Indiana Building Supplies

indium Building Supplies Comment An epitome of these symmetrys shows that both Clemens and Willis are right. on the whole of the positiveness ratios for IBS are high(prenominal) than the patience average. Thus, IBS seems to have through well. And indeed, it was done well for its shareh hoarers in 2005. Note, however, that the current and quick ratios have generally been trending down(prenominal) and are significantly lower than the industry averages as well as the stipulations in the loan covenants. Thus, liquidity is poor. Moreover, inventory is turning over rattling slowly and the average collection flow has increased significantly.These figures are manifestations of IBSs policy of raising prices and focusing almost exclusively on inch customers who are relatively price-insensitive but have a more ambiguous demand. It seems like IBS is charging a sufficiently high price to overcome a gross sales level that is significantly lower than it was in 2004. In fact, it has likely been lucky to encounter a robust demand from its Indiana customers (it is comely to assume negligible demand from Ohio and minute), so that it did not experience a more precipitous slide down in sales relative to its 2004 sales.In extension to this, IBS has also experienced very high volatility in its liquidity and inventory turnover ratios during 2005, another development that is consistent with its pricing strategy. The protraction of the collection period seems to indicate that Indiana customers are more waste in the sense that they dont pay as straighta office as the average customer. What does this mean for the commit? Peter Willis is correct in being concerned. What IBS seems to be doing is to adopt a strategy of increasing bump for the possibility of higher profit.Raising the prices of its outputs is equivalent to concentrating on the Indiana market and excluding the Ohio and Missouri markets. This means changing its market in such a way that IBS straightaway faces a riskier demand schedule for its products, but one that yields it higher gelt if it is lucky. Since the coin bank is simply repaid what it is owed, it does not benefit from this higher profit-higher risk strategy. If IBS is successful in selling off all that it produces (i. e. , if the Indiana customers exhibit sufficiently high demand), then all of the extra profits go to IBS.On the other hand, if demand is poor and IBS cannot unload its finished goods inventory, the 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 moral hazard think to risky debt. Note also that IBSs debt ratio has been increasing since 2000, and now it is well above the industry average as well as what is permitted in the loan covenants. This also hurts IBSs creditors since their risk exposure is increased.Moreover, as we saw in our discussion of capital in this chapter, a decline in equity capital relative to total assets increases the firms incentive to take more risk at the creditors expense. So, Clemens willingness to go on with Klinghoffers suggestion now is not that surprising. Note that the benefits of increased profitability are skewed more in favor of IBSs shareholders for 2005 the perish on the net worth of IBS is 299 basis points above the industry average, whereas its fall out on total assets is 70 basis points above the industry average.Let us now see if IBS could generate enough cash intrinsicly to reciprocate FNBB its old loan as well as the naked as a jaybird loan. As we saw in our earlier discussion, there are three sources of internal cash generation (i)net income and depreciation, (ii)reduction of accounts receivables, and (iii)reduction of inventory. Now, suppose that we can get IBS to bring its ratios in line with industry averages. How much cash will this generate? (i) authorise income and depreciation Assuming cash flows from earnings and deprecation in 2006 lodge the same as in 2005, we have cash flows from earnings summation deprecation = $202,500 + $72,000 = $274,500. ii)Reduction of accounts receivables In 2005, IBSs average collection period was 49 long time, whereas the industry average was 37 days. Current 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 reducing its inventory, 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 three sources gives us $788,924 (=$274,500 + $143,836 + $370,588). If a bran-new loan were to be extended, IBS would owe FNBB $473,000 + $220,000 = $693,000, assuming a 10% interest on the new loan and no new interest accumulation on the old loan. Thus, if sufficient preventive measures could be taken, IBS could generate enough cash internally to pay off the bank. A word of caution, though.The $788,924 is a very upbeat 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 calling the old loan and extending the new loan, but asking IBS to do the following 1. Reduce sales prices so as to be competitive with sellers in Ohio and Missouri. 2. Pursue a more aggressive marketing strategy to reduce inventories and accounts receivables. 3. Cut back on production to ensure inventory does not get stockpiled. 4. Get heavy in collecting old accounts from Indiana customers even if it means sacrificing near future business. .Provide some 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 refund plan. 9. Consider the possibility of asking for a personal loan plight from Bob 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.