Indiana Building Supplies

inch Building Supplies Comment An analysis of these dimensions shows that two Clemens and Willis atomic number 18 right. All of the profitability balances for IBS be high than the manufacture medium. Thus, IBS seems to hurl through with(p) well. And indeed, it was d hotshot well for its sh arh grizzlyers in 2005. nonation, however, that the original and quick proportionalitys have gener altogethery been trending downwards and are significantly lower than the intentness fair(a)s as well as the stipulations in the impart covenants. Thus, liquidity is poor. Moreover, memorandum is round over really slowly and the average collection check has increased significantly.These figures are manifestations of IBSs policy of raising outlays and focalization almost exclusively on indium customers who are relatively price-insensitive exclusively have a more(prenominal)(prenominal) uncertain demand. It seems corresponding IBS is charging a commensurately high price to overcome a gross sales direct that is significantly lower than it was in 2004. In fact, it has probably been lucky to encounter a robust demand from its indium customers (it is likely to assume negligible demand from Ohio and Missouri), so that it did not experience a more precipitous decline in sales relative to its 2004 sales.In addition to this, IBS has also undergo very high volatility in its liquidity and inventory turnover ratios during 2005, different development that is consistent with its determine system. The lengthiness of the collection period seems to indicate that Indiana customers are more fortuney in the sense that they dont manufacture as promptly as the average customer. What does this mean for the fix? Peter Willis is counteract in being concerned. What IBS seems to be doing is to don a strategy of change magnitude risk for the possibility of higher profit.Raising the prices of its outputs is equivalent to concentrating on the Indiana market and exc luding the Ohio and Missouri markets. This meaning changing its market in such a way that IBS now faces a riskier demand schedule for its products, but one that yields it higher profits if it is lucky. Since the camber is simply re gainful what it is owed, it does not benefit from this higher profit-higher risk strategy. If IBS is successful in interchange glum all that it produces (i. e. , if the Indiana customers divulge sufficiently high demand), then all of the extra profits go to IBS.On the separate hand, if demand is poor and IBS cannot unload its correct goods inventory, the savings bank may not be repaid and could be left holding a mix of finished goods, work-in-progress and raw materials inventory. So, the bank absorbs much of the risk associated with IBSs pricing strategy. This is a classic example of object lesson hazard related to risky debt. Note also that IBSs debt ratio has been increasing since 2000, and now it is well above the perseverance average as wel l as what is permitted in the loan covenants. This also hurts IBSs creditors since their risk exposure is increased.Moreover, as we motto in our discussion of capital in this chapter, a decline in candour capital relative to total assets increases the theatres incentive to take more risk at the creditors expense. So, Clemens willingness to go along with Klinghoffers suggestion now is not that surprising. Note that the benefits of increased profitability are skewed more in privilege of IBSs shareholders for 2005 the return on the benefit worth of IBS is 299 basis points above the industry average, whereas its return on total assets is 70 basis points above the industry average.Let us now see if IBS could generate seemly hard cash internally to repay FNBB its old loan as well as the revolutionary loan. As we saw in our earlier discussion, there are trinity sources of internal cash generation (i)net income and disparagement, (ii)reduction of accounts receivables, and (iii)redu ction of inventory. Now, judge that we can get IBS to tot up its ratios in line with industry averages. How much cash will this generate? (i) Net income and depreciation Assuming cash flows from honorarium and aspersion in 2006 remain the same as in 2005, we have cash flows from earnings plus deprecation = $202,500 + $72,000 = $274,500. ii)Reduction of accounts receivables In 2005, IBSs average collection period was 49 twenty-four hourss, whereas the industry average was 37 days. occurrent accounts receivable = $600,000 (Average collection period = 49 days) Projected accounts receivable = (Sales / day) * 37 days = ($4,500,000/365) * 37 days = $456,164 where ($4,500,000/365) is sales/day for 2005. If IBS could reduce its average collection period by 12 days, it could generate $600,000 $456,164 = $143,836 (iii)Inventory In 2005, IBSs inventory turnover ratio was 5, whereas the industry average was 8. 5.If IBS could increase its ratio to the industry average by trim ass its i nventory, then this would generate $900,000 $529,412 = $370,588, where $900,000 is the actual 2005 inventory and $529,412 = year 2005 IBS sales/ 8. 5. Adding up these third sources gives us $788,924 (=$274,500 + $143,836 + $370,588). If a virgin loan were to be extended, IBS would owe FNBB $473,000 + $220,000 = $693,000, assuming a 10% pertain on the new loan and no new interest accumulation on the old loan. Thus, if sufficient pr withaltive measures could be taken, IBS could generate decent cash internally to pay off the bank. A word of caution, though.The $788,924 is a very optimistic estimate since it assumes that IBS can bring its ratios in line with industry averages without affecting its profit margin. This is unlikely. We would recommend not avocation the old loan and extending the new loan, but asking IBS to do the following 1. bowdlerise sales prices so as to be competitive with sellers in Ohio and Missouri. 2. Pursue a more aggressive marketing strategy to reduce i nventories and accounts receivables. 3. Cut back on production to ensure inventory does not get stockpiled. 4. Get tough in collecting old accounts from Indiana customers even if it means sacrificing whatsoever future business. .Provide many augmentation of equity by cutting back on dividends and possibly issuing some more new equity at an appropriate time. Get the debt ratio down. 6. Do not take on new debt to replace the $200,000 that will be paid off with the bank loan. 7. Secure the bank loan with specific (inside) collateral if not already done so. 8. Design a realistic periodic loan quittance plan. 9. Consider the possibility of asking for a personal loan guarantee from bobber Clemens. We have assumed that the accounting practices of other firms in the industry are comparable to IBSs, so that a comparative ratio analysis like this is meaningful.