Reference no: EM1315534

Analysis of financial condition of a Company under Debt management.

In April 1991, the owner and manager of Pop's Recycling Company, J. R. Vann, approached the Crewe National Bank (CNB) concerning a loan. This visit to the bank was the second for Vann in the last eighteen months. An unusual occurrence, he thought, for a highly profitable firm. The company (a recycler of metal, glass, and paper) was in the midst of a healthy increase in sales. Operations were begun in 1980, and the firm had shown a profit each year since 1982.

            The company was founded in 1980 by J. R. Vann in response to the growing usage of
recycled material in the manufacture of paper products, as well as metal and glass products. The primary raw material was scrap, which was hauled in by scrap collectors of various sizes. While paper and glass were recycled by the company, the business consisted mainly of the processing of scrap metal.

            There had been considerable consolidation in the metal recycling business during the past decade. In fact, J. R. Vann, known as Pop to nearly everyone, started Pop's Recycling Company against the advice of certain business associates. Their primary concern was the apparent fall-off in the availability of scrap metal. As a result of that trend, some of the small brokers or recycling yards had either gone out of business or had been bought by larger recycling yards such as Pop's. That meant the larger, more well-established yards were getting r stronger, which in turn meant that a new entrant into the business faced an uphill climb. J. R. Vann, however, was convinced that he could make a strong showing in the business. He had become familiar with the business, over the years, through prior employment in the steel industry. As a result of that conviction, his entire savings and a sizable loan from a local insurance company launched Pop's Recycling Company.

            The processing of the steel taken in from its ^\"across the scale\" purchase of scrap metal consisted of shredding or shearing the metal. Shredding was used to process such metal as junk cars, the primary source of scrap, and shearing was used to process steel bars and other structural type steel. The company took in approximately 30,000 tons of metal which required shredding and about 15,000 tons of metal which needed to be sheared.

            The processed metal was shipped to foundries across the United States for use in a variety of applications. In fact, the company was such an important supplier of metal to specific foundries, it had become necessary to keep a certain level of inventory on hand in order to ensure that the demand could be met without delay. The sales forecast for Pop's for 1992 was $14,500,000.

            The recycling companies which had survived the ^\"shake-out\" of the 1980s, as it had become known throughout the economy, meant to stay very loyal and dependable relative to their customer base. Accordingly, a good relationship with the foundries was a must. At the level of Pop's, this meant keeping a steady supply of scrap metal throughout the year. That goal created a need for cash. Further, machinery had to be kept in good working order and suppliers expected to be paid within the 30-day limit, which had become standard in the business. Of the approximately sixty competitors on the east coast of the United States, twenty were in the mid-Atlantic region and considered direct competitors of Pop's. Thus, a well-managed balance sheet was essential. In that regard, industry averages for certain items are shown as Table 3. Of special concern were the company's payables and inventory levels. Mr. Vann believed that a reasonable level in these areas would permit him to maintain a solid relationship with his suppliers and his customers. Vann believed that his long term debt would be constant, that is, would remain at its present level. In addition, he hoped to move the profit nearer to the industry average level, or beyond.

            The loan which Mr. Vann sought from CNB was for the purpose of increasing the company's stock of scrap metal. In recent months, a large portion of railroad track and rolling stock was being dismantled at certain points in the immediate region, and an unusually large supply of steel had become available. These \"bulges\" in the incoming supply of scrap metal were a typical occurrence. It provided the recycling companies an opportunity to build up their backlog of steel and other metals. Such a supply would be used to feed the emerging and successful new, smaller steel companies in the United States. (The cold-roll production process used by foundries had given some hope to the once flagging steel industry).

            In order to properly manage the situation, Vann considered a loan of $200,000 to be adequate for his short-term needs. The financial statements which follow illustrate certain aspects of the company's operating history.

            The bank's loan officer, Cheryl Fries, wanted to make the correct and appropriate decision. Pop's Recycling had a long-standing reputation as a well-run company. In addition, her informal grapevine indicated that Vann handled his credits well. If the analysis of the company's financial statements bore out these impressions, the bank would have gained another solid commercial customer. The essential questions which Fries wanted to answer related to the necessity of the loan, the size of the loan, and if it were actually needed. She began an analysis of the company's needs based upon the audited financial statements shown as Tables 1 and 2.

Table 1 Pop's Recycling Company Income statement data
	1987	1988	1989	1990	1991
Sales	$8,200,000	$8,700,000	$9,500,000	$11,000,000	$12,000,000
Profit after tax	$410,000	440,000	332,000	330,000	336,000

 

Table 2 Pop's Recycling Company Balance Sheet
	1987	1988	1989	1990	1991
Cash	$290,100	$239,266	$229,500	$215,500	$205,100
Accounts receivable	418,200	488,070	532,950	425,000	634,742
Inventory	964,500	1,171,036	1,489,525	2,598,693	3,220,087
Total current assets	$1,672,800	$1,898,372	$2,251,975	$3,239,193	$4,059,929
Fixed assets, net	2,509,200	2,786,061	3,150,513	3,138,540	3,452,383
Total assets	$4,182,000	$4,684,433	$5,402,488	$6,377,733	$7,512,312
Accounts payable	$385,020	$408,476	$647,869	$1,140,650	$1,550,175
Accrued wages and taxes	510,480	541,098	581,400	610,470	673,130
Notes payable - bank	150,000	78,000	75,000	75,000	75,000
Total current liabilities	$1,045,500	$1,027,574	$1,304,269	$1,826,120	$2,298,305
Long-term debt	$585,480	665,839	775,200	775,200	1,101,600
Owner's equity	1,020,408	1,020,408	1,020,408	1,143,801	1,143,795
Earned surplus	1,530,612	1,970,612	2,302,611	2,632,612	2,968,612
Total liabilities and equity	$4,182,000	$4,684,433	$5,402,488	$6,377,733	$7,512,312

 

Table 3 Pop's Recycling Company Selected Operating Data for Major Recyclers, 1991
Profit margin on sales	5 Percent
Total debt-to-total assets	25 Percent
Inventory-to-sales	28 Percent
Accounts payable as a percent of sales	10 Percent
Current ratio	1.80:1

Please analyze the financial condition of the company; under the following category - debt management