Recovery of Dues from Default Customers

The company is facing a liquidity crisis and has taken a loan to buy back its own shares, which may have an indirect impact on its long-term future. The company's proposed dividend payout in September 2013 should be critically assessed as it seems that the company has not transferred sufficient funds from its profit and loss statement towards retained earnings. It is suggested that the company should focus on repaying its debt rather than paying dividends, to cleanse its balance sheet and attract more investors.

1. Why can’t profitable company like Jackson repay its loan on time? What major company
developments between August 2012 and May 2013 contribute to this situation? Prepare a
sources and uses of funds statement for Aug 2012 through May 2013.
Loan repayment has a thing to do with the Liquidity of the Company. A profitable company
has good profit margins from the business. However, its cash richness or liquidity can be
judged from the Short term Liquidity ratios. The fast movement of stock and receivables
provide fund to repay the suppliers / creditors or outside liabilities. The banks provide short
term working capital term loans with the sole criteria of checking the cash flow statement of
the company for the defined period of loan tenure. A good turnover with low operating
costs does not imply that the company has good realizability of money from the outstanding
receivables.
Jackson is an Automotive Assembler company and has to do business with the Automobile
manufacturers and Engineering / Mechanical manufacturer companies. The payment
depends on the automobile sector and its performance. For eg in peak season the stock
churns very fast which is not the case in slack season. There is huge turnover in terms of
fresh stock requirement which instigates manufacturing. More production means more
creation of income. The same can be fuelled with the support of easy finance and fast
customer repayments. (Piiper, et al, 1970)
It is evident from the financial statements of Jackson that the Receivable balance in the year
2012 has remained stable and has not decreased. So has the inventory maintenance in the
respective months. The sales figures have also remained more or less on same lines. It
appears from the assumptions that the company has policy of 30 days credit to customers.
We have worked out the Debtor Turnover ratio for August 2012 and September 2012 and
have found out following calculations:
The debtor ageing (Reddy, 2004)is actually more than 340 days which indicates that the
payments are not realized. According to me this the prime reason for the company for not
being able to pay off the loan despite having huge profit surpluses. There fore it is very
crucial for the stake holders / investors / fund providers to check the Cash flow statement
over and above the financial statements before investing of showing interest in the
company.
Major Developments
The company has been given a Loan of $ 5 million from financial institutes which is either
having a moratorium period (Frank, 2000) or the repayments have not yet started because
of the cash problem. Apart from this we are unable to see any major development in the
balance sheet of the company.
Particulars \ Month Aug-12 Sep-12
Sales 6,321 5,969
Debtors 5881 6195
Debtor Turnover Ratio
(A/B) 1.075 0.964
Debtor Ageing in days 340 379

Sources and Uses of Fund statement
2. Why does the Company need a new loan? How urgent is the need for the additional
borrowing?
2012 2013
August Septemb
er
Octobe
r
Novem
ber
Decem
ber
Januar
y
Februa
ry March April May
Application
of funds
Cash 8,350 3,328 3,523 4,511 4,239 4,878 5,182 3,962 6,277 4,994
Accounts
receivablea 5,793 5,969 6,421 5,851 6,009 6,170 5,606 5,197 3,365 3,744
Inventory 7,154 7,364 7,524 7,219 7,277 7,097 7,529 8,371 11,23
4
12,16
3
Current
assets 21,297 16,661 17,46
8
17,58
1
17,52
5
18,14
5
18,31
7
17,53
0
20,87
6
20,90
1
Gross PP&E 45,500 45,500 45,50
0
45,50
0
45,50
0
45,50
0
45,50
0
45,50
0
45,50
0
45,50
0
Accumulated
depreciationb 30,368 30,488 30,60
8
30,72
8
30,84
8
30,96
8
31,08
8
31,20
8
31,32
8
31,44
8
Net PP&E 15,132 15,012 14,89
2
14,77
2
14,65
2
14,53
2
14,41
2
14,29
2
14,17
2
14,05
2
Prepaid
expenses 242 58 23 45 47 52 65 46 46 54
Total assets 36,671 31,731 32,38
3
32,39
8
32,22
4
32,72
9
32,79
4
31,86
8
35,09
4
35,00
7
Source of
funds
Accounts
payablec 4,977 5,197 5,347 5,352 5,110 5,130 5,162 5,122 6,223 5,969
Notes
payable, bank 0 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000
Accrued
taxesd 252 4 174 331 107 269 417 140 216 273
Other
accrued
expenses
1,500 1,542 1,542 1,542 1,542 1,542 1,542 1,142 1,142 1,142
Customer
advance
payments
1,651 1,651 1,651 1,200 1,200 1,200 800 800 2,700 2,700
Current
liabilities 8,380 13,394 13,71
4
13,42
5
12,95
9
13,14
1
12,92
1
12,20
4
15,28
1
15,08
4
Shareholders'
equity 28,291 18,337 18,66
8
18,97
3
19,26
5
19,58
8
19,87
4
19,66
4
19,81
3
19,92
3
Total
liabilities and
equity
36,671 31,731 32,38
3
32,39
8
32,22
4
32,72
9
32,79
4
31,86
8
35,09
4
35,00
7

WHY?
Any company needs loan to leverage (Bouchoud, 2001)its finances. There are mainly two types of
finances. Long term finance and short term finance. Generally long term finance is used to procure
long term assets which are income generating. For eg to purchase plant and machinery, office
equipment, furniture and fixtures, office building etc. These are spread over long period. Generally
the finance provider offers a moratorium period for few negotiated months in order to give an
additional space for the company to incur initial expenditures without generating any revenue.
Second type of loan is short term in nature. They are generally meant for meeting short term
liquidity or working capital requirements. These are generally against the hypothecation of stock and
book debts of the company (LaPray J, 2001). Short term finance is generally for a tenure upto 3 years
and long term is more than 3 years.
URGENCY
Urgency depends on the application of funds. If the company wants to pay off the suppliers and avail
trade discount on bulk order purchase, then the requirement of finance is urgent. If the company
seeks a project loan (Esty, 2001), it may defer to about few months which are required for planning
and developing the project feasibilities. In this case, it appears that the company has taken a long
term funding. However, the company is not involved in any capital intensive project. And hence it is
evident that the long term funds are used for short term liquidity ( Kamara, A.,1994) purpose. This is
one of the reason for fundamentally not being able to repay the debt.
3. MONTHLY CASH BUDGET
Months
Particulars Feb Mar Apr May Remarks
opening balance 5,182 6,222 6,666 6,741
Recovery from
Customers 6,170 5,606 5,197 3,365
Outstanding balance of
Previous month is received in
current month as 30 Days
payment cycle
Payment to
Suppliers -5,130 -5,162 -5,122 -6,223
Outstanding balance of
Previous month is paid in
current month as 30 Days
payment cycle
closing balance 6,222 6,666 6,741 3,883
BALANCE SHEET
2013
Februar
y March April May
Cash 5,182 3,962 6,277 4,994

Accounts receivable 5,606 5,197 3,365 3,744
Inventory 7,529 8,371 11,234 12,163
Current assets 18,317 17,530 20,876 20,901
Gross PP&E 45,500 45,500 45,500 45,500
Accumulated depreciationb 31,088 31,208 31,328 31,448
Net PP&E 14,412 14,292 14,172 14,052
Prepaid expenses 65 46 46 54
Total assets 32,794 31,868 35,094 35,007
Accounts payable 5,162 5,122 6,223 5,969
Notes payable, bank 5,000 5,000 5,000 5,000
Accrued taxes 417 140 216 273
Other accrued expenses 1,542 1,142 1,142 1,142
Customer advance payments 800 800 2,700 2,700
Current liabilities 12,921 12,204 15,281 15,084
Shareholders' equity 19,874 19,664 19,813 19,923
Total liabilities and equity 32,794 31,868 35,094 35,007
4. Based on your forecast, and analysis of Jackson’s credit, is the company able to repay its
loan at the end of the fiscal year? What are the risk associated with the proposed loan?
According to my analysis and forecast of Jackson’s credit, the company shall not be able to pay the
Loan because of lack of liquidity as worked out earlier. It appears from the Debtor turnover ratio
that the movement of receivables is not fast. The payment cycle is very long. And so is the operating
cycle of the business. Main risk associated with the proposed loan is the repayment schedule. The
company has liquidity issues and it seems that the company’s customers do not pay their
outstanding dues in time. It is risky for the bank / financial institute to fund the company looking at
the current ratio and cash flow for the coming months. Thus company shall not be able to pay the
loan if it continuously distributes dividend / does not transfer appropriate amount into its reserves
and surplus account
5. Critically evaluate the assumptions on which your forecasts are based and perform
sensitivity analysis on the fiscal year end cash balance when sales forecasts vary‐
from expectations.
Sensitivity analysis (Homma, et al 1996). can be done on the basis of 3 assumptions. Cost, Volume
and Profit / Revenue. With the increase in cost by “x” percentage, the impact of cash profit. With the
increase in volume of sales by “x” percentage, the impact of cash profit. With the increase in sales
price by “x” percentage, the impact of cash profit. Below is a sensitivity analysis of the company. We
have increased the sales price of the product by 10% and have identified its impact on the
profitability. The same has increased on similar lines. However the issue is not confined to the lack of
profitability but it lies in the liquidity of the company.

2013
Februar
y
2013
March
2013
April
2013
May
Eight
Months
Total
Net sales 6,006 5,197 4,165 3,744 44,014
After Sensitivity Analysis 6,306 5,457 4,373 3,931 46,215
COGS 4,692 4,087 3,215 2,876 34,297
Gross profit 1,614 1,370 1,158 1,055 11,918
Operating expenses 744 685 587 566 5,608
Depreciation and
amortization 120 120 120 120 960
Interest expense 25 25 25 25 200
Interest income 8 9 7 10 60
Profit (loss) before tax 733 548 433 355 5,210
Income taxes 249 186 147 121 1,771
Net income 484 362 286 234 3,438
Dividends 0 400 0 0 400
6. Should the bank extend the maturity of the current loan and approve the
additional loan? What terms and conditions should the bank impose to reduce the
risks of the loan to the bank?
According to my opinion, the bank should focus on its repayment rather than enhancing the loan
tenure. The bank should pressurize the customer and try to fetch in maximum payment for the
instalment. The bank can also initiate securitizing act and issue notices to the loanee which would
create a psychological effect on the payment intention. More over the bank should include a clause
for Escrow payment where in the customers of the Company shall deposit the money directly in the
escrow account. Directly it reaches the Bank and it clears its dues and interest. In order to reduce
the risk of the loan to the bank, the bank should restructure the loan and make it comfortable to the
customer. A thourough credit assessment (Miller, et al, 1988) should be done before disbursement of
the loan. The matter should be forwarded to the recovery camps which take care of the recovery on
commission and contract basis. It so happens in a bank, that the primary function of the bank is to
advance money and not to recover. The bank should appoint third party recovery agents who take
care of the recovery of dues from the default customers for a commission payment. As a last resort
the bank can also enter into compromise arrangement with the customers and write off certain
portion / interest / duration of the loan. Short term ad hoc funds are often provided by the banks to
serve the heavy interest. The bank can also think of reducing the interest rate or increase the loan
tenure which reduces the Equated monthly instalment for the company. According to me, the
system of creating Escrow account is the most effective one as it creates a win – win situation to the
banker and the customers. It creates trust for the company’s creditworthiness (Broecker, T., 1990).
The bank can also appoint a nominee director in the company who takes part in the decision making
of the company in the board meeting. The nominee director ensures the bank that the company
functions in accordance with the memorandum of association and articles of association which had
formed a basis of providing finance to the company.
7. Why did the company repurchase a substantial fraction of its outstanding common
stocks? What’s the impact of the repurchase on Jackson’s financial condition?

Logic of repurchasing common stocks, also known as Equity shares from outside parties is to regain
controlling power in the own business. It is possible in case of Jackson that the equity shares were
held by public or owned privately by third parties. The loan was taken by the company to buy back
its own shares. The purpose of taking loan can not be for the purchasing of own stake. This is the
reason why the company could not improve its operating cycle nd thereafter repay the loan amount
regularly. It is clear from the balance sheet and cash flow statement, that the company is facing
liquidity crisis. The company would have thought of changing policies in the articles and modify the
business according to the demand and supply matching requirements. this is why perhaps the
company woud have thought to buy back its own stocks for becoming a closely held company where
all the powers and appropriations get accumulated in the close network of people. This has an
indirect impact on the long term future of the company. The company is actually separate from its
promotors and board of directors. But with this kind of arrangement, the company becomes severly
dependent on the Promotors and directors which is harmful in the interest of stakeholders. The trust
which the stakeholders have in the organizational structure has likelihood of getting diminished.
IMPACT
Impact can be both ways. A proper planning, and correct way of channelizing the payment cycle by
changing the internal and significant accounting / finance policies can help the company to do
excellent financial leverage. It can afford to procure more and more amount of outside liablities and
invest the same in own business. The return on investment if higher than the cost of debt could
substantially help the business to increase its profitability. With the increase and betterment of the
operating cycle, the company can build comfort to collection aspect of its bankers and improve its
credit worthiness in the eyes of the bank. However, with the promotors buying back its own shares
can influence the working pattern of the company. This may lead to generation of disgruntal
employees as they might not wish to function in a closed and rigid framework of policies. The control
is the criteria which can be made to use in the most effective and efficient manner as well in the
most disructive manner.
8. Critically assess the company’s proposed dividend payout in September 2013.
Should the bank agree with the payout? What seems to be an appropriate
amount?
The dividend pay out of the company was very high in the month ended September 2012 and that in
March 2013. The company has distributed profits to the share holders instead of reinvesting in the
business. The company has not transferred appropriate amount in the general reserve it appears
from the analysis of the financial statements. The company should follow a practice of transferring
appropriate amount of money from its profit and loss statement towards retained earnings which
will be ploughed back in the business. Dividend payment is just like withdrawal of funds from the
business. All businesses are designed with the idea of making profits and realizing the same. The
directors are always keen to calculate their share of earnings from the business against the
responsibilities they assume. They should understand the existing position of the company and shall
then withdraw money in the form of dividend from the financial statements. It is unjust for the
outside stakeholders if there are dues outstanding in the business and the company pays dividend to
the share holders who are all closely held which benefit directly or indirectly to the Key management
personnel or their relative. This type of a situation is very common in case of privately / closely held
companies where the relatives (either husband wife or father son / daughter) are the directors and
share holders of the company. The company in this case should not declare dividend and save it for
the supplier payment and improving the operating cycle. The strength of the company is not always
deicided from the networth of the company and its equity holders. But it has a lot to do with the

satisfaction of business which the company provides to the outside parties / suppliers / bankers etc.
it should be more of a social upliftment
According to me the company should not pay dividend for few years and focus more on repaying
the huge burdensome debt so as to cleanse the Balance sheet of the company and attract more
investors.

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