Running Head: Global Machinery and Metals Company Inc 1

Global Machinery and Metals Company Inc

Institution Affiliation

Date
GLOBAL MACHINERY AND METALS COMPANY INC 2

Outline the mechanics of letter of credit management in Global Machinery and metals

Company Inc

Examine the Motor City National bank exposure to risk should it accept time drafts from

Global Machinery and metals Company Inc

In Global Machinery and metals Company Inc case what additional collateral should Motor

City National Bank obtain

Introduction

Emphasis must be placed on the idea that a letter of credit is a promise to pay against

specified documents which must accompany any draft drawn against the credit. The draft, bill

of Lading / Airway Bill. Additional Documents signed the commercial invoice. Insurance

documents certificate of origin certificates of analysis weights, purity, sanitation and Packing

list. Also called a bill of exchange (B/E), is the instrument normally used in international trade

to effect payment. The drawee is asked to honor the draft, i.e. to pay the amount requested

according to the stated terms. When the drawee is the bank, the draft is Bank draft. These are

usually drawn according to the terms of a letter of credit.

Sight drafts, payable upon presentation to the drawee; the drawee must pay at once.

Time drafts, also called usance drafts, permits payment delay. It is accepted by the drawee after

the presentation, and by writing or stamping a notice of acceptance on its face. Time drafts

allow the importer 60 to 90 days to pay for the imported goods. By accepting such an

agreement, the issuing bank creates a “banker’s acceptance” which effectively replaces the

importer’s credit with its own.

GLOBAL MACHINERY AND METALS COMPANY INC 3

In the interim period, the issuing bank must hand over the shipping title to the goods

and is exposed to the usual risks of lending on an unsecured basis. Accordingly, the bank may

ask its client to provide additional collateral before accepting time drafts. The Bill of Landing

Is issued by a common carrier transporting the merchandise. It serves purposes, as a receipt

contract document of title. Company may want to hedge against fluctuation in the foreign

exchange market by purchasing forward currency contracts in the currencies of its exporter

The case reviews the mechanics of international letter of credit (L/C) financing.

GMMC is requesting an extension of its credit lines to stock up inventories to meet the

company’s rapid sales growth. This case demonstrates the usefulness of financial ratio analysis

in determining a client’s needs to finance additional sales. GMMC operates as a dealer for new

and used machine tools and also imports finished products from Japan, Spain, and Korea.

Company’s sales in the Metals Division have shown rapid growth in recent years, and the

company now has about 450 customers in the south and southwest. GMC's borrowing

relationship has been established at Motor City National Bank since 1992. Mr. Wayne has

requested the bank’s newly-appointed VP, Mr. David Farmer to increase his firm’s credit

facilities

Existing Lines of Credit

O/D $ 500,000 @ prime + 2%

Secured by A/R (50%)+ Inventory (40%)

Actual rest period: 60 days in 1993

30 days in 1994
GLOBAL MACHINERY AND METALS COMPANY INC 4

0 days in 1995

Minimum balance $ 265M

L/C $ 750,000 @ 1% issuance comm

The New Request

Request for increased credit facilities resulting from the continued rapid expansion of

sales. O/D line from $ 500M to $ 1,000M, $ 700 to finance an increase in the Machine Tools

Department, remaining for the Metals Division. L/C line from $ 750M to $ 1,000M to finance

additional steel inventory to meet the growing demand for the company’s steel imports.

Financial Ratios

1993 1994 1995

Liquidity

Current 1.48 1.29 1.31

Quick 0.66 0.46 0.38

Leverage

Debt/Asset 0.60 0.73 0.73

Interest Coverage 14.77 7.82 10.59

Activity

Inventory days 140 126 192

Average Coll Period 63 66 67

FA Turnover 20x 32x 38x

Profitability

Gross Margin 36% 28% 28%

Profit Margin 7.4% 4% 5.6%

GLOBAL MACHINERY AND METALS COMPANY INC 5

ROA 15.3% 9% 9.4%

ROE 38.9% 29.1% 35.4%

Trade Cycle Analysis

1993 1994 1995

A/R 458 787 972

Inventory 645 1,528 2,480

Trading Asset 1,103 2,315 3,452

Less: A/P 388 746 1,093

Trade Cycle Needs 715 1,569 2,359

Less: Actual NWC 380 544 843

Surplus (deficit) (335) (1,025) (1,516)

Trade Cycle Analysis recognizes that funds are constantly tied-up in Accounts

Receivable and inventory, collectively known as “trading assets.” Accounts Payable provides

a direct source of financing and is therefore subtracted from trading assets to find the

networking capital needs (the amount of networking capital necessary to support the existing

level of sale). These NWC needs are then subtracted from actual NWC to arrive at the trade

cycle surplus or deficit A surplus indicates the company’s NWC is sufficient to support the

existing level of sales. A deficit indicates the company is using some other current liability

(often bank lines) to support this level of sales.

Product Mix Analysis

GLOBAL MACHINERY AND METALS COMPANY INC 6

1993 1994 1995

Sales NI Sales NI Sales Ni

Metals 45% (14%) 73% 66% 79% 73%

Machine 55% 114% 27% 34% 21% 27%

The line of credit increase has been requested primarily to expand the inventory of the

machine tools division, but the product mix table shows that this division’s contribution to the

company’s sales and consequently its earnings have been steadily declining.

Strengths

Price Advantage, GMMC could sell its imported steel products at prices about 20%

less than its competitors who offered U.S. made products. This has allowed the firm’s metals

division to expand its sales volume rapidly.

Diversified Market Base, GMMC has found a niche for its steel products in the south.

It has now about 450 customers. While one customer does account for 10% of the division’s

sales, no other customer purchases more than 3% of its output. Such a diversified clientele

does not allow any customer to gain a monopolistic advantage over GMMC.

Disadvantages

Being an importing business, GMMC is subject to the fluctuations in the supply of its

merchandise due to dock strike or import restrictions. GMMC, therefore, requires its customers

to place their orders at least 60 days in advance, while domestic suppliers only need 4 to 6

weeks to respond to requests. To facilitate a steady supply of its imported products, the

company has been expanding its inventory. The inventory days has consequently increased

from 140 days to 192 days.

GLOBAL MACHINERY AND METALS COMPANY INC 7

In anticipation of voluntary import restrictions, GMMC has requested an increase of $

250M in its L/C line to finance further inventory accumulation. This would enable the company

to offer an uninterrupted supply to its growing market.