4,75 |
Inventory Turnover in days | 66 | 77 |
Inv. Turn over a year | 6 | 5 |
Turn-Earn Index | 110 | 93 |
GMROI | 1,37 | 1,17 |

Inventory management changed significantly from 2005 to 2006 increasing by 36%, looking at % of sales
bumping up from 14% in 2005 to 17% in 2006. Inventory increase in 2006 is most likely a managerial
decision, as it was stated in the case Jones was very good at demand forecasting and inventory
management allowing him to satisfy demands of the clients with most modest amount of inventory to
keep expense management on a low level. Therefore I believe Jones cashed his inventory predicting a
big sale starting in 2007 which in my opinion didnt happen since we see a modest increase of 18% in Q1
2007 comparing to Q1 2006 in net sales and 25% growth in net income from 4000 in Q1 2005 to 5000 in
Q1 2006. Paying attention to Jones Inventory Turnover ratio which in 2005 was 5,3 and in 2006 was 4,75
which gives an average time to sell his inventory increasing from 66 in 2005 to 75 days in 2006
demanding a high attention to inventory management, this part of his business could be improved since
keeping inventory for such a long time is resulting into unnecessarily high holding costs reducing his cash
as well. Jones Turn-Earn Index is falling down from 110 in 2005 to 93 in 2006 meaning that previously
Jones managed to turn his inventory 6 times a year, but in 2006 only 6 times with gross margin of 20%
(remained the same throughout 2005 and 2006) is a dissatisfying number, best practices are above 170
in turn-earn index. GMROI index shows us that Jones made 1,37$ of 1 dollar invested into inventory in
2005 and 1,17$ in 2006 which distinguish a bad trend however it could be still reasoned by expected
increase in sales volume in 2007 and desire to stock inventory for that.

Question D
When will Jones be able to repay the current line of credit?

We dont know the exact interest on loan but we can estimate it by taking 8% on the Long-Term Debt
payable subtracting the interest expense and dividing the reminder by line credit payable, that gives
approximately 8%.
Therefore, with 8% interest on loan, he would be able to repay his current line of credit in approximately
13 Years. This result has been achieved through this spreadsheet.
Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 |
Value Due | $
$ 159.034 |

250.000 | $ 237.600 | $ 224.208 | $ 209.745 | $ 194.124 | $ 177.254 |

Payment Amount | $
$ 30.000 |

30.000 | $ 30.000 | $ 30.000 | $ 30.000 | $ 30.000 | $ 30.000 |

Interest | 8% | | | | | | |

8 | 9 | 10 | 11 | 12 | 13 | 14 |
$ 139.357 | $ 118.106 | $ 95.154 | $ 70.367 | $ 43.596 | $ 14.684 | -$ 16.542 |
$ 30.000 | $ 30.000 | $ 30.000 | $ 30.000 | $ 30.000 | $ 30.000 | $ 30.000 |

This result is not taking into consideration the additional loan he is seeking. If no major changes affect
Jones Electrical Distribution, this is as soon as he could possibly pay off of his current debt.

Question E
What could Jones do to reduce the size of the line of credit he needs?

For Jones Electrical Distribution to be able to reduce the size of the line of credit he needs to get access
to more money. This can be done in several ways.
Increasing Account Payable: By Increasing the Account Payable, the company gets access to more
money that is not paid to the suppliers, and may utilize the extra capital to make investments. By
increasing the account payable, there is a risk to get a worse relationship with the suppliers, but if the
increase is temporarily, this may be excused.
Decreasing Account Receivable: By lowering the Account Receivables, and thereby demand from buyers
to pay at a faster rate, the company frees capital tied up in the Account Receivables account. With
worse conditions for the buyers there is a risk that they find other sources for their needs, which would
lower the sales.
Selling off Inventory: By selling off Inventory, the capital bound in the excess inventory may be utilized
to lower the line of credit needed.
Other sources of capital: By also selling off Property, Plant & Equipment and perhaps streamline and
tighten up the organisation, the company may also free additional capital resources to lower the line of
credit needed.

Important Ratios |
| 2004 | 2005 | 2006 |
Growth Rates | | | |
Profit Margin | 0.85% | 1.50% | 1.33% |
ROE | 7.5% | 13.5% | 12.3% |
Sustainable Growth Rate | 8.1% | 15.6% | 14.0% |
Internal Growth Rate | 2.4% | 4.5% | 4.0% |
Return on Assets | 2.3% | 4.3% | 3.8% |
Turnovers | | | |
Inventory Turnover | 5.37 | 5.53 | 4.80 |
Asset Turnover | 2.76 | 2.88 | 2.86 |
AP Turnover | 45.5 | 45.6 | 18.8 |
AP Turnover (days) | 7.8 | 7.8 | 18.9 |

Business Measures | | | |
Times Interest Earned | 1.8 | 2.5 | 2.5 |
Acid Test | 1.04 | 0.97 | 0.71 |
Current Ratio | 2.14 | 1.91 | 1.64 |
Equity Multiplyer | 3.20 | 3.12 | 3.23 |
Profit Elasticity of COGS | | | -40 |
Balance Sheet growth Rates |
| 2004 | 2005 | 2006 |
Cash | | 18% | -57% |
Accounts receivable | | 24% | 14% |
Inventory | | 14% | 36% |
Total current assets | | 18% | 19% |
| | | |
Property & equipment | | 8% | 25% |
Accumulated depreciation | | 34% | 35% |
Total PP&E, net | | -9% | 15% |
| | | |
Total assets | | 13% | 18% |
| | | |
Accounts payable | | 18% | 184% |
Line of credit payable | | 44% | 16% |
Accrued expenses | | 5% | 5% |
Long term debt, current portion | | 0% | 0% |
Current liabiliities | | 32% | 39% |
| | | |

Long-term debt | | -13% | -15% |

Total liabilities | | 12% | 20% |
| | | |
Net worth | | 16% | 14% |
Total liabilities and net worth | | 13% | 18% |

Income Statement Growth Rates |

| 2004 | 2005 | 2006 |
Net sales | | 18% | 17% |
Cost of goods sold | | 18% | 16% |
Gross profit on sales | | 19% | 21% |
||||
Operating expense b | | 13% | 13% |
Interest expense | | 11% | 5% |
Net income before taxes | | 109% | 87% |
||||
Provision for income taxes | | 109% | 87% |
Net income | | 109% | 87% |

Balance Sheet as a percentage of Sales |

| 2004 | 2005 | 2006 |
Cash | 3% | 3% | 1% |
Accounts receivable | 12% | 12% | 12% |
Inventory | 15% | 14% | 17% |

Total current assets | 29% | 29% | 30% |

| | | |
Property & equipment | 12% | 11% | 11% |
Accumulated depreciation | -5% | -5% | -6% |
Total PP&E, net | 7% | 5% | 5% |
| | | |
Total assets | 36% | 35% | 35% |
| | | |
Accounts payable | 2% | 2% | 5% |
Line of credit payable | 9% | 11% | 11% |
Accrued expenses | 1% | 1% | 1% |
Long term debt, current portion | 1% | 1% | 1% |
Current liabiliities | 14% | 15% | 18% |
| | | |
Long-term debt | 11% | 8% | 6% |
Total liabilities | 25% | 24% | 24% |
| | | |
Net worth | 11% | 11% | 11% |
Total liabilities and net worth | 36% | 35% | 35% |