Homework answers / question archive / Now that we understand why Jones Electrical Distribution is challenged with its cash flow, we need to analyze whether the company can meet Mr

Now that we understand why Jones Electrical Distribution is challenged with its cash flow, we need to analyze whether the company can meet Mr

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Now that we understand why Jones Electrical Distribution is challenged with its cash flow, we need to analyze whether the company can meet Mr. Jones’ ambitious growth target. Your assignment is to create a pro forma forecast for the full year 2007 and answer the questions in the Blackboard assignment. You will need to create all three financial statements and the sources and uses table to include the pro forma 2007. Please download the attached file to use as a template. All shaded cells must be filled in.

Excel File: Assignment 2 file.xlsx 

Your forecast should include the following assumptions:

Sales is given to you in the case text.

Jones decides to resume taking the early payment discounts and therefore makes his payments within 10 days of invoice. Hence his Days Payables Outstanding is 10 and his Cost of Goods Sold as a percent of sales should reflect the discount.

Operating expenses should be forecasted as a percent of sales based on Q1 2007 data.

Interest expense consists of interest on both the revolving credit line and the long-term debt. Assume that interest is calculated on the beginning balances of both. For this case, you can assume annual payments of interest.

There is no change to the company’s tax rate as compared to prior years.

There are no further capital expenditures in 2007.

Use the DSO and DIO from Q1 2007 for your full year forecast of Accounts Receivable and Inventory, respectively.

There are no further changes to Accrued Expenses after Q1 2007.

For the purposes of calculating the revolving credit line assume that the company needs to maintain a cash balance of at least zero.

You can build this model assuming Jones takes the early pay discounts, you do not have to worry about a scenario or “toggle switch” since it was not covered in class. However, you will need to modify the assumptions to look at the results if Jones did not take the discounts, in order to answer a couple of the questions.

APRIL 6, 2010
THOMAS R. PIPER
JEFFREY DEVOLDER
Jones Electrical Distribution

After several years of rapid growth, in the spring of 2007 Jones Electrical Distribution anticipated
a further substantial increase in sales. Despite good profits, the company had experienced a shortage
of cash and had found it necessary to increase its borrowing from Metropolitan Bank—a local one-
branch bank—to $250,000 in 2006. The maximum loan that Metropolitan would make to any one
borrower was $250,000, and Jones had been able to stay within the limit only by relying very heavily
on trade credit from the manufacturers from whom Jones purchased the electrical products it sold to
its customers. Nelson Jones, sole owner and president of the company, was therefore looking
elsewhere for a new banking relationship that would allow him to negotiate a larger loan.

Jim Lyons, a homebuilder who was a friend of Jones, introduced Jones to Rachel Montrose,
Lyons’s relationship officer at the local branch of Southern Bank & Trust—a large, regional bank.
Southern had a 7-year relationship with Lyons, including a current loan balance of over $3 million.
Jones and Montrose tentatively discussed the possibility that Southern might extend a line of credit to
Jones up to a maximum amount of $350,000. Jones thought that a loan of this size would more than
meet his needs for at least the next year, and he was eager for the flexibility that a line of credit of this
size would provide. After discussion, Montrose had arranged for the credit department of Southern
Bank & Trust to investigate Nelson Jones and his company.

Background of Jones Electrical Distribution

Jones Electrical Distribution was founded in 1999 as a partnership between Nelson Jones and his
college roommate, Dave Verden. In 2003, Jones and Verden had a disagreement on how aggressively
they should grow the business, and Jones ultimately bought Verden out for $250,000. They agreed
that Jones would pay Verden the $250,000 in installments of $2,000 per month plus interest of 8% per
year.

The business sold electrical components and tools to general contractors and electricians. The
products, which included items such as controllers, breakers, signal devices and fuses, were
purchased from nearly 100 different suppliers. Jones’s customers used the products in the
HBS Professor Thomas R. Piper and writer Jeffrey DeVolder prepared this case solely as a basis for class discussion and not as an endorsement, a
source of primary data, or an illustration of effective or ineffective management. The authors thank John A. Schweig of W. W. Grainger, Inc.
(HBS MBA 1983), and Mary A. Noonan of Arrow Electronics (HBS MBA 1990), for their valuable contributions to the development of this case.
This case, though based on real events, is fictionalized, and any resemblance to actual persons or entities is coincidental. There are occasional
references to actual companies in the narration.

Copyright © 2010 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,
write Harvard Business Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. This publication may not be digitized,
photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.
4179 | Jones Electrical Distribution
construction and repair of commercial and residential buildings. To a degree, Jones’s sales followed
the seasonality of its customers’ businesses which had their highest activity during the spring and
summer when weather was most conducive for construction work.

The market in which Jones competed was large, fragmented, and highly competitive. Jones faced
significant competition from national distributors, home centers, and other small supply houses. In
spite of the competition, Jones had built up sales volume by successfully competing on price and
employing an aggressive direct sales force who often visited customers at their job sites. In order to
compete on price, Jones maintained tight control over operating expenses, including paying his
salesforce primarily on commission and keeping overhead to a minimum. In addition, as part of his
expense management effort, Jones had historically paid his suppliers within 10 days of the invoice
date in order to take full advantage of the 2% discounts they offered for quick payments. Jones had
also proved adept at demand forecasting and inventory management, allowing him to satisfy his
customers’ demand with a modest amount of inventory relative to his larger competitors.

Jones’s focus and dedication to his business allowed him to build it into a profitable operation.
Jones Electrical Distribution had grown to $2.24 million in sales and $30,000 of net income in 2006.
Operating statements for years 2004-2006 and for the three months ending March 31, 2007, are given
in Exhibit 1.

Financing the Business Through Southern Bank & Trust

To solve his financing need, Jones wanted to develop a relationship with a larger bank that would
not run into issues with maximum loans to a single borrower as he had experienced with
Metropolitan Bank. He wanted to build a relationship with a bank that could grow with him,
including to more locations if he decided to add additional sites in the future.

As part of its customary due diligence of Jones Electrical Distribution, the Southern Bank &
Trust’s credit department asked Jones’s friend Jim Lyons for a reference on Jones. Lyons’s reference
included the following comments: “Nelson is a businessman of the highest integrity and sharp
acumen who is a very hands-on manager of his operation. He has excellent knowledge of the
products he sells and provides customers with excellent service. He also lives a modest lifestyle.”

The bank also toured Jones Electrical Distribution’s warehouse and office and interviewed the
area sales managers for three of the manufacturers from whom Jones bought the products he sold.
The managers were unanimous in their favorable opinion of Jones. One of them said: “Nelson has
been one of our best performing wholesalers. He really knows how to build relationships and close a
sale. He has also been great with his expense management. The guy does not spend a dime unless
he absolutely has to. We look forward to building a bigger relationship with him in the future.”

In addition to the electrical distribution business, which was Jones’s only source of income, Jones
held jointly with his wife an equity in their home. The house had cost $199,000 to build in 1999 and
was mortgaged for $117,000. He also held a $250,000 life insurance policy, payable to his wife.
Otherwise, they had no sizeable personal investments.

Southern Bank & Trust gave particular attention to the debt position and current ratio of the
business. It noted the ready market for the company’s products at all times and the fact that sales
prospects were favorable. The bank’s investigator reported: “Sales are expected to reach $2.7 million
by the end of 2007.” On the other hand, it was recognized that a general economic downturn might
slow down the rate of increase in sales. Projections beyond 2007 were difficult to make, but the
2 BRIEFCASES | HARVARD BUSINESS SCHOOL

Jones Electrical Distribution | 4179
prospects appeared good for continued growth in the volume of Jones Electrical Distribution’s
business over the foreseeable future.

The bank also noted the rapid increase in Jones Electrical’s accounts payable and line of credit in
the recent past. Jones Electrical’s main suppliers had terms of 30 days net and provided a 2%
discount for payments made within 10 days of invoice date. These terms notwithstanding, the
manufacturers did not object if payments lagged somewhat behind the due date. During the past six
months, Jones had taken very few purchase discounts because of the shortage of funds arising from
the additional investments in working capital associated with the company’s increased sales volume.
Balance sheets at December 31, 2004-2006, and March 31, 2007, are presented in Exhibit 2.

The tentative discussions between Rachel Montrose and Nelson Jones had been about a revolving,
secured line of credit not to exceed $350,000. The specific details of the loan had not been worked
out, but Montrose had explained the agreement would involve the standard covenants applying to
such a loan. She cited as illustrative provisions the requirement that restrictions on additional
borrowing would be imposed, that additional investments in fixed assets could be made only with
prior approval of the bank, and that limitations would be placed on withdrawals of funds from the
business by Jones. She also indicated that while the line of credit would have a limit of $350,000,
Jones’s utilization of the line at any point in time would be limited to an amount equal to 75% of
Accounts Receivable and 50% of Inventory. Interest would be set on a floating-rate basis at 1.5%
percentage points above the prime rate (the rate paid by the bank’s most creditworthy customers).
Montrose indicated that the initial rate to be paid would be about 7.5% under conditions in effect in
early 2007. Jones also understood that he would be required to sever his relationship with
Metropolitan Bank if he entered into a loan agreement with Southern Bank & Trust.

The Future of Jones Electrical Distribution

As he contemplated his next meeting with Montrose, Jones’s thoughts were dominated by the
immediate need for more bank credit. However, he knew that the increasingly tense relationships
with his suppliers and the seemingly unending need for more financing meant that he needed to be
more deliberate about his future growth plans. To get started, he grabbed a blank piece of paper
from his office printer and sketched out the options before him. He started with the pace of sales
growth followed by his taking the 2% discounts—or not—which led into the financing implications
of each alternative. See Exhibit 3 for the diagram of the alternatives as Jones saw them. Jones
promised himself that he would not only close the new bank deal but he would then determine the
right long-term growth path for the company he worked so hard to grow over the past seven years.
HARVARD BUSINESS SCHOOL | BRIEFCASES 3

4179 | Jones Electrical Distribution
Exhibit 1 Operating Statements for Years Ending December 31, 2004-2006, and for First
Quarter 2007 (thousands of dollars)
2004 2005 2006 First Quarter
20077
Net sales $ 1,624 $ 1,916 $ 2,242 $ 608
Cost of goods sold $ 1,304 $ 1,535 $ 1,818 $ 499
Gross profit on sales $320 $ 381 $ 424 $ 109
Operating expense? $ 272 $ 307 $ 347 $ 94
Interest expense $27 $ 30 $31 $ 8
Net income before taxes $21 G44 $ 46 $ 7
Provision for income taxes $ 7 $15 $ 16 $2
Net income $14 $ 29 $ 30 $ 5
@ In the first quarter of 2006, sales were $514,000 and net income was $4,000.
b Operating expenses include a normal level of cash salary for Mr. Jones in all periods
4 BRIEFCASES | HARVARD BUSINESS SCHOOL

Jones Electrical Distribution | 4179
Exhibit 2 Balance Sheet at December 31, 2004-2006, and March 31, 2007 (thousands of dollars)
First Quarter
2004 2005 2006 2007
Cash $ 45 $ 53 $ 23 $ 32
Accounts receivable $ 187 § 231 $ 264 $ 290
Inventory $ 243 $_278 $_379 $ 432
Total current assets $ 475 $ 562 $ 666 $ 755
Property & equipment $ 187 $ 202 $ 252 $ 252
Accumulated depreciation ($ 74) (G 99) ($ 134) ($ 142)
Total PP&E, net $ 113 $ 103 $ 118 $ 110
Total assets $ 588 $ 665 $ 784 $ 865
Accounts payable $ 36 $ 42 $ 120 $ 203
Line of credit payable $ 149 $ 214 $ 249 $ 250
Accrued expenses $ 13 $ 14 $ 14 $ 12
Long-term debt, current portion 5 24 5 24 5 24 $ 24
Current liabilities § 222 $§ 294 $§ 407 § 489
Long-term debt $ 182 $ 158 $ 134 $ 128
Total liabilities § 404 § 452 § 541 $ 617
Net worth $ 184 § 213 $ 243 $ 248
Total liabilities and net worth § 588 $ 665 § 784 $ 865

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