John has been in business for 3 years. His annual turnover is $400,000 and his annual profit is $45,000. He operates with a bank overdraft of up to $50,000. His working capital is sufficient to steadily expand the business.

John wins a contract to supply Business A. The order is for $80,000 a month for two years. He will be paid 75 days after delivery. He phones his suppliers and orders everything needed to fulfill the contract in the first few months. He asks them to deliver everything as soon as possible.

Month 1

Things go very well. All the suppliers start delivering as promised. The only problem is that he is short of space due to the build-up of inventory.

Month 2

Things still look good. John has made his first delivery to Business A. He increases his overdraft.

Month 3

Problems have begun to surface. John has made more deliveries to Business A but his overdraft has reached the allowable limit. He is getting calls from unpaid suppliers.

Month 4

Johns business is now in crisis. He cannot pay all his suppliers. Some have stopped delivering and are threatening legal action. John is confident things will improve because he is still supplying Business A.

Month 5

Johns overdraft is now $10,000 over the limit. Three suppliers start legal action. His bank refuses to pay any more cheques. However, Johns first payment from Business A arrives on time.

a) What topic, discussed in module 11 (Problem Loan Management), does the above scenario describe? List four financial indicators in the scenario that led you to reach this conclusion. (1.5 marks)

The scenario describes _______________________________

Financial indicators include:

1.

2.

3.

4.

b) Your text by Sathye et al. discusses 3 categories of financial distress. Into which of the three categories does the above scenario fit? (0.5 marks)

c) If you were advising Johns bank, what steps would you suggest they take? Why? (1 mark)