Analysis of Company Position

Associated International Supplies Ltd

Circulation: Associated International Supplies Ltd (AIS Ltd.)

Author: A. Consultant, AXY Consulting

Date: July, 2000

General appraisal

The first point to note down is that the company would be regarded as small by most standards and therefore is likely to exhibit many of the problems typical of that sector. In general small companies which are characterised by strong growth also usually exhibit substantial borrowings in relation to equity funds. It is probable therefore that the appropriate mix of financing for the business becomes a critical issue in the appraisal of AIS Ltd.

Growth and liquidity

In the five year period as of 1994 to 1999 sales for AIS have grown by 150%. The pressures of such increase in terms of supporting the business by adequate working capital can be substantial. Therefore in the same period we see that current assets have expanded by 53% and current liabilities by 91%. Whereas this aspect of the business will be dealt-with in more detail below it is worthwhile questioning at this stage whether sufficient funding for working capital is available to support the growth in sales.

Whereas there has been significant growth in sales during the period PBT as a percentage of sales has actually declined from 8% to about 5%. This should seriously call into question the management either of costs (operational or financial) or whether there is an inability to force price increases onto customers. Specified the information available the most likely source of this problem appears to relate to interest costs. Both current as well as long term liabilities have increased substantially (91% and 276% respectively) against a background of barely increased equity funding. Debt funding both long as well as short term looks to have increased and this will have an associated interest burden. This has an significance in relation to the sustainability of the business.

Earnings retentions don't appear sufficient to fund business growth and hence it is clear that borrowings have been increased to deal with this problem. Nevertheless a balance must be kept in the business between its earnings capability and its capacity to service its debt commitments. Whereas PBT has increased by 53% over the period retentions have declined by about 74%. This may be partially explained by an increased tax burden but is obviously due mainly to excessive distributions. In other words not sufficient funds are being retained in the business to support its growth or funded from increased equity issues.

The impact of extreme growth in relation to its funding base will have potentially a severe impact on liquidity. Net current assets aren't seriously out of line if a ratio of current assets to current liabilities of unity is considered acceptable. Nevertheless when current assets are looked-at in relation to sales a different picture emerges. The ratio was 54% in 1994 and merely 33% in 1999. This proposes in combination with the other information that inventory receivables and cash resources might be insufficient in relation to sales. It might be dispute that this reflects greater efficiency in current asset management which it does when receivables days are compared over the period (they declined from 99 to 60) but not in relation to payables days which as well declined (from 96 to 67 during the period).

When working capital as a percentage of sales is measured we observe a decline from 11·4% in 1994 to 0·5% in 1999 which looks to be a reflection of reduced current asset investment and overdraft increases.

For the reason that it is debt rather than equity funding that has grown the business faces a potentially critical situation. We know that current assets are mostly comprised of inventory and receivables because the business has substantial borrowings it is unlikely to simultaneously have large cash balances and that this is being funded by borrowing rather than retained earnings. The basis why this is the case is for the reason that the business isn't generating adequate profits and it is distributing too much of post tax earnings. The outlook is for greater borrowing. The deprived profit figures suggest that a critical point has been reached in terms of liquidity and solvency. This is replicates in debt/equity ratios which have increased from 2·19 in 1994 to 4·22 in 1999 (current and long term liabilities used as debt and capital and reserves used as equity). Unless a capital reorganisation is able to take place quickly either through injected funds or conversion of debt into equity the business is likely to become insolvent.