The Dilemma of better choice
Mr.Sachadeva has joined as the Senior Manager- Finance in ABC Ltd which was commissioned as a start up two years ago. ABC Ltd is engaged in the manufacture of fuzzy logic timers used in white goods.
The company was started with a capital of Rs 1crore and 20% of the capital has come from owner's equity and the rest from venture capital financing @ a cost of 20%.
On joining the company Mr Sachdeva took a look at the balance sheet of the company. The principal takeaways from the profitability statements were as follows:
While the sales book position was comfortable and growing steadily the accumulated losses made until then were largely due to high interest serviced for the venture capital borrowing.
Mr Sachadeva decided to approach the capital market for fresh infusion of capital and decided to keep a target average cost of capital of 12%.
On the operating front as he assumed charge the following position was made available:
1. A short credit position of 30 days from customers which generated a cash surplus position .The cash surplus had been allowed to accumulate as cash keeping in view the need to pay regular interest on the venture capital borrowing
2. The supplier credit position was 45 days from the date of supply. Following a JIT production system the cycle time was pegged at one week.
3. All the customer outstandings were either backed up by bills which can be discounted or letters of credit with a maturity of 30 days.
4. The working capital interest was @ 18% and discounting charges of bills or lc was @ 2% per month.
Five years later:
1. The capital structure was @ 50% equity and 50% debt serviced @ 10%.
2. The post tax free cash flow was at about 20 lakhs per year.
3. The choice before Mr Sachadeva was whether he would spend 50% of the surplus or 75% of the surplus.
Questions:
1. Analyze the approach of Mr Sachadeva to the Treasury function .Analyze the cost benefit function of venture capital financing vs capital market financing.
2. Analyze the advantages of the credit position on the supplier vs customers.
3. Given the advantages of present position make an opportunity cost benefit analysis in discounting vs outright payment.
4. If you were Mr Sachadeva what would be your recommendation for a dividend payout.