A Presentation on

Action Manufacturing
Company
Presented By: (Group 1)
Bikash Thapa Magar
Bishal GC
Brij Bihari Shah
Dikshya Pant
Garima Paudel
Presentation outline
• Introduction
• Objective
• Issue 1
• Issue 2
• Issue 3
• Issue 4
• Issue 5
• Issue 6
• Issue 7
• Issue 8
• Conclusion
Introduction
• Action Standard Manufacturing Company (1920)
• Dianne Covington
• Rapid expansion in 2015
• Project line expansion 2016, 2017
• No cash discounts 2016 on terms 3/10, net 30
• Increased cost
• Decline profit , Liquidity position , Falling ROA by 2017
• Covington’s Consideration on acquiring loans backed by
• inventories
Table 1: Action Standard manufacturing Co. (In '000$)
Particulars 2015 2016Estimated 2017
Cash and securities 1,540 1,980 5,425
Account receivable 7,502 9,933 15,675
Inventories:
Raw material 768 1,342 1,692
Work in progress 6,542 11,144 20,092
Finished goods 413 714 1,152
Total inventories 7,722 13,200 22,935
Total current assets 16,764 25,113 44,035
Net fixed assets 14,036 21,087 25,265
Total assets 30,800 46,200 69,300

Account payable 3,025 7,480 19,470

Notes payable (Bank 10%) 3,421 4,478 5,170
Total current liabilities 6,446 11,958 24,640
Long-term debt 5,941 11,336 16,500
Common equity 18413 22,906 28,160
Total claims 30800 46,200 69,300
Sales 77,000 99,295 137,885
Significant Industry Ratios
Estimated Average
2015 2016 2017 Industry (2016)

Current ratio, times 2.6 2.1 1.79 2.2

Quick ratio, times 1.4 1 0.86 1.2

Debt ratio (%) 40.2 50.4 59.4 43

Profit margin on sales (%) 6 5.3 5.3 6

Rate of return on assets (%) 15 11.4 10.6 11

Rate of return on net worth
(%) 25 23 26 23
Objective of the Study

• Improve Liquidity Position

• Maintain current ratio and quick ratio.
• Improve profit margin on sales and falling return on
assets
ISSUE 1. Does the commercial paper market now
present a feasible alternative to Action Standard?
Explain your reasoning

TABLE: COST OF FUND

Alternatives Cost of Fund
Bank Loan 10.00%
Secured Loan (i.e. Account Receivable) 11.00%
Factoring 14.50%
Commercial Paper 9.00%
Cost of Fund
16.00%
14.50%
14.00%
12.00% 11.00%
10.00%
10.00% 9.00%
8.00%
6.00%
4.00%
2.00%
0.00%
Bank Loan Secured Loan Factoring Commercial
(i.e. Account Paper
Receivable)
ISSUE 2:
Discuss the feasibility of Action Standard's using its
inventory as collateral for a loan. If this form of
financing is undertaken, what type of security
arrangements would probably be used? Do you
think that Action Standard's inventories would
make very good security for a loan?
The feasibility of Action Standard's using its
inventory as collateral for a loan
• Inventories are regarded as reasonably liquid assets. They are acceptable
as security to the lender for short term loan.
• The inventories of Action Standard are low marketable as because they
are lawnmowers, garden tractors, snow blow machines, which are
specialized equipment’s.
• These types of inventories are difficult sell in market so the loan provide
by lender will be comparatively low.
• As the company’s goods have not good marketability, due to which it is
difficult to sale, the lender may hesitate to provide loan at this situation.
• At the time of sale the company’s equipment involve cost, which reduces
the chance (probability) of getting higher proportion of loan
Types of security arrangements used
Action Standard will be able to use the following security arrangements:
Floating lien: Lien generally means the claim made by lender on property of
borrower as collateral. Borrower may pledge inventories in general without
specifying the kind of inventory involved.
Trust Receipt Loan: Trust receipt is a device by which the borrower holds
specific inventory in trust for the lender.
Blanket Inventory Lien: A blank line gives the lender a lien against the
entire borrower’s inventory. Blanket lien gives a creditor a legal interest in all
of the debtor's assets.
Chattel Mortgage: In chattel mortgage of inventory financing, inventories
are identifiable by serial number or by some other means and loan is
provided against this inventory
Continue..
Terminal Warehouse Receipt Loans: In terminal warehouse receipt
financing loan is obtained by storing inventory with a public, or terminal,
warehousing company.
Field Warehouse Receipt Loans: Field warehousing, will permit loans to
be made against inventory that is located on Action Standard's premises.

The inventories are such that they are specialized equipment’s and will be
difficult to sell. The lender will have to incur additional expenses in its
selling with the inventories being of reasonably large size and face
difficulty in selling due to their low marketability. The lender may provide
small percentage of loans against the inventories or may refuse to lend. So,
Action Standard's inventories will not make a good security for the loan
Issue 3
Determine the approximate rate of interest on foregone
discounts (Both on the present as well as proposed terms of
sale). What are the case advantages and disadvantages of
allowing accounts payable to build up, as the financial staff
has suggested? Discuss specifically the firm's declining
liquidity position and its use of "spontaneous" financing
through trade credit. Would it be a wise policy to build up
accounts payable?
1. The approximate rate of interest on foregone
discount i.e. 2/5, net 30

Annual Interest Cost=×

=×

=49.66%
Annual Interest Cost is 49.66%
2 . The approximate rate of interest on the
present terms of sale i.e. 2/5, net 30
Annual Interest Cost=×

=×

=29.79%
Annual Interest Cost= 29.79%
Advantages of accounts payable
a. It is one of the most flexible sources of financing.

b. It is the readily available source of fund for the company.

c. It is a continuous source of fund.

d. There is no need to go under financial formalities.

e. The fund is very easy to obtain in a short period of time.

f. Pledge of collateral is not made.

g. The firm not qualified for the bank loan is qualified for this kind of
fund.
Disadvantage of Accounts Payable:
a) The cost of not taking the discount may be very high.

b) Financial, position of the firm weak.

c) The supplier may not supply materials.

d) Delay in delivery of goods.

e) Intangible benefits could be lost.

f) Delayed payment could hurt the company’s reputation

Significant Industry Ratios
Estimated Average
2015 2016 2017 Industry (2016)

Current ratio, times 2.6 2.1 1.79 2.2

Quick ratio, times 1.4 1 0.86 1.2

Debt ratio (%) 40.2 50.4 59.4 43

Profit margin on sales (%) 6 5.3 5.3 6

Rate of return on assets (%) 15 11.4 10.6 11

Rate of return on net worth

(%) 25 23 26 23
Continue..
• Liquidity position of Action Standard's company is declining, evident from
decreasing Current and Quick ratios.
• Current assets are increasing at a lower rate compared to current liabilities,
contributing to the liquidity challenge.
• Debt ratio is higher than industry average, adding to financial strain.
• Increased purchase of raw materials has led to a buildup of accounts payable,
worsening liquidity.
• Agreement with long-term debt holders requires maintaining a current ratio of
at least 2:1 to preserve company reputation and avoid penalties.
• Financing accounts payable would exacerbate liquidity issues and harm credit
rating.
• Urgent need to address liquidity concerns through strategic financial
management.
Issue 4
Discuss the pros and cons of Action Standard's using
account receivable financing at the present time. What
would be the impacts of accounts receivable financing
on current ratio and quick ratio? Determine the new
level of these ratios. If the company elects to use
receivable? (Assume 95% loan on receivable). Also
prepare the Balance sheet that would like if the
company undertakes receivable financing.
Pros of Account Receivable Financing
• Fast infusion of cash.
• Size of receivables.
• Protection against the bad debts losses.
• Continuous and flexible.
• Discretionary financing.
• Non requirement of Collateral.
• Retain business ownership
Cons of Account Receivable Financing
• Expensive source of financing.
• Limit other financing.
• Additional cost / dual cost.
• Contract Length.
• Risk of losing business.
• Loss of control.
Impacts of Accounts Receivable financing on
current ratio and quick ratio
Decrease in Account Receivables
Decreases by the pledged amount i.e. $15,675 thousands.

Decrease in Accounts payables

Account Payable decreases by = 95% of account receivable
i.e. $14,891.25 thousands.
 New level of Current ratio and
Quick Ratio
Estimated After
Estimated Receivable Average Industry
Quick ratio, times 2017 Financing (2016)

Current ratio, times 2.99 2.91 2.2

0.64 0.56 1.2

 Factoring or Pledging
Cost of loan on pledging of Account receivables= 11% of 15675 = 1724.25 Thousands.

Cost of loan on factoring of account receivables= 10% of (15675*95%) = 1489.125

Thousands.

Net cost/ Benefit= (1724.25-1489.125 )=235.125 Thousands.

The company's best choice is to pledge its receivables. In spite of the $235.125 thousands
net cost of pledging, this expense is insignificant due to the company's own credit
department costs.
Action Standard manufacturing Co. After Receivable
financing 2017
Particulars Estimated 2017 After Receivable Financing
Cash and securities 5,425 5,425
Account receivable 783 783
Inventories:
Raw material 1,692 1,692
Work in progress 20,092 20,092
Finished goods 1,152 1,152
Total inventories 22,935 22,935
Total current assets 29,144 29,144
Net fixed assets 25,265 25,265
Total assets 54,409 54,409

Account payable 4,579 4,579

Notes payable (Bank 10%) 5,170 5,170
Total current liabilities 9,749 9,749
Long-term debt 16,500 16,500
Common equity 28,160 28,160
Total claims 54,409 54,409
Sales 137,885 137,885
Issue 5
Assume that Action Standard does not go along
with suggestions of building up accounts
payable to 50 days (reflected in the 2017
proforma balance sheet in Table 1) but opts
instead to start paying in 10 days and taking
discounts.
 (A). What is revised amount of Action Standard's
projected year end 2017 accounts payable?
Revised Amount of Account payable =× 5 =$ 1.947 Million

By taking advantage of the discount and paying on time, intangible benefits such as:

• Company’s reputation for being an excellent and responsible could be maintained.

• Suppliers would make every effort to give the company not only quick delivery,
but also first call on available suppliers during shortage periods.

• Action Standard would be able to negotiate favorable prices in its supply contracts
(B). Determine the amount of funds Action Standard would
have to borrow in order to take discounts. What would be
the effective cost? Assume at this point that bank borrowing,
at 8 percent discount interest and with a 12 percent
compensating balance requirement, is used. Also assume that
all asset accounts, including cash and securities now on
hand, cannot be reduced. Base your answer on Action
Standard's "steady state" borrowing requirements, which
means disregarding the one-time funds requirements to
account for the fact that accounts payable are currently
carried at net, yet most of them, will have to be paid off at
gross.
Calculation Results and Findings:
• Accounts Payable in the year 2017 = $ 19.47 Million
(net of discounts)
• In addition, the bank borrowing demand 8% discount
and 12% compensating balance.
• Hence, funds to be borrowed is = $23.847 Million
• The effective cost will be 10%
(C).What are the net savings that Action
Standard will realize from borrowing to take
the discounts? Note that accounts payable are
recorded net of discounts. (Hint: find the
annual gross purchases as the initial step,
followed by discount received, interest on
borrowing and so on).
Calculation Results and Findings:
• The net savings that Action Standard will realize from borrowing is
$1.1089 Million
• The discount received is higher than the interest to be paid on the amount
borrowed.
• Hence, the company enjoys gain when money is borrowed from the bank
at credit terms of 2/5, net 20
Issue 6:Effect of Covington's decision to take cash
discounts has upon the current ratio, quick ratio and
profit margin.

The various effect of taking the cash discount are

described below:
• Current ratio: The current ratio is the ratio of current
assets and current liabilities.
• Quick ratio: The quick ratio is the computed using the
formula
The various effect of taking the cash discount
has described below:
• Current ratio: The current ratio is the ratio of current assets and
current liabilities.
• Quick ratio: The quick ratio is also known as Acid-test or Liquidity
ratio.
• Profit margin: Covington's decision to take cash discounts will have
significant difference in profit margin of the company. In this case if
company takes the cash discount then it waves the costlier amount
need for working capital.
Issue 7 Should Action standard establish
relations with and arrange a line of credit from
Security and Bank and Trust Company? Give
reasons
Financing Alternatives are:
Alternatives Effective Cost%
Trade Credit 49.66%
Bank Loan 10.00%
Secured Loan (i.e. Account
Receivable) 11.00%
Factoring 14.50%
Commercial Paper 9.00%
Interpretation
• Cost of trade credit is very high which has, in recent years led the
company to a miserable state.
• Loan from Security Bank & Trust Company seems the most feasible
and profitable alternative.
• In pledging and factorings, the banks may be very selective in
choosing the account receivables.
• Commercial paper seems a cheaper option.
• Loan secured by inventories are also subject to rigorous observations
by banks on the basis of various factors like marketability,
perishability etc.
Issue 8: What specific actions do you think
Dianne Covington should recommend for action
standard during the coming year?
Specific actions recommend for Action Standard
Manufacturing
• Develop relationship with big Banks.
• Expedite collection of Receivables.
• Establish line of credit with banks.
Conclusion
• Building up of accounts payable will further deteriorate the liquidity
position to less than prescribe by its lender.
• The cost of forgone discount is quite high and stretching of accounts
payable also hampers its credit rating and image. So, it would not be
wise policy to build account payable.
• Action Standard Manufacturing Company should establish relation
with and arrange a line of credit from the bank
Thank You!!!