Q. 1) What is the critical issue facing Delta Inc.? 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.
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 for 1999 = 625,254 / 786,467 = 0.80
Debt to total asset ratio for 2000 = 811,016 / 1,099,323 = 0.74
Debt to total asset ratio for 2001 = 944,257 / 1,427,180 = 0.66
Q. 2) List some topics related to receivables management.
Some topics related to receivables management are:
Aging Analysis: Aging analysis is the analysis which 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.
Factoring: Factoring is a financial service designed to help firms to arrange their receivable better. Factoring offers credit coverage and guarantees the payment of doubtful debtors. Under a typical factoring arrangement a factor collects the accounts on due dates, effects payments to the firm on these dates and also assumes the credit risks associated with the collection of the accounts.
Collection: 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.
Credit Limit: Credit Limit is the maximum amount that a firm is willing to risk in an account. Credit Limits helps the creditor in the following ways:
It frees up valuable time for other credit management tasks
It speeds up the sales process
It reduces risk and improves collection activity and efforts.
It is an account monitoring tool
Provision for Bad Debts: The provision for bad debts might refer to the balance sheet account also known as the Allowance for Bad Debts, Allowance for Doubtful Accounts, or Allowance for Uncollectible Accounts. In this case Provision for Bad Debts is a contra asset account (an asset account with a credit balance). It is used along with the account Accounts Receivable in order to report the net realizable value of the 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. Delta's receivables turnover ratio was lower than the industry average. Delta's receivable 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 form of corporate financial reorganization which typically allows companies to continue to function while they follow debt repayment plans. 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:
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.
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.
It can also exploit opportunities like advance receipt of fees from loyal clients. We can see that it is left with receivables of $267593 (668982 - 401389) after deducting amount written off for Pink Tree Finance. So there exists an opportunity of getting an amount of $100000 from the receivables. It can offer partnership to the clients in return for the amount.
