Cape Chemical Case Study

Cape Chemical is a new regional distributor of liquid and dry chemicals, headquartered in Cape Girardeau, Missouri. The company's sales have been growing by 50% and 70% in the last three years. This type of growth is huge but it does not put the company in a position of financial health.

Cape Chemical has two factors that have allowed the company to grow at such rates: Next day delivery service, making their inventory grow parallel to the sales a flexible credit policy, which allows costumers to buy products on credit. This type of credit policy is one of the main causes for the company to not produce enough cash to meet its obligations. The company does make plenty of sales, but the asset that increases parallel to the sales is the accounts receivable account and not the cash account. When cash is not available as in this case, managerial and financial measures must be taken, if not the company has no viable way of being successful.

Examination of the variable costs shows that variable costs as related to sales is stable; 89% of sales are variable costs. This means that the company operates on low margins. Through the last three years, accounts receivables and inventory compared to sales have been rising a lot with a ratio of 0.132 and 0.133 respectively, which means that for every dollar increase in sales, 0.132 and 0.133 dollars must be invested in accounts receivable and inventory. However, accounts payable are increasing, with 0.095 for 2007, meaning that Cape Chemical is taking longer to pay its suppliers. Taking longer to pay the suppliers makes the working capital decrease because the company is using creditors (suppliers) money to finance their operations.

When you look at the income statement of the company it clearly shows that the earnings after taxes of the company is only 1% of the company's sales, the highest it has been in the past three years. This number dangerously low and has to be dealt with because this is one of the key factors of the lack of cash flow in the company.

Bellow three different scenarios would be explained in order to show the different options the company may take in order to stay in business by making enough cash to pay its obligations. The actions taken will eventually allow for the company to create its new line of chemical products.

Scenario 1: High Growth (No changes in policy)

The first scenario done assumes that there is no change in the current policy by which the company currently runs. If this approach is taken the company will continue to grow exponentially but this wont be good for the company. By growing like this Cape Chemical will only produce more debt through the years and only produce negative Cash Available To Owners. As this happens, Cape Chemical will finally go out of business because the company will not be able to pay its obligations.

Scenario 2: Operations Improvement (Change in Working Capital)

This scenario explores the possibility of the company to reduce the inventory, which