Case Introduction

Mid-year 2015, Danh Bach, owner of the Bach Manufacturing Company (Bach), sought a local bank for an additional P$ 50 million1 in cash to meet his footwear manufacturing companys capital requirements. After quadrupling revenue from 2 million to 8 million in three years and quadrupling after tax profits (PAT)2 in the same time frame, Bach boldly acknowledged his companys financial needs. Bach highlighted the development of his company, as well as the dynamics and potential opportunities in Petorias footwear and accessories markets, during a lengthy and fruitful discussion with the bank manager. Bach enthusiastically presented his companys results to the bank manager, which he considered was excellent in light of the industrys high level of competition. The bank manager gave over Bachs financial papers to his loan officer, including an income statement and balance sheet (see Figures 1 and 2), and assured Bach that he would contact him within a week once the materials were reviewed and analyzed. He directed the loan officer to expeditiously process Bachs loan application and inform him of the banks decision.

Petorian Footwear Manufacturing Sector

The nation of Petoria (pronounced peh-TOR-ee-a), is the second largest footwear manufacturer in the world. Petorias footwear industry contributed 2 percent of global spindle capacity and 8 percent of global rotor capacity. By 2021, this sector is expected to achieve a value of USD 223 billion. With abundant raw materials and a skilled labour, the country has established itself as a profitable hub for the worldwide footwear industry3 The Petorian footwear sector contributed 4 percent to the countrys gross domestic product; it accounted for 14 percent of Petorias industrial output and accounted for 27 percent of the citys foreign exchange inflows. The apparel sector employs around 45 million people directly or indirectly. Demand for footwears in both the domestic and international markets has bolstered the sectors growth hopes. In 2014, cloth output increased by 6 percent in the Petorian mill industry, while man-made fibre production increased by 4 percent. The accessory and footwear manufacturing area was expected to experience strong, robust expansion, which was backed up by data. Additionally, the industry average of key ratios demonstrates that the financial performance of textile companies is consistent and reliable. The footwear and accessories market in Petoria has grown by around 14.58 percent during the last three years. In FY2013/14, the Petoria footwear sector garnered USD 11 billion in foreign direct investment, and a industry analyst predicted that footwear exports from Petoria will reach $60 billion within three years. This would be facilitated by rising labour costs in China, greater demand from the United States, and a boost in the quality of Petoria-manufactured items. In 2013-14, exports of footwear items in Petoria increased by almost 12 percent over 2012-13, reaching an encouraging USD 35.4 billion4 The United States had previously been Petorias principal market for footwear exporters.

Challenges faced by the Petorian Footwear Industry

The Petorian footwear sector faced numerous obstacles, including:

a scarcity of trained people lack of energy and concurrently rising energy expenses

prohibitively high transportation costs imprecise and out-of-date labour laws

obsolete technology and industry unwillingness to adopt new technologies

an absence of scale economies

Bach Manufacturing Company

Bach was founded in 2012 and specialised in fancy party shoes for girls up to the age of 12. Bach, a trained engineer who had worked for nearly 12 years in a local footwear manufacturing company, had left his job to establish this tiny manufacturing unit with the assistance of several talented labourers he had known for years. He was well aware of the sectors competitiveness, given the presence of both small-scale and large-scale manufacturing facilities. Bach contended that there was a scarcity of high-quality shoes in the market. He was certain that by providing clients with new and sophisticated footwear and accessories at a low cost, he could capture a sizeable portion of the market that had not been tapped by large firms. He was also aware that opportunities in this category were expanding. Bach was familiar with the entire footwear production process, and hence had little difficulty launching the business. With P$ 1.2 million in limited cash, he began operations in April 2012 at his home, half of which he transformed into a small factory. Installing machines and acquiring raw materials were not difficult chores for him, and he was able to get all the resources necessary for manufacture without meeting any difficulties. The only difficulty he encountered was locating a designer who could assist him in creating new, current shoe styles for children. He believed that his experience to design was insufficient; hence, he hired Quang Phan, a young fashion designer who had completed a fashion design study program at a local Petorian/Australian University. With Phans devotion, a staff of motivated, skilled labourers, and Bachs experience and expertise, the production unit unexpectedly began receiving orders in quantities far exceeding its estimates. Demand for the footwear increased as a result of the fresh and innovative designs, high-quality fabrics, and fine finishing elements.

Bachs Financial Situation

Financial liquidity and finance issues became more prevalent as the business expanded. Bach encountered funding difficulties as a result of

the working capital required to make regular purchases of raw materials

the lengthy credit periods offered to consumers

a lack of finances to purchase new manufacturing machines

insufficient industrial space

Bach launched the company as a private limited company in 2012, with him and his wife as the only stockholders; they had 1.2 million shares. During that year, he borrowed money in the form of a mortgage loan and used it to meet the companys short-term and long-term needs. During 2012, the company borrowed a total of 0.736 million (taken against the mortgage of his assets, which had a value of 1.9 million). He continued to borrow money from the bank as the business grew and the asset requirements increased. The loan from the mortgage was 1.236 million in the second year and 2.5 million in the third year. Bach obtained the mortgage loan with little trouble because the mortgaged value of his assets was fairly high, and he also offered collateral security (his residence house) to the bank. With positive cash flows from business, servicing interest on loans was also not a concern. Bach was unconcerned about the financial subtleties of long-term or short-term loans, so he just proceeded to withdraw money and use it wherever he saw fit. Bachs financial records were kept by a part-time accountant. The accountant maintained daily accounting records for the company, which included vouchering, cash management, receipts, and payments, and created monthly, quarterly, and annual financial statements in accordance with regulatory standards. A certified public accountant independently audited his financial statements. Bach was happy and always felt like a successful entrepreneur because the business was profitable after all expenses and interest payments were made.

Future Prospects

Domestic and foreign demand, analysts predicted, would propel the Petorian footwear and accessorises sector beyond the USD 220 billion level by 2020. The retail sector was seeing fast growth as a result of rising consumption and disposable income. Numerous national and international businesses entered the footwear sector in Petoria. Over the next decade, the apparel segment was predicted to grow at a compound annual rate of more than 13 percent. The following factors contributed to the textile sectors rise in the Petorian market:

Increases in per capita income and distribution of the population shift in the youths preference for branded products and changes in the broader populations lifestyle

Products of exceptional quality

Favourable trade policies.

Increased export opportunities

Increases in fabric manufacturing in response to domestic demand

Increases in the retail sector in response to rising consumerism and disposable income in the population

The Petoria government is committed to providing training for approximately 2.7 million residents through their integrated skill development scheme. According to the 2012- 17 five-year plan, this project would span ten garment sub-sectors, including footwear, accessories, knit apparel, silk farming, and artisanal handicrafts.

As his business grew and his clientele grew, his financial difficulties grew as well. Bachs market credibility was strong, and he had little difficulty obtaining the necessary raw materials, but he ran into trouble when attempting to collect money from his consumers, as he lacked an organised method for tracking credit period extensions. Bach also noticed stock stacking up in his factory as orders were either not fulfilled or were delayed by clients. His machines were likewise becoming obsolete, and he believed the time had come to replace them with more contemporary and efficient models. The factory space was insufficient, and an expansion was necessary. Additionally, he needs new skilled labourers and some additional staff members to assist his expansion goals. In sum, Bach needs an extra P$ 50 million to maintain smooth operations and expand his business, and so, he waits in his office, eagerly expecting the banks decision. Bach anticipates the decision would be favourable.

2. From the given figure, analyse the profitability and efficiency of Bach for the relevant years. Consider sector (industry) averages when formulating your analysis. 3. Assume the position as an expert in financial analysis, suggest four areas Bach can focus on (financially) to best position himself for future prospects. 4. Assume the position of the bank, and decide on Bachs proposal for funding. Start your answer by stating that the proposal should be accepted or rejected. Thereafter, justify your decision with four arguments.

Ratio acid test ratio Year 1 Year 2 Year 3 1.3 0.92 0.79 Industry Ratio (given) Current asset turnover ratio 3.03 1.54 1.79 3 Current ratio 2.5 1.79 1.6 Debt-to-equity reatio 0.61 0.77 1.25 0.35 fixed assets turnover ratio 1.05 1.92 1.7 gross margin ratio 0.38 0.41 0.4 interest coverage ratio 9.67 7.07 4.53 Inventory days 58 117 103 Inventory turnover ratio 6.25 3.12 3.55 Long-debt to total capital 0.29 0.22 0.27 0.24 net margin ratio 0.182 0.14 0 0.18 Receivable days 61 76 91 Receivable turnover ratio (times) 6 4.8 4 Return on equity 23% 25% 22% Return on fixed assets Return on total assets 0.196 0.27 0.18 0.24 14.21% 12% 9% Total assets turnover ratio 0.78 0.86 0.87 Working capital turnover 50 3.5 4.77 8