Delta Inc. is a company which has an enormous amount of revenue as receivables (60%) from its customers like 'Pink Tree Finance' (PTF). The critical issue facing Delta is receivables management, risk of failure and financial direction of cash flows. Flexibility of cash flows would enable the company to react to unforeseen events like that of PTF bankruptcy. Delta worked on a two-way revenue model but foregone the revenue from the borrower for finding them an institution to loan the money required. This led to Delta's inability to respond to the situation of PTF bankruptcy. Delta had some liquidity as well as solvency issues as the firm's liquidity ratios were below industry averages. From the below ratios, we can infer that Delta's liquidity ratios were below the industry average. Thus it was already in a risky business which totally depended on its debtors. The return-to-assets ratio is improving but at a very slow pace. This indicates that Delta is not using its assets properly for earning income.
Current Ratio (1999) = 112286 / 195224 = 0.58
Current Ratio (2000) = 425142 / 380986 = 1.12
Current Ratio (2001) = 752999 / 514227 = 1.46
Current cash debt coverage ratio (2000) = 17,146 / (195,224 + 380,986) = 0.03
Current cash debt coverage ratio (2001) = 18,210 / (514,227 + 380,986) = 0.02
Cash debt coverage (2000) = 17,146 / (811,016 + 625,254) = 0.012
Cash debt coverage (2001) = 18,210 / (944,257 + 811,016) = 0.01
Debt to total asset ratio (1999) = 625,254 / 786,467 = 0.80
Debt to total asset ratio (2000) = 811,016 / 1,099,323 = 0.74
Debt to total asset ratio (2001) = 944,257 / 1,427,180 = 0.66
Return on Assets (1999) = 61213 / 786467 = 0.08
Return on Assets (2000) = 127094 / 1,099,323 = 0.11
Return on Assets (2001) = 194616 / 1,427,180 = 0.13
Q. 2) List some topics related to receivables management.
Some topics related to receivables management are:
Aging Analysis: Aging analysis is used to calculate the average number of days taken by the company to collect payments from the customers. The aging analysis is used to find out liquidity of the firm.
Factoring: Factoring refers to the sale of a firm's account receivables to a financial institution or a third party called as a factor. The firm and the factor agree on the basic credit terms for each customer. The customer sends the payment directly to the factor, and the factor bears the risk of nonpaying customers. The factor earns by buying the receivables at a discount of 0.35 - 4 % of the value of the invoice amount. The benefits of factoring are credit coverage and guarantee for payment of doubtful debts.
Collection: Collection refers to obtaining payment of past-due accounts. For effective collection, a team responsible for collection should be formed and to refer the receivables to collection agencies. Analyzing the levels of effort in record keeping and collection is important to ensure its proportion with collection value. A tighter collection policy can reduce the probability of default which in turn can raise the NPV of a liberal credit policy.
Granting credit limit:
It frees up valuable time for other credit management tasks
It speeds up the sales process
It is an account monitoring tool
Provision for Bad Debts: Provision for doubtful debts are known as Allowance for Bad Debts, Doubtful Accounts or uncollectible accounts. It is a type of contra account with a credit balance. It gives the net realizable value of accounts receivable.
Q. 3) To what extent did Delta's business strategy impact the firm's accounts receivable and cash flow problems?
Delta's strategy of being a discount broker backfired in this case. Delta charged fees for brokerage services to clients without direct billing. Delta charged brokerage fees from the lender after the loan transaction was closed by the client. This delayed the collection process thus leading to low receivable liquidity and increased the cash flow risks. Their revenue strategy worked on paper because as given in the case its net income increased by 267% and 217% respectively in just 2 years. Delta's receivables turnover ratio was lower than the industry average. Delta's receivables liquidity problem also contributed to the firm's low cash flow position.
Delta's receivable turnover ratios:
Accounts receivable turnover ratio (2001) = 820,226 / [(668,932 + 359,285) / 2] = 1.6 times
Accounts receivable turnover ratio (2000) = 531,617 / [(359,285 + 63,575) / 2] = 2.51 times
Q. 4) How should Delta report the Pink Tree debt in its financial statements?
Chapter 11 bankruptcy is a situation of corporate reorganization with debt repayment plans for the company. As Pink Tree had filed chapter 11 bankruptcy and Delta had not securitized its receivables, it should be reported as uncollectible assets and written off. The amount should be credited from receivables head and debited to provision for doubtful debts.
Q. 5) What are the major constraints against the continued success of Delta as a discount broker?
The major constraints acting against Delta are the following:
Diversification from core competency business of brokering.
Collection of accounts receivable should be organized in a timely manner.
Financial risk of business partners should be assessed using different FRM models.
Financial liquidity should be maintained by mitigation of risk through investment in liquid assets and gain form new opportunities
Q. 6) What suggestions related to the liquidity and solvency of Delta's operations would you make?
Delta should revive its business model and make clients pay for the services especially from future tenants at West Baltimore Street. An effective accounting reporting system that would alert the management of potential problems with financial flexibility should be set for active functioning of the business activities. Risk analysis of its clients as well as business partners would strengthen its accounts receivables and collections.
Delta can use the following financial models for risk analysis:
ALTMAN MODEL
SPRINGATE MODEL
FULMER MODEL
BLASZTK SYSTEM
CA-SCORE MODEL
The ALTMAN MODEL is the most precise and consistent model widely used in the industry.
Q. 7) What recommendations related to Delta's financing of the $100,000 would take?
Due to unavailability of time, Delta Inc. should finance the loan transaction through a fast-track bridge financing program offered by some lending institutions. Although the interest rate of such programs can be as high as 15% for 90-days, the advantage is that financing can be obtained in as little as 10 days and no upfront fees are required.
They can lease their long term assets to bank or financial institution for a short-term and arrange for financing of $100,000. Raising funds by floating commercial paper in the market is also one option that Delta can work upon for financing $100,000.
It can also exploit opportunities like advance receipt of fees from loyal clients. We can see that it is left with receivables of $267,593 (668,982 - 401,389) after deducting amount written off for Pink Tree Finance. So there exists an opportunity of getting an amount of $100,000 from the receivables. It can offer partnership to the clients in return for the amount.
