Tire City Case
Tire City, Inc is a growing distributor of tires in the Northeastern part of the United States. Tire City, Inc is positioned in eastern Massachusetts, southern New Hampshire and northern Connecticut. Tire City, Inc distributes its product through a chain of 10 stores and a central warehouse outside Worcester, Massachusetts. In the past three years, Tire City has grown at an annual compound rate of 20% which was attributed to its excellent reputation for service and competitive pricing. Due to its growth, Tire City is currently at maximum capacity in its warehouse and is considering expanding its current warehouse facility to accommodate service levels. Jack Martin and Abeer Mandil are in the process of presenting the financial position of the company to their bank in order to request a five-year loan for the expansion.
Lower debt ratio makes it easier for the Tire City Inc to borrow additional funds without Raising equity capital. Tire City Inc. has reduced its debt ratio from 48.03% in 1994 to 44.17% in 1995.
Also, Tire City has improved time interest earned coverage from 18. 16 in 1994 to 23. 50 in 1995. The increased TIE coverage is due to the higher net income and the decreased interest expense in 1995 than 1994. L.T Debt and Debt/Equity ratios has decreased slightly in 1995 than 1994 due to the decrease in the long term debt from $875,000 in 1994 to $750,000 in 1995.
Asset management ratios are used to measure how effectively the company is managing its assets. Tire City Inc inventory turnover declined from 6.47 in 1994 to 6.22 in 1995. The reason is the increasing inventory from 1994 to 1995 as a percentage of increased sales. Therefore, days of Inv outstanding increased from 56.
39 days in 1994 to 58.72 days in 1995. Also, receivable turnover declined from 6.58 in 1994 to 6.44 in 1995 and accordingly days of receivable outstanding increased from 55.0 days to 56.
71 days. Tire City’s payable turnover has increased from 8.98 in 1994 to 9.45 in 1995 and accordingly days of payable outstanding decreased from 40.65 days in 1994 to 38.
61 days in 1995. The Company cash conversions cycle has increased in 1995 to 76. 82 days from 71. 24 in 1994. In the other side, Tire City’s has improved FA turnover; it increased from 8.
93 in 1994 to 9.65 in 1995. The company TA turnover has increased slightly from 2.60 in 1994 to 2.62 in 1995.
The increased is due to the increased sales and increased planet and equipment.Tire City was profitable in 1995. Tire City’s profit margin increased from 4.90% in 1994 to 5.
06% in 1995. This is due to the decrease of both COGS and interest expense as a percentage of sales and the increase of sales. Also, gross profit margin has improved from 41.55% in 1994 to 42.09% in 1995. Tire City’s ROA has increased too from 12.
75% in 1994 to 13.25% in 1995. While the ROE has decreased slightly from 24.53% in 1994 to 23.73% in 1995.
Pro forma Blanca sheet & Income statement for 1996 -1997
We used percentage of sales methodology to forecast the pro forma.
The assumptions we used are based on growth of 20% for the sales and the historical average of sales percentage for the years 1993 to 1995. After calculating the pro forma as shown in the appendix the external financing needed for 1996 -1997 will be total of $ 1,393,000. In 1996 it will be $ 354,800 and in 1997 will be $1,038,260.Tire City Inc. current ratio has declined from 2.
03 in 1995 to 1.66 in 1997. The Quick ratio also declined from 1.35 to 1.10. The reason is the expansion in the warehouse which increased fixed assets and the AFN needed.
Tire City’s cash ratio increased in 1997 from 0 .22 in 1995 to 0.2 as cash was increasing in 3% of sales. Working capital ratio increased slightly in 1997. Tire City Inc has reasonable cash flow in 1997.Tire City Inc has increased its debt ratio from 44.
17% in 1995 to 44.10% in 1997 by planning to take the bank loan for the additional fund needed. Also, Tire City time interest earned coverage increased from 23.50 in 1995 to 28.25 in 1997. L.
T Debt decreased slightly in 1997 than 1995 due to the decrease in the long term debt from $750,000 in 1995 to $500,000 in 1997. Debut to equity ratio has increased slightly from 0.79 in 1995 to 0.82 in 1997.Tire City Inc inventory turnover declined slightly from 6.22 in 1995 to 6.
18 in 1997. The reason is the inventory increased again in 1997 with the percentage of increased sales after the reduced inventory in 1996. Therefore, days of Inv outstanding increased slightly from 58.2 days in 1995 to 59.11 days in 1997.
Receivable turnover increased slightly from 6.44 in 1995 to 6.47 in 1997 and days of receivable outstanding remained the same. Tire City’s payable turnover has declined from 9.45 in 1995 to 9.18 in 1997 and accordingly days of payable outstanding increased from 38.
61 days in 1995 to 39.77 days in 1995. The Company cash conversions cycle has decreased in 1997 to 75.78 days from 76.82 in 1995. Tire City’s has declining FA turnover from 9.
65 in 1995 to 7.89 in 1997 and the company TA turnover has declined from 2.2 in 1995 to 2.47 in 1997. This is due to the investment in 1996 for the warehouse expansion.
Tire City is still profitable in 1997. Tire City’s profit margin and gross profit margin almost will stay stable in 1997. Tire City’s ROA decreased slightly in 1997 due to the increase in the TA. Also, ROE decreased slightly in 1997 with the increased RE.
- If Inventory is not reduced at the end of 1996: the additional financing needed will increase from a total investment of $1.393m to $2.
470m. This is primarily driven by a decline in the liquidity position of the company as reflected by the downward trend in the liquidity ratios.
- If accrued expenses grow less than expected:we assumed 5% instead of 7% the AFN will increase from $1.93m to $2.684m total investment. This is primarily due to the need for additional financing to offset the increase in assets for the expansion investment.
- If more than 5% of the total warehouse cost is depreciated in 1997: we assumed 10% then the need for additional financing needed increases. This is due to a reduction in the net plant assets and a reduction and also can be related to a reduction in ROE.
- If inflation if higher than expected: we assumed 25% this will create higher prices and thus higher levels of revenue. But this also means all corresponding expenses will increase a well resulting in an increase in AFN needed from $1.393 to $1.
630. This can be attributed to a decrease in the working capital ratio and an increasing debt ratio.
- As days receivable is reduced: the need for AFN decreases due to the improvement in liquidity. With a $2m decrease in accounts receivable the days receivable was reduced from 56.11 days to 25.
6 days and no need for external financing.
- As days payable increased: by reducing Cost of Goods sold and increasing account payable by $2m, the days payable increased from 38. days to 108 days and eliminating the need for AFN.
Summary ; Conclusion
Tire City is in a good financial position as reflected by consistent liquidity ratios, stable leverage even after the expansion project into 1997. Additionally, asset management ratios have also been stable and as discussed in the sensitivity analysis there is an opportunity to improve by reducing receivables, delaying payables, and maintaining low levels of inventory.
Profitability ratios are forecasted to decline but not to a significant level and in line with past historical performance.Tire City should have no problem absorbing the expansion investment and maintaining consistent profitability as shown in the forecast and financial ratios. As an alternative recommendation Tire City should consider reducing inventory their level to allow for improved liquidity and potentially avoid additional financing needed. As was discussed in the sensitivity analysis there is potential to reduce or avoid AFN. The proximity of the distribution center to the stores and also the expectation to maintain service levels despite reducing inventory in 1996; shows the ability to maintain service.