Mid-year 2015, Danh Bach, owner of the Bach Manufacturing
Company (Bach), sought a local bank for an additional P$ 50
million1 in cash to meet his footwear manufacturing company’s
capital requirements. After quadrupling revenue from 2 million to 8
million in three years and quadrupling after tax profits (PAT)2 in
the same time frame, Bach boldly acknowledged his company’s
financial needs. Bach highlighted the development of his company,
as well as the dynamics and potential opportunities in Petoria’s
footwear and accessories markets, during a lengthy and fruitful
discussion with the bank manager. Bach enthusiastically presented
his company’s results to the bank manager, which he considered was
excellent in light of the industry’s high level of competition. The
bank manager gave over Bach’s financial papers to his loan officer,
including an income statement and balance sheet (see Figures 1 and
2), and assured Bach that he would contact him within a week once
the materials were reviewed and analyzed. He directed the loan
officer to expeditiously process Bach’s loan application and inform
him of the bank’s decision.
Petorian Footwear Manufacturing Sector
The nation of Petoria (pronounced peh-TOR-ee-a), is the second
largest footwear manufacturer in the world. Petoria’s footwear
industry contributed 2 percent of global spindle capacity and 8
percent of global rotor capacity. By 2021, this sector is expected
to achieve a value of USD 223 billion. With abundant raw materials
and a skilled labour, the country has established itself as a
profitable hub for the worldwide footwear industry3 The Petorian
footwear sector contributed 4 percent to the country’s gross
domestic product; it accounted for 14 percent of Petoria’s
industrial output and accounted for 27 percent of the city’s
foreign exchange inflows. The apparel sector employs around 45
million people directly or indirectly. Demand for footwears in both
the domestic and international markets has bolstered the sector’s
growth hopes. In 2014, cloth output increased by 6 percent in the
Petorian mill industry, while man-made fibre production increased
by 4 percent. The accessory and footwear manufacturing area was
expected to experience strong, robust expansion, which was backed
up by data. Additionally, the industry average of key ratios
demonstrates that the financial performance of textile companies is
consistent and reliable. The footwear and accessories market in
Petoria has grown by around 14.58 percent during the last three
years. In FY2013/14, the Petoria footwear sector garnered USD 11
billion in foreign direct investment, and a industry analyst
predicted that footwear exports from Petoria will reach $60 billion
within three years. This would be facilitated by rising labour
costs in China, greater demand from the United States, and a boost
in the quality of Petoria-manufactured items. In 2013-14, exports
of footwear items in Petoria increased by almost 12 percent over
2012-13, reaching an encouraging USD 35.4 billion4 The United
States had previously been Petoria’s principal market for footwear
exporters.
Challenges faced by the Petorian Footwear
Industry
The Petorian footwear sector faced numerous obstacles,
including:
• a scarcity of trained people • lack of energy and concurrently
rising energy expenses
• prohibitively high transportation costs • imprecise and
out-of-date labour laws
• obsolete technology and industry’ unwillingness to adopt new
technologies
• an absence of scale economies
Bach Manufacturing Company
Bach was founded in 2012 and specialised in fancy party shoes
for girls up to the age of 12. Bach, a trained engineer who had
worked for nearly 12 years in a local footwear manufacturing
company, had left his job to establish this tiny manufacturing unit
with the assistance of several talented labourers he had known for
years. He was well aware of the sector’s competitiveness, given the
presence of both small-scale and large-scale manufacturing
facilities. Bach contended that there was a scarcity of
high-quality shoes in the market. He was certain that by providing
clients with new and sophisticated footwear and accessories at a
low cost, he could capture a sizeable portion of the market that
had not been tapped by large firms. He was also aware that
opportunities in this category were expanding. Bach was familiar
with the entire footwear production process, and hence had little
difficulty launching the business. With P$ 1.2 million in limited
cash, he began operations in April 2012 at his home, half of which
he transformed into a small factory. Installing machines and
acquiring raw materials were not difficult chores for him, and he
was able to get all the resources necessary for manufacture without
meeting any difficulties. The only difficulty he encountered was
locating a designer who could assist him in creating new, current
shoe styles for children. He believed that his experience to design
was insufficient; hence, he hired Quang Phan, a young fashion
designer who had completed a fashion design study program at a
local Petorian/Australian University. With Phan’s devotion, a staff
of motivated, skilled labourers, and Bach’s experience and
expertise, the production unit unexpectedly began receiving orders
in quantities far exceeding its estimates. Demand for the footwear
increased as a result of the fresh and innovative designs,
high-quality fabrics, and fine finishing elements.
Bach’s Financial Situation
Financial liquidity and finance issues became more prevalent as
the business expanded. Bach encountered funding difficulties as a
result of
• the working capital required to make regular purchases of raw
materials
• the lengthy credit periods offered to consumers
• a lack of finances to purchase new manufacturing machines
• insufficient industrial space
Bach launched the company as a private limited company in 2012,
with him and his wife as the only stockholders; they had 1.2
million shares. During that year, he borrowed money in the form of
a mortgage loan and used it to meet the company’s short-term and
long-term needs. During 2012, the company borrowed a total of 0.736
million (taken against the mortgage of his assets, which had a
value of 1.9 million). He continued to borrow money from the bank
as the business grew and the asset requirements increased. The loan
from the mortgage was 1.236 million in the second year and 2.5
million in the third year. Bach obtained the mortgage loan with
little trouble because the mortgaged value of his assets was fairly
high, and he also offered collateral security (his residence house)
to the bank. With positive cash flows from business, servicing
interest on loans was also not a concern. Bach was unconcerned
about the financial subtleties of long-term or short-term loans, so
he just proceeded to withdraw money and use it wherever he saw fit.
Bach’s financial records were kept by a part-time accountant. The
accountant maintained daily accounting records for the company,
which included vouchering, cash management, receipts, and payments,
and created monthly, quarterly, and annual financial statements in
accordance with regulatory standards. A certified public accountant
independently audited his financial statements. Bach was happy and
always felt like a successful entrepreneur because the business was
profitable after all expenses and interest payments were made.
Future Prospects
Domestic and foreign demand, analysts predicted, would propel
the Petorian footwear and accessorises sector beyond the USD 220
billion level by 2020. The retail sector was seeing fast growth as
a result of rising consumption and disposable income. Numerous
national and international businesses entered the footwear sector
in Petoria. Over the next decade, the apparel segment was predicted
to grow at a compound annual rate of more than 13 percent. The
following factors contributed to the textile sector’s rise in the
Petorian market:
• Increases in per capita income and distribution of the
population shift in the youth’s preference for branded products and
changes in the broader population’s lifestyle
• Products of exceptional quality
• Favourable trade policies.
• Increased export opportunities
• Increases in fabric manufacturing in response to domestic
demand
• Increases in the retail sector in response to rising
consumerism and disposable income in the population
• The Petoria government is committed to providing training for
approximately 2.7 million residents through their integrated skill
development scheme. According to the 2012- 17 five-year plan, this
project would span ten garment sub-sectors, including footwear,
accessories, knit apparel, silk farming, and artisanal
handicrafts.
As his business grew and his clientele grew, his financial
difficulties grew as well. Bach’s market credibility was strong,
and he had little difficulty obtaining the necessary raw materials,
but he ran into trouble when attempting to collect money from his
consumers, as he lacked an organised method for tracking credit
period extensions. Bach also noticed stock stacking up in his
factory as orders were either not fulfilled or were delayed by
clients. His machines were likewise becoming obsolete, and he
believed the time had come to replace them with more contemporary
and efficient models. The factory space was insufficient, and an
expansion was necessary. Additionally, he needs new skilled
labourers and some additional staff members to assist his expansion
goals. In sum, Bach needs an extra P$ 50 million to maintain smooth
operations and expand his business, and so, he waits in his office,
eagerly expecting the bank’s decision. Bach anticipates the
decision would be favourable.
- Case Introduction Mid Year 2015 Danh Bach Owner Of The Bach Manufacturing Company Bach Sought A Local Bank For An A 1 (138.14 KiB) Viewed 72 times
- Case Introduction Mid Year 2015 Danh Bach Owner Of The Bach Manufacturing Company Bach Sought A Local Bank For An A 2 (356.52 KiB) Viewed 72 times
’efficiency’ of Bach for the
relevant years. Consider sector (industry) averages when
formulating your analysis.
3. Assume the position as an expert in financial analysis, suggest
four areas Bach can focus
on (financially) to best position himself for future
prospects.
4. Assume the position of the bank, and decide on Bach’s proposal
for funding. Start your
answer by stating that the proposal should be accepted or rejected.
Thereafter, justify
your decision with four arguments.
Ratio Year 1 Year 2 Year 3 Industry Ratio (given) acid test ratio 1.3 0.92 0.79 Current asset turnover ratio 3.03 1.54 1.79 3 Current ratio 2.5 1.79 1.6 Debt-to-equity reatio 0.61 0.77 1.25 0.35 fixed assets turnover ratio 1.05 1.92 1.7 gross margin ratio 0.38 0.41 0.4 interest coverage ratio 9.67 7.07 4.53 Inventory days 58 117 103 Inventory turnover ratio 6.25 3.12 3.55 Long-debt to total capital 0.29 0.22 0.27 0.24 net margin ratio 0.182 0.14 o 0 0.18 Receivable days 61 76 91 Receivable turnover ratio (times) 6 6 4.8 4 Return on equity 23% 25% 22% Return on fixed assets 0.196 0.27 0.18 0.24 Return on total assets 14.21% 12% 9% Total assets turnover ratio 0.78 0.86 0.87 Working capital turnover 5 3.5 4.77 8
Ratio Current ratio Acid test ratio (quick ratio) Receivable turnover ratio Receivable days Inventory turnover ratio Inventory days Long-term debt to total debt Debt-to-equity ratio Gross profit ratio Net profit ratio Return on equity Return on total assets Total asset turnover ratio Fixed asset turnover ratio Current asset turnover ratio Interest coverage ratio (times int. earned) Working capital turnover ratio Return on fixed assets Sector Average 2.30:1 1.20:1 7 times 52 days 4.85 times 75 days 24% 35% 40% 18% 22% 10% 1.1 2 3 10 8 24% Figure 3: Industry average of key ratios