Cape Chemical Case

After preparing a cash flow forecast(table 1,attached) for Cape Chemicals , I have noticed that based on a much lower growth rate than prior years, operating cash flows are going to come negative and getting even worse by the year of 2010 and 2011, therefore we will need to do something about it. There are several risk factors with the company at this precise moment. One is the cash has been declining, not enable the company to meet its obligations on time, secondly account receivable and inventory are representing more than 60% of their total current assets.

In my opinion, sales target of $78000 for 2008 year is not going to be feasible due to the fact that to be able to accomplish that, Cape Chemical will need approximately $4.2 million in new financing to acquire a specialty chemical line and provide the necessary resources to achieve the planned sales growth. Based on their current financial position, no bank will lend them the money because their debt ratio is above 50 %. Therefore, my assumption is that I cannot based my growth rate sole on prior years growth, but instead I can assume that their growth is going to be lower than prior years around 0.36, until the company can lower their debt ratio to be able to borrow money to invest in the specialty product line that will increase their sales growth and help their cash flows.

Analyzing the variable cost factor, I said that cost of goods sold and selling expenses are going to be my variable costs because these change relative to sales. Costs are really high, it is currently reflecting as 86% of revenue. For the fixed cost analysis, I decided that general and administrative expenses are fixed. These costs can change over time, but I do not think they are closely related to the change in sales.

Analyzing working capital, based on 2007 factor of 0.170, and assuming a 0.165 for the future, I can say that for $1.00 sales increase, Cape Chemical needs $0.132 in receivables and $0.133 in inventory, and trade creditors will finance $0.095 of the investments. These ratios reveals some problems. First of all, I do not see a similar trend in the account receivables because the company collectors had slow down the collection of payments causing many customers to be passed due, and as a consequence affecting the company cash flows.

Another issue is inventory ratios because those do not show any trend either, and the most recent is the highest compared to the prior three years of data. This increased in inventory was to support the "the next day delivery" policy that the company implemented in 2007, which even though it increased sales, it was affecting the company's cash flow because inventory represents about 33% of its total asset. Finally, the working capital factor has been increasing, indicating that a relative amount of working capital has been used to support sales, which in theory it is the least productive investment in a firm.

It is hard to estimate how much investment will be needed to preserve current capacity based on historical information, however I see that gross fixed assets have increased by about $1200 in the past 2 years, so I will use this to calculate C[replacement].

Based on the theory that if a company generates cash flow, it can be used to pay some debt, and if cash flows are negative, it will need to borrow money to pay for its obligations. Analyzing gross debt compared to the free cash flows, Cape Chemical is not making enough cash flow to meet their obligations, however by making principal payments, their debt is getting better over time.

By showing a shortage in inventory of $0.8 million for the year of 2008, it has helped out operating cash flow to be cut by almost half, however this will probably affect