"Growth comes with a price"

Subject Company (SC) is founded in 1985 by Mr. Builder Tan. The firm operates in more than 3 countries in Asia, primarily dealing with construction and development of land for residential and commercial projects. It has around 100 employees and currently embarks on an aggressive campaign to grow its business in an ailing industry.

Summary:

Despite having a high liquidity rating of LR2.1 (LR1= excellent, LR6 = poor), SC's financial condition is still constrained by an abnormally high incidence of non-cash assets in its balance sheet. This reflects a biased liquidity position, as the quality of current assets, particularly “other current assets", may be questionable.

Strong revenue performance was registered, but this came at the expense of cashflows, where the latter constituted only around 1.3% of total assets during the year. The decline in cashflows stemmed from various reasons, such as investments in fixed assets as well as cashflows that were tied to non-cash items. The total cashflow existing in the firm is still insufficient to meet the working capital requirements. Such rapid growth experienced by the firm, although may seem positive at the onset, may potentially be a source of concern to creditors as a result of these factors. Within the cashflow from operations, SC paid around $10m to pay off its overdrafts and investment in other current assets amounting to $4.6m.  Further understanding from Management is required to ascertain whether this is a one-off or a recurring event.

Within SC's operations, it is noted that despite having a constrained cashflow position, SC adopted a faster payment approach to creditors; which could also be the result of demand for faster payment from creditors.

SC's balance sheet is not particularly strong overall because under a harsh condition of sales decline of 10% to 30%, it may not be able to absorb the drop, and likely to require additional funding amounting to around $1.3m and $7.9m respectively.

     Summary: Overall Liquidity Strength                                 2004                        2003

                                                             Liquidity           Credit Ratios             Liquidity

         Rating
         Current Ratio (x)                              2.00         1.33                         1.41         4.00
         Quick Ratio (x)                                2.00         1.33                         1.41         2.00
         Average LR Score (single-year)         2.0                                                         2.4

         Wtd Average LR Score (2-year) 2.1           LR1 = Excellent liquidity - LR6 = Poor liquidity

Based on its liquidity ratings, it can be suggested that a high degree of liquidity exists in the balance sheet with significantly high level of liquid assets providing more than adequate
There was significantly higher sales growth, accompanied by increased cash balances compared to the previous period.

SC posted revenue of 32,683,877 compared to 21,681,961 in 2003. This was significantly higher compared with 2003, registering a change of 50.74%.

On the other hand, SC posted a surge in cashflows by 107.40%, making its total cash levels operating at a very alarming level relative to its revenue stream of circa1.30% compared to 0.95% in 2003.
The level of operating cashflows may not be adequate to cover its short-term liabilities reliance on other forms of financing is necessary to support its working capital requirements.

1 higher proportion of cash to assets compared with previous year.
2-4 non-cash assets formed around 2% of assets, worth a total $1,062,812 in 2004

Positive trend exhibited with cash balances experiencing a major surge in absolute terms, on the back of higher sales recorded for the period.

A higher proportion of cash to total assets was achieved during the year - the firm generated higher level of cash for every dollar of assets being invested.

From the table above, it can be seen that a lower proportion of trade debtors exist in its balance sheet for the year - fewer debtors are being generated as a percentage of total assets, compared to the previous period.

Meanwhile, there was an unchanged position in terms of the proportion of inventories relative to total assets of the firm.

note: Figures generated from the system may differ from published statements due to adjustments and assumptions made to the underlying variables. The operating cashflows stated herein are an estimate only

Cashflow Statement (excerpts)                2004         Key comments for the year
Profits for the period                          477,502.00       SC made profits
Depreciation                                               0.00 
Increase in trade debtors                   -441,587.00      Cash tied up in customers
Unchanged stock levels                               0.00      No cash tied up in inventory
Increase in other current assets      -4,634,205.00      Cash tied up in non-core current assets
Increase in trade creditors               5,225,936.00      Credit extended for supply acquisition
Decrease in overdraft                   -10,680,180.00       Repayment of overdrafts by the firm
Decrease in Other CL                       -277,285.00       Payments to other non-trade creditors
Cashflow from Operations         -10,329,819.00       *Warning* - Decline in CashFlow

Operational diagnosis: Operating Cash Cycle Diagnosis

There is a deterioration seen in the cash cycle of the firm, with longer collection periods experienced as compared with payment and inventory days in total.

                                                                                    2004               2003                Notes
Accounts Receivable Turnover (x)                        15.52             10.30                    5
Average A.R Collection (days)                               23.52             35.45                    6
Average Inventory Turnover (x)                                 0.00               0.00                    7
Inventory Days (days)                                                0.00               0.00                    8
Average Creditors Turnover (x)                                1.85               1.38                    9
Average Payment Days (days)                            197.82           264.64                 10
Cash Cycle (days)                                                -174.30          -229.18

The negative contribution from operating cashflows could be partly explained by:

Note 5     Implies that the firm operates on a cash basis with some improvement or that its extension of credit and collection of accounts rceivables is more efficient

Note 6      An improved turnaround time for debtors to get converted into cash

Note 7      Unchanged inventory turnaround time - stable inventory movements.

Note 8      Unchanged leadtime for stock to cash conversion over the year

Note 9      The firm may have decided to hold onto its money longer or that it is having greater difficulty paying creditors. However, the firm may be losing customer discounts if payments not prompt.

Note 10   *WARNING* Shorter payment days to suppliers vs previous year - need to manage trade cycle more carefully.

*ACTUAL FIGURES BELOW     Drop in revenue base - impact on cashflows and profits
                                    2004                               5.00%              10.00%              30.00%
Sales            32,683,877.00
Operating           867,328.00
Profit after tax     477,502.00                                         Amount affected

                                                     1,634,193.85          3,268,387.70           9,805,163.10
Impact on net profits (new)               -1,156,691.            -2,790,885.             -9,327,661.
Impact on net profit margin (new)         -3.54%                  -8.54%                  -28.54%
Impact on total cashflows                 -1,208,676.            -2,842,870.             -9,379,646.
Applied against existing     867,328.00
operating expenses level   867,328.00

Net cash balance / (deficit)                -2,076,004.85         -3,710,198.7           -10,246,974
                                                           *WARNING*          *WARNING*          *WARNING*

Availability of funding from key sources

Trade debtors           2,326,816.00          note: Quality of current assets need to be assessed by the user of this
Stocks                                       0.00          report. For instance, how liquid are the inventories, how saleable
Short-term loans                      0.00          and  the quality of its debtors - can this be reasonably collected and
Long-term loans                      0.00           to what extent this can be financed by the banks or the FIs.
Total                            2,326,816.00         

                                                             Drop in revenue base - impact on cashflows and profits

                                                                     5.00%              10.00%              30.00%
Additional funding required to support         0 .00              1,383,383           7,920,158
working capital needs (estimated)

% of total assets                                           0.00%                4.95%               28.32%
% of total equity                                            0.00%               14.58%              83.48%
% of total sales                                             0.00%                 4.23%              24.23%

Key Comments from the What-If

Assuming a 10% to 30% drop in  revenue is experienced by the firm, the resultant effects this has on its overall cash balances, and taking into account its operational needs, suggests that the firm requires additional external and internal funding to support its operations (other than its existing assets and loan facilities). The firm's current balance sheet strength may not be able to withstand economic shock based on its existing financial structure.