Question

Liquidity Management

Global Manufacturing Company (GMC) is an Ohio-based company specializing in electronic controls for automated manufacturing and assembly line machinery. GMC’s products are used in a wide variety of industries, including automotive, computers, consumer electronics, and appliances. The company was founded by two electrical engineers, Frank Kilowatt and Larry Voltz and began operations in 1979, initially selling their products to smaller manufacturing machinery suppliers in the U.S. market.

They have expanded significantly in recent years and now sell a small portion of annual sales to companies in Canada, Mexico, and Europe. Due to the high level of demand for their products, they are able to price all of their sales in US Dollars and sales have been growing rapidly (about 25 percent per year. For the last three years (2016 – 2018) their profits have been exceptionally strong, but there always seems to be a shortage of cash for their operations.

Even though Frank and Larry have put in extra equity capital, reinvested all net profit back in the business, and used long-term borrowing as much as possible for the expansion of production facilities, they are continually having to make short-term borrowing arrangements with their bank to cover funds shortfalls, sometimes with very little notice.

Working with your consulting team, examine GMC’s current financial position and see if you can determine why they are having these liquidity problems. The firm’s current financial statements are provided in the excel spreadsheet. Assume a tax rate of 35 percent and a weighted average cost of capital (WACC) of 10 percent.

Specific Questions:

1. Why may companies with high growth rates have liquidity problems?
2. How does the fact that this company is a manufacturer affect its liquidity needs as it grows?
3. Are revenues, profits, and cash flows all basically the same thing?
4. What liquidity problems does this firm have?
5. Are the liquidity problems related to the company’s growth and capital structure?
6. What would you do to solve this company’s problems?

Answer 1

1. Why may companies with high growth rates have liquidity problems

GMC is a highly growing company. When a company gets growing then there will be a huge need for cash. When more sales come in more employees are needed, more offices are required and more inventory and new machines are also purchased. Money can easily vanish if there is a sudden increase in the demand for a product.

2. How does the fact that this company is a manufacturer affect its liquidity needs as it grows?

Global Manufacturing Company (GMC) is an Ohio-based company specializing in electronic controls for automated manufacturing and assembly line machinery. GMC’s products are used in a wide variety of industries, including automotive, computers, consumer electronics, and appliances. They have expanded significantly and their sales are growing 25% every year. GMC is manufacturing electronic controls and its inventory will be more expensive and it has also expanded its operation to Canada, Mexico, and Europe so the company had to hire new labours and employees and it required new offices, manufacturing units and more inventory. These factors affected GMC's liquidity needs to grow.

3. Are revenues, profits, and cash flows all basically the same thing?

Revenues, profits and cash flow are not the same thing but interrelated.

Revenue is the total sales of the company. Revenue includes Cost of goods sold plus the profit of the company.

Profit comes from the Revenue of the company. Cost of goods sold and all other expenses reduced from revenue or total sales of the company is the profit of the company

Cash flow is the net amount of cash and cash equivalents being transferred into and out of the business. Cash flow is the amount of available cash within a business at a given time, as a result, of the inflow and outflow of money.

4. What liquidity problems does this firm have?

This firm is experiencing a short term working capital requirements. The company has borrowed long term funds to expand production units now the company is suffering from working capital requirements which are working of day to day operations of the business due to less cash flow. Day to day operations includes the purchase of inventory and salaries to labors etc.

High profit and low cash flow result in a profitable business unable to pay its debt. Business may borrow funds to meet the requirements but the amount of profit may not be received at the time of sales many wholesale customers hold their invoices up to 120 days before payment. So the company needs to borrow funds and required to pay a huge amount of interest.

The liquidity crisis is a big problem for the company. If the per-unit cost exceeds breakeven it can lead a company to bankruptcy.