Good Forecasting Future Financing Needs Case Study Example

As I have come to know that the management is re-considering the additional bank overdraft to pay off the suppliers and reduce the payable period to 40 days, I am preparing this report with the objective of assisting you and provide you with real scenario our company is going through.
-Forecast for 2016
*Revenue figures are assumed to increase by 5% during 2016, while all the other expenses increase in proportion to revenue.

As we can witness from the above forecasted income statement, our net income is only expected to increase by $0.01 million, and with current situation where we are facing payment pressures, there is no way we can get out of this situation until we take additional funds, both for financing debt payments and future expansion.
-Liquidity and Efficiency Position
i) Liquidity Ratios
-Current Ratio: Current Assets/ Current Liabilities
= 7.5/5.4
= 1.38
-Acid Ratio: Current Assets- Inventory/ Current Liabilities
= (7.5-3.8)/5.4
= 0.67

Liquidity Analysis

Beginning with the current ratio of the company, we found that the company is having strong working capital position, with current assets representing 1.38 times the current liabilities. However, the real situation was unveiled by the acid ratio which indicated that the current assets constitute majorly of inventory, and the liquidity position is rather weak, as the acid ratio of the company is only 0.67.
Thus, it is clear that the company do not have strong liquidity roots, and the management consider this situation on an urgent basis.
ii) Efficiency Ratios
- Days of Inventory: (365* Inventory)/ Cost of Goods Sold
= (365*3.8)/7.8
= 177 Days
- Days of payables: (365* Payables)/ Cost of Goods Sold
= 365*1.8/ 7.8
= 84 Days

Efficiency Analysis

Just as the liquidity ratios, the trend in the efficiency ratio was again discouraging. The days of inventor of the company goes up to as high as 177 days, while the suppliers are getting their payment in 84 days. Both the situation notifies of the weak efficiency of the management, and also indicates that the company is not able to sell its inventory at a rapid pace, and is also not able to make their payments under an acceptable time period.
-Required Payment to bring down the payable period to 40 days

In order to reduce average payment period to 40 days, the company must reduce the accounts payable to:

Days of payables: (365* Payables)/ COGS
40= (365*Payable)/7.8
Payable= (40*7.8)/365
= $0.85 Million
Thus, our company will need to reduce the accounts payable to $0.85 million or will have to pay $0.95 million (1.8-0.85), to reduce the average payment period to 40 days.
-Possible Reaction of Bank for additional overdraft
Considering the profitability position of the company, where we are earning net income of $0.30 million per year, I believe that the bank will not cooperate over our demand for additional bank overdraft amount. In addition, the bank will most likely access our liquidity position, which will clearly spell out our weak financial position and inability to pay our suppliers.
Hence, I am assured that either our request for additional funding will be rejected or it be funded at exorbitant high interest rate.
-Other sources of finance

Apart from bank overdraft, we may also consider following alternative source of funds to pay our suppliers:

I) Receivable Factoring
Many financial institutions allow factoring finance provision, under which an entity can borrow 70-75% of the total outstanding receivables. However, the responsibility to collect the receivables is still with the entity obtaining the loan. Financial Institutions generally charge interest rate of 15-20% under this agreement.
ii) Purchase order financing
This is another form of receivable financing that allow the company to raise loan on the basis of purchase order obtained in advance from the loyal buyer of the company. Here also, financial institution charge interest rate at 1-4% per month, while all the payments made by the customer are first deposited with the financial institution.
iii) Inventory Financing
Many financial institution grant loans by taking the inventory as collateral security and the amount is paid back as inventory is sold and proceeds are received by the borrower. Since inventory financing is secured, interest rate is relatively low at 10-12% per annum.
iv) Personal Savings, and Borrowing from family& friends
You may also consider increasing the capital employed in the business by bringing your own personal savings into the company or may also consider additional funding from family and friends, as this will probably be an interest-free lending, and protect the company from any additional interest rate burden.

Preferred source of financing

Considering the high cost of financing associated with factoring and purchase note receivables, I would suggest that we should arrange additional funds through personal savings and inventory financing.
I hope that the above analysis and report will assist you in taking a rationale and prudent decision for the company.
Best Regards.