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Financial Management

INTRODUCTION
Silver River Manufacturing Company (SRM) owned by Greg White is a large regional
producer of farm and utility trailers, specialized live stock carriers and mobile home chassis.
It depends on farmers for roughly 45 to 50 percent of its total sales. More than 85% of its
sales come from the southeastern part of US. Several major boat companies in Florida work
closely with SRM in designing trailers for their new offerings. The products manufactured by
SRM are not subject to technological obsolesces or to deterioration and in those instances
where technology is to be considered, SRM holds several patents with which it can partially
offset some of the risk.
In the decade prior to 2003, SRM had experienced high and relatively steady growth in sales,
assets and profits. Toward the end of 2003, the demand for new field trailers in the citrus and
vegetable industries started to fall off. The recession that had been plaguing the nations farm
economy and disastrous freezes for two straight winters resulted in high curtailment of
demand for grove retailer and citrus transport carriers; SRM was not immune to this. Though
SRM had shown high and steady growth in sales, assets and profits prior to 2003, however,
towards the end of 2003 the demand for new field trailers in citrus and vegetable industries
started for fall off. In order to sustain profits and superior market performance Mr. White
aggressively reduced prices to stimulate further sales. He had full confidence that national
economic policies would revive the ailing farm sector so; the downturn in demand would be
short-term. Consequently, production continued unabated and inventories started increasing.
Mr. Whites next step was to relax credit terms and standard to maintain preciously high
growth and to reduce the ever expanding inventory. This effort of Mr. White increased sales
through the third quarter of 2005, but inventories also increased steadily and particularly
short-term credits and accounts receivable grew up dramatically.
Hence, to finance these increase in assets, SRM turned to Marion Country National Bank,
(MCNB) for long term loan in 2004 and increase in its short term credit loan in both 2004
and 2005. MCNB had been a major banker of SRM for a long time. In the start, Lesa Nix, the
vice-president of MCNB, had handled the case of SRM. Later, she got promoted and was no
longer responsible for handling SRMs account. However, as Mr. White was a close friend,
she still took keen interest on SRM. Even this was insufficient to cover the aggressive
expansion on the asset side. Consequently, Greg White who always made prompt payments,
started to delay payments. This resulted substantial increase in accounts payable and other
short term loans.
Upon analyzing SRMs financial conditions, Lesa Nix found that the banks computer
analysis system revealed a number of significant adverse trends and highlighted several
potentially serious problems. Its 2005 current, quick and debt ratios failed to meet the
contractual limits of 2, 1.0 and 55percent respectively. Technically, the bank had a legal right
to call for immediate repayment of both long and short-term loans, and, if they were not
repaid within ten days, could force the company into bankruptcy.
Despite such adverse conditions Nix considered the company to have good long run
prospects, assuming, of course that management reacted immediately and appropriately to the
current situation. Hence, Nix looked upon the threat of accelerating the loan repayment
primarily as a means to get Greg Whites undivided attention and to force him to think about
corrective actions that must be taken at once to reverse the deterioration and to correct SRMs
near-term problems. Even though she hoped to avoid calling the loans if at all possible
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Financial Management
because that action would back SRM into a corner from which it might not be able to emerge
intact, Nix realized that the banks examiners, due to the recent spate of bank failures, were
very sensitive to the issue of problem loans. SRMs Altman Z factor (2.88) for 2005 was
below 2.99 which indicated that SRM was likely to get bankrupt in two years. Because of this
deficiency, MCNB was under increased pressure from the regulators to reclassify SRMs loan
as problem category and take whatever steps needed to collect the money due and reduce
the banks exposure as quickly as practicable. In order to avoid reclassification, SRM
required strong and convincing evidence to prove that its problems were temporary in nature
and it had good chance of reversing the trend.
The current financial problems were not the only problem Mr. White faced. He had recently
signed a contract for a plant expansion that would require another $6375000 of the capital
during the first quarter of 2006. He had planned to obtain this money by a short term loan
from MCNB to be repaid from the profit generated in the first quarter of 2006. He believed
that new facilities would enhance the production capabilities in a very lucrative area of
custom horse van.
According to Mr. Whites analysis, the financial position of the company could improve
significantly over the next two years if the bank maintained or even extended the credit lines.
Once the new facility is added, the company would be able to increase output in rapidly
growing segments of market (horse van and home chain) and also reduce the dependency on
farm and light utility sales to 35% or less. He also projected that the sales growth would be
6% and 9.5% in an average for 2006 and 2007 respectively, assuming there is no significant
improvement in either national or farm economy. He also assumed that SRM would change
its policy of aggressive marketing and sales promotion and return to full margin prices,
standard industry credit term and tighter credit standards. These changes would reduce cost of
goods sold to 82.5% in 2006 and 80% in 2007. Similarly administrative and selling expenses
are likely to decrease from 9% to 8% in 2006 and 7.5% in 2007. Also, the miscellaneous
expense would reduce to 1.75% and 1.25% of sales in 2006 and 2007 respectively.
Regarding the financial data provided in the case and the projected income statement and
balance sheet, we have to analyze whether SRM is eligible to obtain the bank loan. Now, the
question is whether the bank should extend the existing short and long-term loans or should
rather demand immediate repayment of both existing loans. Also we have to propose
alternatives available to SRM if the bank were to decide to withdraw the entire line of credit
and to demand immediate repayment of the two existing loans.
In support of the answers provided to the questions, we have included the key financial
statements and financial ratios of SRM.

Financial Management
Question 1
(a) Prepare a statement of changes in financial position for 2005 (sources and uses of funds
statement) or complete Table 6.
Solution:
Table 6: Silver River Manufacturing Company
Statement of Changes in Financial Position Year Ended December 31st(thousands of dollars)
Particulars
2004
2005
Sources of funds
Net income after taxes
6,351.70
755.02
Depreciation
1,657.50
2040
Funds from operation
8,009.20
2795.02
Long term loan
3,187.50
0
Net decrease in working capital
428.26
Total sources
11,196.70
3223.26
Application of funds
Mortgage change
Fixed assets change
Dividends on stock
Net increase in working capital
Total uses
Analysis of changes in working capital
Increase (decrease) in current assets
Cash change
AR change
INV change
CA change
Increase(decrease) in current liabilities
AP change
NP change
ACC change
CL change
Net increase(decrease) in working capital

267.75
2,339.62
1,587.93
7,001.40
11,196.70

261.38
2773.13
188.76
0
3223.27

-1,145.83
1,364.25
14,095.12
14,313.54

-9671
10894.86
13629.75
24427.9

3,742.13
1,912.50
1,657.50
7,312.13
7,001.41

9492.38
13132.5
2231.28
24856.16
-428.26

The table shows the sources and uses of fund of Silver Manufacturing Company. The major
sources of fund are net income after tax, depreciation, long term loan and net decrease in
working capital. The major applications of fund are changes in fixed assets, mortgages,
dividend on stock and net increase in working capital.
As long as there are more short term assets than liabilities, the firm is said to be in a relatively
liquid position. From the analysis of change in working capital, the company is in a relatively
liquid position in 2004 but the current assets are less than current liabilities in the year 2005
showing that it is not relatively liquid. Hence the company cannot pay off all of its short term
obligations without having to liquidate any long term assets in 2005.
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Financial Management

Particulars
Sources of funds
Net income after taxes
Depreciation
Funds from operation
Long term loan
Net decrease in working
capital
Total sources
Application of funds
Mortgage change
Fixed assets change
Dividends on stock
Net increase in working
capital

2004

2005
(Calculated)

Difference

6,351.70
1,657.50
8,009.20
3,187.50

755.02
2040
2795.02
0

11,196.70

428.26
3223.26

Given
Given
755.02+2040
9562.50-9562.50
CA change CL
change
2795.02+428.26

267.75
2,339.62
1,587.93

261.38
2773.13
188.76

2601-2339.62
20100.37-22873.5
Given

7,001.40

Total uses
Analysis of changes in
working capital
Increase (decrease) in
current assets
Cash change
AR change
INV change

11,196.70

3223.27

-1,145.83
1,364.25
14,095.12

-96.71
10894.86
13629.75

CA change

14,313.54

24427.9

Increase(decrease) in
current liabilities
AP change
NP change
ACC change
CL change

3,742.13
1,912.50
1,657.50
7,312.13

9492.38
13132.5
2231.28
24856.16

Net increase(decrease) in
working capital

7,001.41

-428.26

261.38+2773.13+1
88.76

3905.77-4002.48
29356.86-18462.00
46658.62-33028.87
96.71+10894.86+1
3629.75

19998.39-10506.01
18232.50-5100.00
7331.28-5100
45562.17-20706.01
CA change CL
change
24427.9 - 24856.16

Financial Management

Table 7: Silver River Manufacturing Company


Ratio Analysis Year Ended December 31
Particulars

2003

2004

2005

Industry
Average

Liquidity ratios
Current ratio
Quick ratio

3.07
1.66

2.68
1.08

1.75
0.73

2.50
1.00

Leverage ratios
Debt ratio(%)
Times interest earned

40.46
15.89

46.33
7.97

59.796
1.49

50.00
7.70

Asset management ratios


Inventory turnover(cost)
Inventory turnover(selling)
Fixed assets turnover
Total asset turnover
Average collection period

7.14
9.03
11.58
3.06
36.00

4.55
5.59
11.95
2.60
35.99

3.57
4.19
12.097
2.04
53.99

5.70
7.00
12.00
3.00
32.00

Profitability ratios
Profit margin(%)
Gross profit margin(%)
Return on total assets
Return on owner's equity

5.50
20.89
16.83
28.26

3.44
18.70
8.95
16.68

0.386
14.86
0.786
1.95

2.90
18.00
8.80
17.50

6.69

4.75

2.88

1.89/2.99

Potential failure indicator


Altman Z factor

Notes:
a) Uses cost of goods sold as the numerator.
b) Uses net sales as the numerator.
c) The Altman Z factor range of 1.81-2.99 represents the so-called zone of ignorance".
d) Year-end balance sheet values were used throughout in the computation of rations
embodying balance sheet items
e) Assume constant industry-average ratios throughout the period 2003-2007.

Financial Management

(b) Calculate SRMs key financial ratios for 2005 and compare them with those of 2003,
2004, industry average, and contract requirement or complete Table 7.
Solution:
Liquidity Ratios:
Current Ratio
Current Ratio
3.5
3

Ratio

2.5
2

Current Ratio
Industry Average

1.5
1
0.5
0
2003

2004

2005

Years

The Current ratio has decreased in 2005 as compared to 2003, 2004 and industry average.
The companys ability to fulfill short term obligations with current assets has decreased.
Quick Ratio

Financial Management

The quick ratio is also showing declining trend. The Company is showing less liquidity in
2005 as the ratio is less than that of the years 2003, 2004 and industry average.
Leverage Ratios:
Debt Ratio

The debt ratio of the company is in increasing trend showing that it is becoming riskier. The
company has been able to finance about more than half of its assets by borrowing in 2005. In
2005, its debt ratio surpassed the industry average by 9.796%.
Times Interest Earned Ratio

It is better to have a higher times interest earned ratio. The industry average is 7.70. The ratio
is more in the years 2003 and 2004 as compared to 2005. The ratio has drastically gone down
to 1.49 in 2005 and is less than the industry average showing its inability to cover the
necessary interest expenses.

Financial Management
Asset Management Ratios:
Inventory Turnover Ratio (Cost)

Inventory Turnover Ratio (Selling)

The company has not been efficient in managing its inventories in 2005 with respect to 2003
and 2004 as the inventory turnover ratio is less in the year. In both cases, when inventory
turnover ratio is calculated based on cost of goods sold and net sales, the ratio is less than the
industry average in 2005.

Financial Management
Fixed Asset Turnover Ratio

The fixed asset turnover ratio is greater than the industry average in 2005. The ratio in 2005
is also higher than the ratios in 2003 and 2004. The number of times the fixed assets are
turned over 2005 is higher.
Total Assets Turnover Ratio

The number of times the total assets have turned over has decreased from 2003. The ratio has
slightly declined from 2004 and is less than the industry average.

Financial Management
Average Collection Period

The number of days tied up in accounts receivables has increased in 2005. The collection
period is less in 2003 and 2004. Also, the industry average is lower. The company is not able
to appraise accounts receivables in a timely manner.
Profitability Ratios
Net Profit Margin

The profit margin is expected to be higher for the company to earn profit. However, the
company is facing constant decrease in profit margin since the percentage is less in 2005 than
in 2003 and 2004. The industry average is also more than the margin obtained in 2005.

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Financial Management
Gross Profit Margin

The companys gross profit has decreased 2005 as compared to 2003 and 2004. The gross
profit margin of 2005 is also less than the industry average which shows the less proportion
of sales revenues going towards paying for cost of goods sold.
Return on Total Assets

The Return on total assets shows the return on total assets after interest and taxes. The
operating management is inefficient in 2005 as the return is less as compared to the returns in
the year 2003 and 2004. Also this return is less than the required industry average.

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Financial Management
Return on Owners Equity

The efficiency of the company with respect to its operating and financing decisions is based
on the return on owners equity. The company is also inefficient in this regard as the return is
lower than the returns in 2003 and 2004 as well as the industry average.
Potential Failure Indicator
Altman Z factor
The Altman Z factor indicates that the company falls in the gray zone which shows that there
is no possibility of predicting whether the firm will or will not fail. The firm is in less safe
zone as compared to the Altman Z factor given in 2003 and 2004.
Comparison of SRMs 2005 ratios with the contractual requirements
Particulars

Contractual requirement SRM 2005

Current Ratio 2.0%

1.75%

Quick Ratio

1.0%

0.73%

Debt Ratio

55%

59.796%

The 2005 current, quick and debt ratios are below the contractual limits. From the calculation
of the ratios above, the company is facing serious problems. All the ratios show negative
trend apart from the fixed asset turnover ratio. The liquidity ratios are decreasing showing
that the company is not able to meet its short term obligations with its current assets. The
company is facing higher risks as the company is has financed its assets with higher
borrowed funds. All the asset management ratios apart from fixed asset turnover ratios are
decreasing. This shows the firm is not effectively utilizing its assets to generate sales.
Profitability ratios are used as overall measures of the efficiency and effectiveness of a firms
management. The company is facing decreased profitability ratios over the years. Also the
Altman z factor shows that the company has moved from non failure zone to gray zone.

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Financial Management

Working notes of Table 7


Particulars

Formula

Computation

Current ratio

Current assets /
current liabilities

79,921.26 / 45,462.17

1.75

(79,921.26 - 46,658.62) /
45,562.17

0.73

Debt ratio
Times interest earned

(Current assets inventories) / Current


liabilities
Total debt / Total
asset
EBIT / Interest

Inventory turnover(cost)

COGS / Inventory

166,642.58 / 46,658.62

3.57

Inventory turnover(selling)

Sales / Inventory

195,731.63 / 46,658.62

4.19

Fixed assets turnover

Sales / Fixed asset

195,731.63 / 16,179.75

12.097

Total asset turnover

Sales / Total asset

195,731.63 / 96,101.01

2.04

Average collection period

Receivables / Sales
per day

29,356.86 / (195,731.63 /
360)

53.99

Profit margin (%)

(Net income / Sales)


* 100

(755.02 / 195,731.63)*100

0.386

Gross profit margin (%)

(Gross profit / Sales)


* 100

(29,089.05 /
195,731.63)*100

14.86

Return on total assets

(Net income / Total


asset) * 100

(755.02 / 96,101.01)*100

0.786

Return on owner's equity

(Net income / Total


equity) * 100

(755.02 / 38,636.72)*100

1.95

Quick ratio

57,464.29 / 96,101.01
4,443.25 / 2,991.4

59.796
1.49

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Financial Management
Question 2.
Based on the case data and the results of your analysis in Question 1, what are the SRMs
strengths and weaknesses? What are the causes thereof? (Use of the DU Pont system and
Altman Z factor would facilitate analysis and strengthen your answer.)
Solution:
DU Pont System:
Particulars Return
Equity
(ROE)
2003
2004
2005
Industry
Average

28.26
16.68
1.95
17.50

on = Net
margin

Profit Asset Turnover

= Net Income
Sales
=
5.50
=
3.44
=
0.39
=
2.90

Sales______
Total Assets

3.06

2.66

2.04

3.00

Equity
Multiplier
Asset
Equity

1.68

1.86

2.49

2.00

DU Pont System:
Du Pont system decomposes ROE into its component parts. This decomposition helps us to
find out exactly where the strengths and weaknesses lie. Management can use this system to
analyze ways of improving the firms performance.
If ROE goes up due to an increase in net profit margin or asset turnover, it is beneficial for
the company because it shows the operating efficiency and asset use efficiency. But if the
equity multiplier is the source, it means that company is taking excessive debt and making it
very risky.
Altman Z factor
The Z-Score Bankruptcy-Predictor combines several of the most significant variables in a
statistically derived combination.
Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 0.999X5
Where,
X1 = working capital / total assets (working capital is current assets less current liabilities)
X2 = retained earnings / total assets
X3 = earnings before interest and taxes / total assets
X4 = market value of equity / book value of total debt (market value of equity includes both
preferred and common shares, and debt includes current and long-term liabilities)
X5 = sales / total assets
Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 0.999X5
We have, for the year 2005,
Working capital = Current assets Current liabilities
= $ (79921.26 45562.17) = $ 34359.09
Total Assets = $ 96101.01
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Financial Management
Retained Earnings = $ 15367.72
EBIT = $ 4443.25
Market value of equity = $ 3500.54
Book value of debt (Total Liability) = $ 57464.29
Sales = $ 195731.63
Altman Z factor = 1.2Working capital + 1.4Retained earnings + 3.3EBIT
Total Assets
Total Assets
Total Assets
+ 0.6Market value of equity + 0.999Sales
Book Value of debt
Total Assets
= 1.2 34359.09
+ 1.4 15367.72 + 3.3 4443.25 +
96101.01
96101.01
96101.01
0. 6 3500.54
+ 0.999 195731.63
57464.29
96101.01
= 1.2 0.357531 + 1.4 0.159912 + 3.3 0.046235 + 0.6 0.060917
+ 0.999 2.036728
= 2.88
SRMs Altman Z Score = 2.88
Industry Average
= 1.81 - 2.99
The Interpretation of Altman Z-Score:
Altman provides multivariate analysis of bankruptcy utilizing financial ratios. It allows
combining several financial ratios into a single predictive equation.
Z score below 1.8: High probability of failure
Z score above 3.0: High probability of non failure
Z score between 1.8 and 3.00: hard to predict with confidence whether the firm will or will
not fail. This range is also known as gray zone
Strengths
1. Favorable fixed asset turnover ratio: The fixed asset turnover ratio is increasing in
2005. The number of times that SRM has been able to turn its fixed assets is high.
This shows that the fixed assets are used effectively.
2. Altman Z score: SRMs Altman Z score is compatible with the industry average (i.e.
2.88 against the industry average of 1.81/2.99). Even though, the factor is compatible
with the industry average, it is not a good sign for the company. The company falls
under gray zone and needs to be more careful about going bankrupt.
Weaknesses
1. Declining profitability ratios: All the profitability ratios are in declining trend in
2005. The net profit margin has drastically reduced from 2003 to 2005 and is less than
the industry average in 2005. From Du Pont analysis, it can be seen that the net profit
margin is below the industry average of 2.90 reflecting the operating inefficiency.
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Financial Management

2. Inefficiency in major asset management ratios: The major asset management ratios
are showing declining trend from 2003 to 2005. The Du Pont analysis also shows that
the asset turnover ratio has decreased from 3.06 in 2003 to 2.04 in 2005. The industry
average is 3. The assets have not been efficiently utilized to generate sales.
3. Deteriorating financial leverage: The Company has financed about more than half
of its assets by borrowing as can be seen from the debt ratio in 2005. The Du Pont
analysis also show that the equity multiplier is higher in 2005 as compared to 2003,
2004 and industry average. This reflects that SRM is using more debt to finance its
assets than its competitors. This indicates that the company has high chances of being
bankrupt.
4. Liquidity position: The Company is not in a relatively liquid position. The company
has fewer current assets than the current liabilities thereby showing negative net
working capital. The current ratio and quick ratio also reflect the less liquid position
of SRM.

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Financial Management
Question 3.
If the bank were to maintain the present credit lines and grant an additional $6,375,000 shortterm loan at a 16 percent rate of interest effective from January 1, 2006, would the company
be able to retire all short-term loans existing on December 31, 2006? (Assume that all of
Whites plans and predictions concerning sales and expenses materialize. In these
calculations cash is the residual balancing figure, and SRMs tax rate is 48%. Assume that
SRM pays no cash dividends during the year.) Complete tables 9 and 10 included as
worksheets to facilitate analysis.
Solution:
Table 9: Silver River Manufacturing Company
Pro Forma Income Statements (Projected)
Worksheet for Year End 2007 (Thousands of Dollars)
Particulars
2005 2006 Projected
2007 Projected
Net sales
1,95,731.63
207475.5278
227185.7029
Cost of goods sold
1,66,642.58
171167.3104
181748.5624
Gross profit
29,089.05
36308.21737
45437.14059
Administrative and selling
16,880.96
16598.04222
17038.92772
Depreciation
2,040.00
2,422.50
1,823.00
Miscellaneous expenses
5,724.72
3630.821737
2839.821287
Total operating expenses
24,645.68
22651.36396
21701.74901
EBIT
4,443.25
13656.8534
23735.39158
Interest on short-term loans
1,823.25
3,937.20
3,937.20
Interest on long-term loans
956.25
956.25
956.25
Interest on mortgage
211.90
190.54
171.52
Net income before tax
1,451.94
8,572.86
18,670.42
Taxes
696.94
4114.974434
8961.802359
Net income
755.02
4,457.89
9,708.62
Dividends on stock
188.76
0
0
Additions to retained earnings
566.27
4,457.89
9,708.62

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Financial Management
Table 10: Silver River Manufacturing Company
Pro Forma Balance sheets (Projected)
Worksheet for Year End 2007 (Thousands of Dollars)
Particulars
2005
2006 Projected 2007 Projected
Assets
Cash
Accounts receivable
Inventory
Current assets
Land, buildings, plant, and equipment
Accumulated Depreciation
Net fixed assets
Total assets
Liabilities and equities
Short-term bank loans
Accounts payable
Accruals
Current liabilities
Long-term bank loans
Mortgage
Long-term debt
Total liabilities
Common stock
Retained earnings
Owners' equity
Total capital

3,905.77
29,356.86
46,658.62
79,921.26
22,873.50
-6,693.75
16,179.75
96,101.01

36,450.24
18,442.27
29,639.36
84,531.87
29,248.50
-9,116.25
20,132.25
1,04,664.12

45,451.62
20,194.28
32,455.10
98,101.00
30,125.96
-10,939.20
19,186.76
1,17,287.76

18,232.50
19,998.39
7,331.28
45,562.17
9,562.50
2,339.62
11,902.12
57,464.29
23,269.00
15,367.72
38,636.72
96,101.01

24,607.50
15,994.88
9,301.13
49,903.51
9,562.50
2,103.75
11,666.25
61,569.76
23,268.75
19,825.610
43,094.36
1,04,664.12

24,607.50
16,794.62
11,626.41
53,028.53
9,562.50
1,893.75
11,456.25
64,484.78
23,268.75
29,534.23
52,802.98
1,17,287.76

Working notes of Table 9:


Particulars
Projected sales

2006

2007

195,731.63 * 1.06
82.5% of
207,475.52

2,07,475.52

16,598.04

Miscellaneous expenses

8% of 207,475.52
1.75% of
207,475.52

Taxes

48% of 8,572.87

4,114.97

Cost of goods sold


Administrative and selling
expenses

1,71,167.31

3,630.82

207475.52 *
1.095
80% of
227,185.7
7.5% of
227,185.7
1.25% of
227,185.7
48% of
18,670.42

2,27,185.70
1,81,748.56
17,038.93
2,839.82
8,961.80

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Financial Management
Working of Table 10:
1.

Retained Earnings

For 2006: Retained earnings (2005) + Additions in 2006


i.e. 15,367.72 + 4,457.89 = 19,825.61
For 2007: Retained earnings (2006) + Additions in 2007
i.e. 19,825.61 + 9,708.62 = 29,534.23
2. Accounts Receivables
For 2006: Average collection period = Receivables / Sales per day
i.e.
32
= Receivables / (207,475.53 / 360)
Therefore, receivables = 18,442.27
For 2007: Average collection period = Receivables / Sales per day
i.e.
32
= Receivables / (227,185.71 / 360)
Therefore, receivables = 20,194.28
3. Inventory
For 2006: Inventory turnover = Sales / Inventory
i.e.
7
= 207,475.53 / Inventory
Therefore, inventory = 29,639.36
For 2007: Inventory turnover = Sales / Inventory
i.e.
7
= 227,185.71 / Inventory
Therefore, inventory = 32,455.10
Notes:
1. Cash is the balancing figure.
2. Accounts receivables and inventory has been calculated by using the industry average
ratios.
In 2006, the company has total cash balance of 36,450.24 thousands and during the same
year the short-term bank loan to be retired is 24607.50.
= $(36450240 24607500)
= $11842740
The company should maintain cash balance of 5% of sales.
Minimum cash balance = $ (207475527 * 0.05)
= $ 10373776.35
From the calculation we can see that the company is able to maintain the minimum cash
balance. Hence, it has enough cash balance to retire the short-term bank loans.

19

Financial Management
Question 4.
Compute projected financial ratios for 2006 and 2007 (or complete Table 11). Compare these
ratios with 2005 along with industry averages and analyze improvement or deterioration in
financial condition.
Solution:
Table 11: Silver River Manufacturing Company
Ratio Analysis Year Ended December 31, 2007 (Projected)
2006
2007
Particulars
2005
Projected
Projected
Liquidity ratios
Current ratio
1.754
1.69
1.85
Quick ratio
0.73
1.10
1.24

Industry
average
2.50
1.00

Leverage ratios
Debt ratio (%)
Times interest earned

59.79
1.48

58.83
2.69

54.98
4.69

50.00
7.70

Asset management ratios


Inventory turnover (Cost)*
Inventory turnover (Selling)*
Fixed asset turnover
Total asset turnover
Average collection period

3.57
4.19
12.09
2.04
53.99

5.77
7.00
10.30
1.98
32.00

5.60
7.00
11.84
1.94
32.00

5.70
7.00
12.00
3.00
32.00

Profitability ratios
Profit margin (%)
Gross profit margin (%)
Return on total assets
Return on owners' equity

0.39
14.86
0.79
1.95

2.15
17.50
4.26
10.34

4.27
20.00
8.28
18.39

2.90
18.00
8.80
17.50

Working notes of Table 11:


Particulars

Formula

Current ratio

Current assets /
current liabilities

Quick ratio

(Current assets inventories) / Current


liabilities

(84,531.87 - 29,639.36)
/ 49,903.51

Debt ratio

Total debt / Total asset

61,569.76 / 104,664.12

58.8 64,484.78 /
3 117,287.76

54.98

Times interest
earned

EBIT / Interest

13,656.86 / 5,083.99

23,735.39 /
2.69 5,064.97

4.69

Inventory
turnover(cost)

COGS / Inventory

171,167.31 / 29,639.36

181,748.56
5.77 / 32,455.10

5.6

2006
84,531.87 / 49,903.51

2007
98,101 /
1.69 53,028.53
(98,101 32,455.10) /
1.1 53,028.53

1.85

1.24

20

Financial Management
Inventory
turnover(selling)

Sales / Inventory

207,475.53 / 29,639.36

227,185.70
7 / 32,455.10

Fixed assets
turnover

Sales / Fixed asset

207475.53 / 20,132.25

227,185.70
10.3 / 19,186.76

11.84

Total asset turnover

Sales / Total asset

207475.53 / 104,664.12

227,185.70
1.98 / 117,287.76

1.94

20,194.28 /
(227,185.70
32 / 360)

32

Average collection
period

Receivables / Sales
per day

18,442.27 /
(207,475.53 / 360)

Profit margin (%)

(Net income / Sales) *


100

(4,457.89 /
207,475.53)*100

(9,708.62 /
227,185.70)
2.15 *100

4.27

Gross profit margin


(%)

(Gross profit / Sales)


* 100

(36,308.22 /
207,475.53)*100

(45,437.14 /
227,185.70)
17.5 *100

20

Return on total
assets

(Net income / Total


asset) * 100

(4,457.89 /
104,664.12)*100

(9,708.62 /
227,185.70)
4.26 *100

8.28

(4,457.89 /
43,094.36)*100

(9,708.62 /
10.3 52,802.98)*
4 100

18.39

Return on owner's
equity

(Net income / Total


equity) * 100

Notes: Figures for 2005 have been taken from table 7.


Current Ratio
3
2.5
Ratio

Projected

1.5

Revised
Industry Average

1
0.5
0
2005

2006

2007

Years

In 2006, the projected current ratio is lower than that of 2005 and Industry average. This
shows that the firms ability to meet its short term obligations has decreased in the year 2006.
In 2007, the projected current ratio is slightly higher than that of 2005 and lower than the
industry average. This shows that the firms ability to meet short term obligations has
improved but it is still poor in comparison to industry average.

21

Financial Management

Quick Ratio
1.6
1.4

Ratio

1.2
1

Projected

0.8

Revised

0.6

Industry Average

0.4
0.2
0
2005

2006

2007

Years

In 2006, the projected quick ratio is higher than that of 2005 and industry average. This
shows that the ability of firm to meet short term obligations has improved. In 2007, the
projected quick ratio is much higher than that of 2005 and industry average. This shows that
the firm has substantially improved its ability to meet the short term obligations.
Debt Ratio
70
60

Ratio

50

Projected

40

Revised

30

Industry Average

20
10
0
2005

2006

2007

Years

In 2006, the projected debt ratio is lower than that of 2005 and much higher than the industry
average. This shows that the company has decreased its assets financing from debts but it is
much higher in comparison to industry average. In 2007, the projected debt ratio has
decreased than that of 2005 and higher than the industrial average. The improved debt ratio
indicates that the company has lowered its risk level.

22

Financial Management

It is better to have a higher times interest earned ratio. The industry average is 7.70. In 2006
the ratio has increased than 2005 and is significantly lower than the industry average. This
shows that the company is still unable to cover the necessary interest expenses. In 2007, the
ratio has gone up but is still below the industrial average showing improvement in ability of
the company to cover the necessary interest expenses.
Inventory Turnover
7
6

Ratio

Projected

Revised

Industry Average

2
1
0
2005

2006

2007

Years

23

Financial Management

Inventory Turnover
8
7

Ratio

6
5

Projected

Revised

Industry Average

2
1
0
2005

2006

2007

Years

Higher inventory turnover ratio indicates efficient management of inventories. In 2006, there
has been increase in inventory turnover ratio (in costs) in comparison to 2005 and is also
above the industry average. In 2007, this ratio is higher than that of 2005 but is below the
industry average showing deterioration in the companys capacity in efficiently managing the
inventory. If we evaluate the inventory turnover in terms of sales we see in both the years
2006 and 2007 there have been significant improvement in inventory turnover in comparison
to the year 2005 and both the years have inventory turnover equal to that of industry average.
However, a better measure of inventory turnover is inventory turnover in terms of cost rather
than in terms of sales.

Fixed assets turnover ratio shows how efficiently the firm is utilizing fixed assets to generate
the largest possible level of sales revenues. The utilization of fixed assets seems to be less
efficient in the year 2006, in comparison to that of the year 2005 and industry average.
However, there is some progress in utilization of fixed assets in the year 2007 but it is still
below in comparison to 2005 and industry average. This shows the deterioration in the
capacity of the company to efficiently utilize fixed assets to generate revenue.

24

Financial Management

Total assets turnover shows how efficiently the overall assets of the company are utilized to
generate sales revenues. The total assets turnover ratios in the year 2006 and 2007 are lower
in comparison to the year 2005 and industry average. This ratio in the year 2005, 2006 and
2007 shows the decreasing trend. The company has not been able to match this ratio with
industrial average in all three years i.e. in all these cases the ratio is below the industry
average. Thus, the capacity of the company to utilize its overall assets efficiently is in
decreasing trend.

Average collection period (ACP) shows the number of days sales that are tied up in the
receivables. Lower ACP frees up funds, which can be invested somewhere else and earn
some return. In both the year 2006 and 2007 ACP is equal to industry average. The firm is
projected to have significant improvement in ACP in comparison to the year 2005. The
decreased ACP has improved the financial condition.

25

Financial Management

Profit margin ratio measures the overall efficiency and effectiveness of the companys
management. It shows how much a company is able to earn of each sales after paying all the
necessary expenses. In 2006, the projected profit margin has improved in comparison to the
year 2005 but is still below the industry average. However, in the year 2007 the projected
profit margin has improved significantly and is higher than industry average. This shows that
there will be considerable improvement in financial condition of the company in the year
2007.

Gross profit margin shows the proportion of firms sales revenue going toward paying for
cost of goods sold. In the year 2006 and 2007 the projected gross profit margin has increased
in comparison to the year 2005. In the year 2006 it is below industry average but in 2007 it is
above industry average showing the improvement in financial condition

26

Financial Management

Return of total assets (ROA) measures the return on total assets after interest and taxes. It is
important for assessing the effectiveness of the operating management of the firm. This ratio
has increased in the year 2006 and 2007 in comparison to the year 2005 but is still below the
industry average showing the necessity for the company to bring improvement in the
operating management.
Return On Owners' Equity
25

Ratio

20
Projected

15

Revised
10

Industry Average

5
0
2005

2006

2007

Years

Return on owners equity helps to assess the effectiveness of the management with respect to
both its operating and financial decisions. In the year 2006, there has been great improvement
in ROE in comparison to the year 2005 but is still below the industry average. However, in
2007 it is above the industry average showing the improvement in both operating and
financial decisions of the company.

27

Financial Management
Question 5.
If all short-term bank loans are repaid towards the end of the first half of 2006, do you think
that company is still able to pay regular dividends and maintain minimum cash balance?
Revise the tables 9, 10, 11 (or complete the tables 12, 13 and 14). Do you find any situations
developing that may indicate poor financial policy? What should be the impact of such
situations on the ratios for the company, and are such impacts necessarily either good or bad?
Why?
Solution:
Note: The figures for the revised data are shown in question no 4.
Table 12: Silver River Manufacturing Company
Pro Forma Income Statements (Revised)
Worksheet for Year End 2007 (Thousands of Dollars)
Particulars
Net Sales
Cost of Goods Sold
Gross Profit
Administrative and Selling
Depreciation
Miscellaneous expenses
Total operating expenses
EBIT
Interest on short-term loans
Interest on long-term loans
Interest on mortgage
Net income before tax
Taxes
Net income
Dividends on stock
Additions to retained earnings

2005
1,95,731.63
1,66,642.58
29,089.05
16,880.96
2,040.00
5,724.72
24,645.68
4,443.25
1,823.25
956.25
211.90
1,451.94
696.94
755.02
188.76
566.27

2006 Revised
2,07,475.52
1,71,167.30
36,308.22
16,598.00
2,422.50
3,631.00
22,651.50
13,656.71
1,968.20
956.25
190.54
10,541.72
5,060.03
5,481.69
1,370.42
4,111.27

2007 Revised
2,27,185.70
1,81,748.56
45437.13
17,038.90
1,823.00
2,840.00
21,702.00
23,735.13
0
956.25
171.52
22,607.36
10,851.53
11,755.83
2,938.96
8,816.87

Table 13: Silver River Manufacturing Company


Pro Forma Balance Sheets (Revised)
Worksheet for Year End 2007 (Thousands of Dollars)

Particulars
Assets
Cash
Accounts Receivable
Inventory
Current Assets
Land, Buildings, Plant and Equipment
Accumulated Depreciation
Net Fixed Assets
Total Assets
Liabilities and Equities
Short-term bank loans
Account payable
Accruals
Current liabilities

2005 2006 Revised 2007 Revised


3,905.77
29,356.86
46,658.62
79,921.26
22,873.50
-6,693.75
16,179.75
96,101.01

11,495.86
18,442.27
29,639.36
59,577.49
29,248.50
-9,116.25
20,132.25
79,709.74

19,605.72
20,194.28
32,455.10
72,255.10
30,125.96
-10,939.20
19,186.76
91,441.86

18,232.50
19,998.39
7,331.28
45,562.17

0.00
15,994.88
9,301.13
25,296.01

0.00
16,794.62
11,626.41
28,421.03

28

Financial Management
Long-term bank loans
Mortgage
Long-term debt
Total liabilities
Common stock
Retained earnings
Owners' equity
Total Capital

9,562.50
2,339.62
11,902.12
57,464.29
23,269.00
15,367.72
38,636.72
96,101.01

9,562.50
2,103.75
11,666.25
36,962.00
23,268.75
19,478.99
42,747.74
79,709.74

9,562.50
1,893.75
11,456.25
39,877
23,269
28,295.86
51,564.86
91,441.86

Table 14: Silver River Manufacturing Company


Particulars
Liquidity Ratios
Current ratio
Quick Ratio

Ratio Analysis Year Ended December 31 (Revised)


2005
2006 Revised
2007 Revised

Industry average

1.75
0.73

2.36
1.18

2.54
1.4

2.5
1

Leverage Ratios
Debt ratio (%)
Times interest earned

59.79
1.48

46.37
4.38

43.61
21.04

50
7.7

Asset Management Ratios


Inventory turnover (Cost)
Inventory turnover (Selling)
Fixed asset turnover
Total asset turnover
Average collection period

3.57
4.19
12.09
2.04
53.99

5.77
7
10.3
2.6
32

5.6
7
11.84
2.48
32

5.7
7
12
3
32

Profitability Ratios
Profit margin (%)
Gross profit margin (%)
Return on total assets
Return on owners' equity

0.39
14.86
0.79
1.95

2.64
17.5
6.88
12.82

5.17
20
12.86
22.79

2.9
18
8.8
17.5

Working notes of Table 12


Particulars
Projected sales
Cost of goods sold
Administrative and selling expenses
Miscellaneous expenses
Taxes

2006
195,731.63 * 1.06
82.5% of
207,475.52
8% of 207,475.52
1.75% of
207,475.52
48% of 10,541.72

2007
2,07,475.52 207475.52 * 1.095

2,27,185.70

1,71,167.31 80% of 227,185.7


16,598.04 7.5% of 227,185.7

1,81,748.56
17,038.93

3,630.82 1.25% of 227,185.7


5,060.03 48% of 22,607.36

Working notes of Table 13


1. Retained earnings
For 2006: Retained earnings (2005) + Additions in 2006
i.e., 15,367.72 + 4,111.27 = 19,478.99
For 2007: Retained earnings (2006) + Additions in 2007
29

2,839.82
10,851.53

Financial Management
i.e., 19,478.99 + 8,816.87 = 28,295.86
2. Accounts receivables
For 2006: Average collection period = Receivables / Sales per day
i.e.
32
= Receivables / (207,475.53 / 360)
Therefore, receivables = 18,442.27
For 2007: Average collection period = Receivables / Sales per day
i.e.
32
= Receivables / (227,185.71 / 360)
Therefore, receivables = 20,194.28
3. Inventory
For 2006: Inventory turnover = Sales / Inventory
i.e.
7
= 207,475.53 / Inventory
Therefore, inventory = 29,639.36
For 2007: Inventory turnover = Sales / Inventory
i.e.
7
= 227,185.71 / Inventory
Therefore, inventory = 32,455.10
Notes:
3. Cash is the balancing figure.
4. Accounts receivables and inventory has been calculated by using the industry average
ratios.

30

Financial Management
Working notes of Table 14
Particulars

Formula

Current ratio

Current assets /
current liabilities

59,577.49 /
25,296.01

72,255.10 /
2.36 28,421.03

2.5

Quick ratio

(Current assets inventories) /


Current liabilities

(59,577.49 29,639.36) /
25,296.01

(72,255.10 32,455.10) /
1.18 28,421.03

Debt ratio

Total debt / Total


asset

36,962 /
79,709.74

Times interest earned

EBIT / Interest

13,656.86 /
3,114.99

23,735.39 /
4.38 1,127.77

Inventory turnover(cost)

COGS / Inventory

171,167.31 /
29,639.36

181,748.56 /
5.77 32,455.10

Inventory turnover(selling)

Sales / Inventory

207,475.53 /
29,639.36

227,185.70 /
7 32,455.10

Fixed assets turnover

Sales / Fixed asset

207475.53 /
20,132.25

227,185.70 /
10.3 19,186.76

11.8

Total asset turnover

Sales / Total asset

207475.53 /
79,709.74

227,185.70 /
2.6 91,441.86

2.4

Average collection period

Receivables / Sales
per day

18,442.27 /
(207,475.53 / 360)

20,194.28 /
32 (227,185.70 / 360)

Profit margin(%)

(Net income / Sales) (5,481.69 /


* 100
207,475.53)*100

(11,755.83/
2.64 227,185.70)*100

5.1

Gross profit margin(%)

(Gross profit /
Sales) * 100

(36,308.22 /
207,475.53)*100

(45,437.13 /
17.5 227,185.70)*100

Return on total assets

(Net income / Total


asset) * 100

(5,481.69 /
79,709.74)*100

(11,755.83 /
6.88 91,441.86)*100

12.8

Return on owner's equity

(Net income / Total


equity) * 100

(5,481.69 /
42,747.74)*100

(11,755.83/
12.82 51,564.86)*100

22.7

2006

2007

39,877 /
46.37 91,441.86

If all short term loans are repaid by end of first half of 2006, the company would obviously
be able to pay regular dividends in 2006 as well as in 2007. This is because the interest on
short term is being decreased in 2006 and is nil by 2007.
The minimum cash balance required at the end of 2006 is 10373.76 (5% of 207475.520). The
company after paying the dividend of 25% during the year 2006 has the cash balance of
$11,495.88. So, the company will be able to maintain the minimum cash balance of
$10373.76.
The following table shows the changes in the ratios of the company after the payment of short
term bank loans in the first half of year 2006.

31

43.6

21.0

Financial Management
Ratios

Liquidity ratios
Current ratio
Quick ratio

Not
Revised
2006

Not
revised
2007

Revised
2006

Revised
2007

1.69
1.10

1.85
1.24

2.36
1.18

2.54
1.4

58.83
2.69

54.9
8
4.69

46.37
4.38

43.61
21.04

5.77

5.60

5.77

5.6

7.00

7.00
11.8
4
1.94
32.0
0

10.3
2.6

11.84
2.48

32

32

2.64

5.17

17.5
6.88

20
12.86

12.82

22.79

Leverage ratios
Debt ratio (%)
Times interest earned
Asset management
ratios
Inventory turnover
(Cost)*
Inventory turnover
(Selling)*
Fixed asset turnover
Total asset turnover

10.30
1.98

Average collection period

32.00

Profitability ratios
Profit margin (%)
Gross profit margin (%)
Return on total assets
Return on owners' equity

2.15
17.50
4.26
10.34

4.27
20.0
0
8.28
18.3
9

Since, after the


payment of short
term loan all the
ratios of the
company
are
improving we
find that there is
after the payment

no situation that indicates poor financial policy. The impacts on the ratios
of short term bank loans are as follows:
Liquidity ratios
a. Current ratio: The improvement in the current ratios of the company shows better
ability of the company to meet its current obligations.
b. Quick ratio: the increase in quick ratio indicates improvement of the companys
ability to meet its short term obligations.
Leverage ratios:
a. Debt ratio: The decrease in debt ratio of the company shows the less involvement of
debt to finance fixed assets of the company.
b. Times interest earned: The improvement in the TIE ratio shows the increase in the
operating earnings to pay interest.
Asset management ratio:
a. Total asset turnover: The increase in the ratios shows that the company has more
efficiently utilized the overall assets to generate sales revenue.
Profitability ratios:

32

Financial Management
a. Profit margin: The increase in the profit margin ratio shows the improvement in the
companys ability to earn of each sale after paying all the necessary expenses.
b. Return on total assets: The improvement in return on total assets ratio indicates the
enhancement in the effectiveness of the operating management of the firm.
c. Return on owners equity: the increase in the ratio shows the improvement in both
operating and financial decisions of the company.
Question 6.
On the basis of your analyses, do you think that the bank should:
a. Extend the existing short and long-term loans and grant the additional $6,375,000
loans, or
b. Extend the existing short and long-term loans without granting the additional loan,
or
c. Demand immediate repayment of both existing loans?
If you favor (a) or (b) above, what conditions (collateral, guarantees, or other safeguards)
should the bank impose to protect itself on the loans?
Solution:
On the basis of our analysis, bank should
Extend the existing short and long- term loans and grant the additional $6,375,000 loans.
SRM was a good client of MCNB as they were prompt in making payments when it was due,
and had a reputation of unquestioned integrity in its business dealings. The current problem
faced by SRM is temporary in nature. The problem occurred due to financial downturn which
was not the only problem faced by Mr. White.
Recently, Mr. White had signed a contract for a plant expansion. He believed that new
facilities would enhance the production capabilities in a very lucrative area of custom horse
van. According to Mr. Whites analysis, the financial position of the company could improve
significantly over the next two years. Once the new facility is added, the company would be
able to increase output in rapidly growing segments of market (horse van and home chain)
and also reduce the dependency on farm and light utility sales to 35% or less. He also
projected that the sales growth would be 6% and 9.5% in an average for 2006 and 2007
respectively, assuming there is no significant improvement in either national or farm
economy. He also assumed that SRM would change its policy of aggressive marketing and
sales promotion and return to full margin prices, standard industry credit term and tighter
credit standards. These changes would reduce cost of goods sold to 82.5% in 2006 and 80%
in 2007. Similarly administrative and selling expenses are likely to decrease from 9% to 8%
in 2006 and 7.5% in 2007. Also, the miscellaneous expense would reduce to 1.75% and
1.25% of sales in 2006 and 2007 respectively.
Hence, on the basis of our analysis we can be assured that if SRM will undertake new
facilities then within two year period SRM will be able to generate enough profit to meet the
entire obligation owed to the bank.
In addition for the purpose of safety, bank should impose collaterals, guarantees and other
safeguards. The collaterals will serve as a value given or pledged as security for payment of
loan. In this case, the bank may charge SRM following collaterals:

33

Financial Management

Financial collaterals: Stocks, bonds and negotiable paper assuming SRM possess
these securities.
Merchandise collaterals: Warehouse receipts, trust receipts, rights in real estates, bills
of sale of movable goods such as crops, machineries, furniture, livestock.
The most promising collateral option for the bank to charge SRM would be the new operation
which is going to start. Above mentioned collaterals may also be charged by the bank in
securing itself from default. In case of default, the bank may sell the collateral pledged by
SRM and apply the money thus acquired to payment of the debt.
Question 7.
If the bank decides to withdraw the entire line of credit and to demand immediate repayment
of the two existing loans, what alternatives would be open to SRM?
Solution:
Though SRM had shown high and steady growth in sales, assets and profits prior to 2003,
however, towards the end of 2003 the demand for new field trailers in citrus and vegetable
industries started to fall. In order to sustain profits and superior market performance Mr.
White aggressively reduced prices to stimulate further sales. Consequently, production
continued unabated and inventories started increasing. Mr. Whites next step was to relax
credit terms and standard to maintain preciously high growth and to reduce the ever
expanding inventory. This effort of Mr. White increased sales through the third quarter of
2005, but inventories also increased steadily and particularly short-term credits and accounts
receivable grew up dramatically.
In, case if the bank withdraws the entire line of credit and demands immediate repayment of
the two existing loans, SRM can adopt following actions:

Take mortgage loan from bank:


SRM has land, buildings, plant and equipment worth of $ 22873500 and it has
mortgage worth of $ 2339620. This reflects that SRM has the capacity to mortgage
its land and buildings. Hence, it can request loan with another bank mortgaging its
land and buildings.

Sell accounts receivables and liquidate inventory:


SRM has accounts receivables of $ 29356860 and inventory worth $ 46658620. It
can sell its receivables and liquidate the inventory in order to repay the loan.

Make strict collection policies:


The average collection period of SRM is 54 days in 2005. The company has to make
its collection policies stricter so that the creditors will pay in time. Here, SRM is
adopting liberal collection policies.

Increase the minimum cash balance:


The current minimum cash balance is 5% of net sales. SRM has to increase the
percentage so that it has more cash reserve and can utilize it when necessary.

SRM has to take immediate actions as well as gradual steps to stabilize its condition. It can
mix the above mentioned actions at once.

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Financial Management

CONCLUSION & LESSON LEARNT


Silver River Manufacturing company (SRM), a large regional producer of agricultural utility
such as grove trailers, citrus transport carrier, is being hit hard by deteriorating nations farm
economy. This company has been a good customer of Marion country National Bank
(MCNB) however, due to inability to meet the contractual financial ratio by the company,
Lesa Nix, Vice-president of MCNB had made a alerting phone call to the Greg White,
founder and president of SRM.
Due to ensuing loss of public trust the regulators of MCNB are becoming strict in their
examination of bank loan portfolios and lending practice, because of which SRM might have
to suffer.
Greg White, an optimistic person, after attending seminar on executive development
convinced that the key to sustained profit and superior performance was sales growth and the
achievement of higher share of the market so; he started producing all his products
relentlessly and relaxed the credit term to capture more market share. Until the third quarter
of 2005 indeed, the sales was high but during fourth quarter inventories as well as receivable
started rocketing.
Over optimist White had always taken it for granted that MCNB would increase his line of
credit and when he was about to turn to MCNB to finance increase of assets , MCNB was
considering reducing or even eliminating such loan. Knowing this ground reality, White
realized, for the sales growth and sustainable profit is possible only when reasonable profit
margins at every sale are made which was the crux point. Failing this point to notice early
was the main cause of his company to be in such deteriorating condition.
White, Knew he focused much on marketing and production issues without paying adequate
attention to their financial attention, started to switch his production form volatile farm sector
to more stable medium-to-high growth markets of Horse Vans, Mobile home chassis etc.
Likewise, SRM will change its policy of aggressive marketing and sales promotion and
return to full-margin pricing, standard industry credit terms and tighter credit standards;
remaining within the periphery of industry average.
Also a manager must not be over optimistic and also should be prepared for a situation when
forecasts go wrong.

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