Colby Wagoner
Oct. 4, 2015
T 7:10-10
Case: Cape Chemical
Case summation
Even though sales has grown to double digits ,Cape Chemical has acquired more debt by acquiring more land, storage space, increasing the size of the work force and expanding capacity. By adding “next day delivery” option , Cape Chemical Inventory cost will increase substantially. The company focuses on expanding by coming up with new ideas such as new product lines. The new lines and new feature will attract customers but in the long run if they are not able to manage cash flow ,the company will soon go bankrupt.
Another problem with their cash flow is being very lenient to the credit policy. Although there is a record of double digit sales growth , it does not mean that Cape Chemical will and has received any cash/payment. The company has also reached its bank-borrowing limit at the end of 2006, and also acquired an additional $3,000,000 in long-term borrowings by borrowing against the company’s fixed assets. An extra $1,000,000 was incurred after asking for a loan extension from the bank in 2007.
The bank has refused to grant additional loans. Stewart continues to focus on just marketing and R&D. She has been attempting to acquire an attractive specialty chemical product line. This line will require a total investment of $4,200,000 in new financing.
Data
The variable costs shows it is stable to sales ; 89% of sales are variable costs. This means that the company operates on low margins. In the last three years, accounts receivables and inventory compared to sales have been rising substantially with a ratio of 0.132 and 0.133 respectively, which means that for every dollar increase in sales, 0.132 and 0.133 dollars must be invested in accounts receivable and inventory.
Still, accounts payable is increasing, with 0.095 for 2007, meaning that Cape Chemical is not covering it’s payment to suppliers. In turn the company is using creditors (account payable) money to finance their operations. One of the key factors of the lack of cash flow in the company, the earnings after taxes of the company is only 1% of the company’s sales which may cause a lot of risk for the company.
High Growth Scenario
With variable cost and working capital requirements remaining the same as the previous year. With sales increasing to 78 million the high growth is .597 and in a high growth situation the inflator equals the growth factor. In this scenario net operating cash flow continues to decrease and Free cash flow decrease also. Similarly without changing the disposition the level of debt rises from around eight million to over 12 million.
So that signifies that the company would have to make a changes and focus on cutting cost. The company has increase their variable cost to 0.91 because of investing in their new venture. Debt is not lowered so it continues to increase along with the added debt. In the forecast the inflator decreases at the end of year 2011 to 0.30.
Low Cost Scenario
In this scenario the company is focusing on cutting cost. The company can reduce its cost by decreasing its variable cost or increasing the price of sales. The company can do this by reducing the wages of production workers or salespeople, raw materials, electric power to run machines, and the cost of maintaining inventory. Instead of supporting a new product line which will need more people to hire to stock and sell these items we can eliminate the new venture for right now in this scenario.
The company can also lower variable cost by lowering shipping cost , transportation etc. The growth and v factor is has now decrease to .3 and .88 (from .91)respectively . The operating cash flow has increased and shows positive cash flow . Likewise free cash flow has increased but is still negative.
Recession Scenario
This scenario does not focus on growth but tries to improve the current condition. If management has perfect foresight of when the recession is coming and of what its effect on sales will be, and if management reacts very well to minimize the damage The company in this scenario refuses the idea of expansion and denies the “next day” delivery option. By doing so they will not have to worry about future added cost.