FINE 332 MODULE 7 SHORT TERM ASSET FINANCE

OVERVIEW:

All corporations, especially young ones or those experiencing fast growth, must carefully monitor their short-term accounts. All companies like growth, but growth comes at a cost: fast growing receivables, inventory piling up in warehouses, cash shortfalls as payment receipts can not keep up with production costs, etc. Then, these firms will need working capital financing in many cases; however, in order to obtain that, they must show that they have a good handle on future growth account by account.

The reason why each account is looked at separately is that receivables can usually be turned into cash fairly easily. Basically, a receivable is a promise to pay from a client, and that promise is based on that client’s credit position, which can be ascertained rather quickly.

Inventory, however, is much more difficult to monetize and thus is usually discounted for working capital loan purposes. So, a bank may provide only a fraction of the value of the inventory as they don’t want to be stuck with stale inventory if things go wrong.

Returning to receivables, credit policy at the corporate level is crucial. That is because receivables tend to be much larger than inventory – after all, the receivables already have the profit margin baked in! So, determining and implementing a savvy and effective credit policy is something that all corporations must have.

Moab Aviation: Short-Term Asset Finance
Alfonso F. Canella Higuera
October 19, 2021
Moab Aviation was having a bumper decade by the time 2020 arrived. Moab was a fixed
base operator (FBO) serving four airports in southeastern Utah – Canyonlands (CNY), Green River
Municipal (RVR), Monticello City (MXC), and Blanding Municipal (BDG).
This area of Utah had been experiencing constant increases in air traffic thanks to its
spectacular natural surroundings, which were popular with outdoor enthusiasts of all ages. In
particular, two parks – Arches National Park and Canyonlands National Park – were bringing in
significant tourist traffic to the area and with them increased wealth to what was once a backwater.
Because of the scenic views and the large extensions of territory, the Moab area was popular
with people looking to see it from the air. The airports were doing well and Moab benefited from
that activity. Further, the area was doing significant business with mountain bikers looking to ride
the long trails that crossed the area. So, on the whole, the Moab area boomed and with it so did
Moab Aviation.
However, Bing Perez, Moab’s CFO, looked at the boom with concern. One of his concerns
was that the company may just be growing too fast. Moab’s 2019 financials showed the fast growth.
Bing suspected that the revenue growth, while pleasant to look at in the income statement, was going
to cause disorder in the balance sheet.
Bing laid out Moab’s quarterly financials for 2019 on his desk:
Operating Revenues
– implicit annual growth
Operating Expenses:
Salaries, wages and benefits
Aircraft fuel and taxes
Landing fees and other rents
Depreciation/amortization
Maintenance and repairs
Other operating expenses
Total Operating Expenses
Operating Income
Other income/(expense)
Income before taxes
Income tax expense
Net Income
– implicit annual growth
in ‘000$
Total
Q3
Q4
Q2
Q1
4,113.8 4,244.5 4,443.8 4,700.7 17,502.8
13.3%
20.1% 25.2%
1,005.8 1,023.1 1,074.3 1,122.5
4,225.7
675.6
688.3
902.0
851.9
3,117.8
150.1
155.3
166.2
176.2
647.8
222.2
223.1
232.9
258.1
936.3
159.1
160.2
157.5
175.1
651.9
5,455.0
1,304.4 1,311.0 1,384.5 1,455.1
3,517.2 3,561.0 3,917.4 4,038.9 15,034.5
596.6
683.5
526.4
661.8
2,468.3
(145.5)
(42.0)
(11.3)
(45.6)
(46.6)
550.0
637.9
515.1
619.8
2,322.8
143.1
724.7
121.6
230.5
229.5
320.5
407.4
393.5
476.7
1,598.1
161.1% -13.0% 115.4%
The implicit annual growth rates in the top line revenue, particularly in 4Q, which tradition
pointed to being the low water mark for the company, were spectacular and unexpected. Bing
suspected that the traditional seasonality in Moab’s financials was disappearing because more and
more people were living year-round in the area. With more people there year-round, there was a
relative reduction in the importance of summer season activity in the overall yearly results.
Further, Bing was hearing from Moab’s staff that tourists were coming in heavily during all
four seasons in order to see the area under different climatic conditions. Further, these tourists were
trying to escape their expectations of summer hordes and the accompanying increases in prices for
lodging and services. So, Moab was looking at a bumper business that was growing every quarter
and that was probably going to be the new normal into the foreseeable future. This required that
Moab rethink how it handled its short-term asset financings.
In particular, Bing reasoned that the fast growth rates would require significant working
capital investments over time, mostly to the cover growth in receivables. This much was clear from
the balance sheet numbers that accompanied the firm’s income statement:
Cash and equivalents
Accounts receivable
Fuel inventory
Parts/supplies inventory
Prepaid expenses
Total Current Assets
PP&E
Depreciation allow.
Net PP&E
Goodwill
Other assets
Total Assets
Working Capital
– implicit annual growth
Q1
157
2,314
592
46
141
3,250
4,416
1,582
2,834
231
2,328
8,642
1,053
in ‘000$
Q2
Q3
165
158
2,401
2,333
595
598
47
47
141
142
3,349
3,278
4,420
4,441
1,584
1,588
2,836
2,853
231
231
2,340
2,432
8,756
8,794
Q4
288
2,855
573
52
126
3,894
4,622
1,615
3,007
231
2,390
9,522
1,123
29.1%
1,565
392.0%
1,051
-23.2%
Accounts Payable
Air traffic liability
Accrued liabilities
Curr. maturities of LTD
Other current liabilities
Total Current Liabilities
LTD and lease obligations
Pension obligations
Deferred revenue
Non-current operating leases
Other long term liabilities
Stockholder’s equity
Total Liab. and equity
Q1
1,298
466
112
152
169
2,197
825
916
365
580
113
3,646
8,642
in ‘000$
Q2
Q3
1,301
1,301
472
471
115
113
153
153
185
189
2,226
2,227
830
834
917
925
365
369
583
586
133
114
3,702
3,739
8,756
8,794
Q4
1,327
512
108
229
154
2,329
887
845
351
529
284
4,296
9,522
The working capital growth, particularly in Q4, was staggering. This was all due to the fast
rise in receivables that came from the growth in revenues that quarter. If kept unchecked, Moab
would be hampered by a liquidity crunch just as things were really starting to pick up. A check of
the company’s key operating metrics showed the following:
Days Receivable
Days Inventory
Operating Cycle
Days Payable
Cash Cycle
Implicit annual growth:
Days Receivable
Cash Cycle
Page 2 of 8
Key Ratios
Q1
51
69
119
51
68
Q2
51
68
119
51
68
Q3
47
55
102
45
57
Q4
55
55
109
45
65
2.3%
-0.2%
-25.8%
-51.3%
79.1%
62.2%
The way Bing saw it, the growth in receivables, particularly in 4Q was too much and the fall
in payables in 3Q was also too much. These two had combined to increase the firm’s cash cycle
making the balance sheet top heavy. Bing knew he had to do two things:
1. Reduce receivables and increase payables – both as much as possible
2. Obtain working capital lines of credit from Moab’s bank to cover the growth in working
capital – this would be Plan B, though, as these lines of credit tended to be expensive and
the bank’s conditions rather onerous
Before anything else, though, Bing had to train Ted, his new (and only) assistant in the
finance office, on the details of Moab’s financials. Since he had the key ratios at hand and since
they were showing the most important developments for the firm, he started with those.
Starting with days receivables, Bing explained the formula for calculating it:
𝟏𝟏𝑸𝑸 𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 =
𝟏𝟏𝟏𝟏 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹
𝟏𝟏𝟏𝟏 𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹
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𝟗𝟗𝟗𝟗
Ted asked why Bing was dividing revenues by 90. Bing replied that since the revenues were
quarterly, they had to be divided by the number of days in that period – which was always assumed
to be 90 no matter whether or not it was 89 or 91 or 92 in reality. It was just the convention. Bing
added that if the period were monthly, you would assume 30 days, even if it was February or
December or any month with 31 days. Again, he said, it was just the convention.
With the formula all sorted out, Bing went on to explain how to read the results:
Days Receivable
Key Ratios
Q1
51
Q2
51
Q3
47
Q4
55
The values shown for days receivable were much too high for a firm like Moab. In the FBO
industry, the days receivable should not be higher than 30. So, as it was Moab was giving too much
leeway to its clients to pay. In effect, it was lending them money at zero interest while Moab was
effectively borrowing that same money at its opportunity cost (in other words, the Weighed Average
Cost of Capital or WACC, which was 7.5% for Moab).
Bing explained how much extra money was tied up in receivables by using the 4Q days
receivable (55) and comparing it to the benchmark of 30. This showed that Moab had 25 days’
worth of revenues in receivables. Bing took the year’s sales ($17.5M) and divided them by 360 days
to get the average daily sales – which gave $41,619. He then took the $41,619 and multiplied it by
25 to get the receivables that were in the balance sheet but should not be there; instead, they should
be in the cash account as collected revenue!
Page 3 of 8
This number was $1,198,670, well over a million and certainly to be even more if Moab kept
growing and did not change its seemingly lackadaisical accounts collections policies. Bing then
showed Ted the general formula he should use to calculate how much this was actually costing Moab
in terms of funding costs:
𝟐𝟐𝟐𝟐𝟐𝟐𝟐𝟐 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹
𝒙𝒙 (𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨 𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 −
𝟑𝟑𝟑𝟑𝟑𝟑
𝟐𝟐𝟐𝟐𝟐𝟐𝟐𝟐 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶 𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭 𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪 =
𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰 𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩 𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹) 𝒙𝒙 𝑾𝑾𝑾𝑾𝑾𝑾𝑾𝑾
Using the values that Bing calculated, the formula worked out to:
𝟐𝟐𝟐𝟐𝟐𝟐𝟐𝟐 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶 𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭 𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪 = $𝟒𝟒𝟒𝟒, 𝟔𝟔𝟔𝟔𝟔𝟔 𝒙𝒙 𝟐𝟐𝟐𝟐 𝒙𝒙 𝟕𝟕. 𝟓𝟓% = $𝟖𝟖𝟖𝟖, 𝟗𝟗𝟗𝟗𝟗𝟗
While this was not a huge number, it was an unnecessary expense that Moab was incurring.
Bing went on to say that he had some ideas on how to change this but first he wanted to go over all
the formulas for the key ratios that he wanted Ted to calculate going forward on a monthly basis.
The key ratios, once calculated on a quarterly basis, would now be calculated on a monthly
basis to keep a short leash on the growth of receivables now that it was clear that the company was
growing very rapidly and receivables would pile up.
Bing went on to explain the general formula for calculating days inventory:
𝟏𝟏𝟏𝟏 𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫 𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰
=
[𝟏𝟏𝟏𝟏 𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭 𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰 + 𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷 & 𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺 𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰]
𝟏𝟏𝟏𝟏 𝑭𝑭𝑭𝑭𝑭𝑭𝒍𝒍 & 𝑻𝑻𝑻𝑻𝑻𝑻𝑻𝑻𝑻𝑻 𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬 + 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 & 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬
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𝟗𝟗𝟗𝟗
Bing noted that the 4Q inventory days was 55 and that it was also too high relative to the
industry standard of 30. So, in effect for 2019, Moab was overspending in having too much
inventory in its hands:
𝟐𝟐𝟐𝟐𝟐𝟐𝟐𝟐 𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰 𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶 𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭 𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪
𝟐𝟐𝟐𝟐𝟐𝟐𝟐𝟐 𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭, 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 & 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬
=
𝒙𝒙 (𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨 𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫 𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰
𝟑𝟑𝟑𝟑𝟑𝟑
− 𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰 𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩𝑩 𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫 𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰) 𝒙𝒙 𝑾𝑾𝑾𝑾𝑾𝑾𝑾𝑾
Using the values that Bing calculated, the formula worked out to:
𝟐𝟐𝟐𝟐𝟐𝟐𝟐𝟐 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶 𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭 𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪 = $𝟏𝟏𝟏𝟏, 𝟒𝟒𝟒𝟒𝟒𝟒 𝒙𝒙 𝟐𝟐𝟐𝟐 𝒙𝒙 𝟕𝟕. 𝟓𝟓% = $𝟏𝟏𝟏𝟏, 𝟒𝟒𝟒𝟒𝟒𝟒
The combined overage funding costs of $109,361 represented 6.8% of Moab’s entire 2019
profits. Moab’s net margin was 9.1% and if these costs had not been incurred, they would have been
9.8%, a sizeable difference.
Page 4 of 8
Clearly, it was time to make changes to the way that receivables and inventory were being
handled, especially as the company was growing so rapidly. Still, before he continued with his ideas
for how to handle these, Bing explained to Ted the concept of the operating cycle:
The operating cycle did what Bing had just done with dollars but instead did them with days:
Key Ratios
Q1
51
69
119
Days Receivable
Days Inventory
Operating Cycle
Q2
51
68
119
Q3
47
55
102
Q4
55
55
109
The operating cycle was just the sum of the days receivable and days inventory. Nothing
more to it so Bing defined it and moved on to the days payable.
𝟏𝟏𝟏𝟏 𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫 𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷
=
𝟏𝟏𝟏𝟏 𝑨𝑨𝑨𝑨𝑨𝑨𝒐𝒐𝒐𝒐𝒐𝒐𝒐𝒐𝒐𝒐 𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷
𝟏𝟏𝟏𝟏 𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭 + 𝑳𝑳𝑳𝑳𝑳𝑳𝑳𝑳𝑳𝑳𝑳𝑳𝑳𝑳 𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭 + 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴. & 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 + 𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶 𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬
�
�
𝟗𝟗𝟗𝟗
Bing noted that payables had dropped from 51 in 1Q and 2Q to 45 in 3Q and 4Q. While this
wasn’t necessarily a bad progression, it did not make sense for Moab to lengthen its receivables days
while shortening its payables days. Bing noted that Moab’s payables were someone else’s
receivables and that in paying them sooner, they were doing the work that their suppliers should be
doing. Bing made it clear that going forward, Moab would only pay within 45 days if it cut its days
receivables and inventory to the industry standard of 30 days. So, starting from now, Moab would
institute the following policies for collecting receivables:
•
•
all clients must pay the full bill within 30 days
any client paying their full bill within 5 days would get a 1% discount
Bing showed Ted what the above policy would translate into as an effective annual rate
(EAR) to its clients:
a) Effective Annual Rate (EAR)
Notional purchase
Discount (%)
Days difference
Page 5 of 8
5,000.00
1.00%
25
Discount ($)
Rate (%)
Days difference in 1 year
50.00
1.01%
14.60
EAR
15.8%
Starting from the top, Bing noted that he was using a notional (in other words, example for
the use of illustration) client purchase of $5,000. The 1% discount in dollars would then be $50.
The days difference was the difference in days between the 30 days final limit to pay the bill
and the 5 days limit to get the 1% discount – so it was 30 minus 5 equaling 25 days difference.
The actual rate was to be calculated using the formula:
𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 (%) =
𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫 ($)
[𝑵𝑵𝑵𝑵𝑵𝑵𝑵𝑵𝑵𝑵𝑵𝑵𝑵𝑵𝑵𝑵 𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷 − 𝑫𝑫𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊 ($)]
The days difference in a year would be calculated as follows:
𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫 𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫 𝒊𝒊𝒊𝒊 𝟏𝟏 𝒚𝒚𝒚𝒚𝒚𝒚𝒚𝒚 =
𝟑𝟑𝟑𝟑𝟑𝟑
𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫 𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫
With the days difference being 25, the above was 365 divided by 25 or 14.6.
All these factors were combined into one formula that gave the EAR as follows:
𝐸𝐸𝐸𝐸𝐸𝐸 (%) = [1 + 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 (%)]𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑖𝑖𝑖𝑖 1 𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦 − 1
When all was said and done, Bing calculated that many clients would opt to pay within 5
days as this would give them a 15.8% implicit annual rate, which was likely much higher than the
clients’ opportunity costs. Not everyone would pay so early, Bing reasoned, because many clients
just preferred to pay their bills at the end of the month, just as their income was received also at the
end of the month.
Bing estimated that 10% of the clients would pay early and the rest would pay within 30
days. If that was the case, Bing calculated that Moab’s receivables would be as follows:
𝑵𝑵𝑵𝑵𝑵𝑵 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫 = 𝟏𝟏𝟏𝟏% 𝒙𝒙 𝟓𝟓 + 𝟗𝟗𝟗𝟗% 𝒙𝒙 𝟑𝟑𝟑𝟑 = 𝟐𝟐𝟐𝟐. 𝟓𝟓 𝒅𝒅𝒅𝒅𝒅𝒅𝒅𝒅
This number was exactly half the 4Q days receivable that Moab experienced. Bing thought
it was fortuitous that it was so but took it as a good omen that this was the right way to go.
With the policy laid out, Bing asked Ted what he thought of it. Ted replied that it was a good
policy because it was the industry standard for one and for two it provided clients with a decent
discount if they paid within 5 days. Further, for Moab it worked well because it would radically
reduce receivables and obviate the need to work out large increases in working capital loans with
Moab’s bankers.
Ted asked, what was Bing’s proposal for dealing with inventory? Bing replied that first
things first and that he wanted to run his calculations on how the new policies would look in 2020:
Page 6 of 8
b) 2020 Estimates
Gross revenue
Avg. receivables before new policy
% paying early
Avg. receivables after new policy
Change in receivables
Cost of capital
Projected savings in capital costs
minus: discounts
Projected savings net of discounts
Gross margin
Gross revenues must rise by:
– in dollars
– in percent
20,128,220
1,677,352
10.0%
1,537,572
139,779
7.5%
10,483
20,128
(9,645)
14.1%
68,391
0.3%
With the 2020 estimates laid out, Bing went to explain his methodology. First, the gross
revenue line was his estimate for 2020 revenues – basically a 15% increase in 2019’s revenues.
(Little did he know that 2020 would be a chaotic year world-wide especially in air travel but we
can’t blame him for what he doesn’t know and can’t control!)
The average receivables before the new policy were based on the gross revenue divided by
360 to get the daily revenue rate and then multiplying that new revenue rate by 30 to get the
receivables for that month. Bing made it clear that the new policy was not so new – Moab should
have been enforcing a 30 day limit for clients to pay their bills. What was new was the discount to
those paying within 5 days.
As he noted earlier, with the new discount policy, 10% of clients were predicted to pay in 5
days and the remaining 90% would pay in 30. This meant that the new receivables days was 27.5,
as he had shown earlier in his formula. The difference between the average receivables – what Bing
had labeled as the “change in receivables” – after the new policy and the average receivables before
the new policy was just the difference in dollars between the two.
This change in receivables in dollars, when multiplied by the WACC of 7.5% that Moab had
as its opportunity cost of capital, would yield the projected savings in capital costs.
The discounts were the gross revenues multiplied by the 10% of clients taking the discount
times the 1% discount offered.
Bing then took the projected capital cost savings and subtracted the discounts to get the
projected savings net of discounts.
Page 7 of 8
The gross margin that Moab used for 2020 was based on calculations that used 2019 figures.
Basically, the gross margin formula was:
𝟐𝟐𝟐𝟐𝟐𝟐𝟐𝟐 𝑮𝑮𝑮𝑮𝑮𝑮𝑮𝑮𝑮𝑮 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 (%) =
𝟐𝟐𝟐𝟐𝟐𝟐𝟐𝟐 𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶 𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰𝑰
$𝟐𝟐, 𝟒𝟒𝟒𝟒𝟒𝟒. 𝟑𝟑
=
= 𝟏𝟏𝟏𝟏. 𝟏𝟏%
𝟐𝟐𝟐𝟐𝟐𝟐𝟐𝟐 𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹
$𝟏𝟏𝟏𝟏, 𝟓𝟓𝟓𝟓𝟓𝟓. 𝟖𝟖
Bing then showed that the gross operating revenues had to rise by the absolute value (ABS)
of the projected savings net of discounts divided by the gross margin:
𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶𝑶 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎 𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓 =
𝑨𝑨𝑨𝑨𝑨𝑨(𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷 𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺 𝒏𝒏𝒏𝒏𝒏𝒏 𝒐𝒐𝒐𝒐 𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫)
𝑮𝑮𝑮𝑮𝑮𝑮𝑮𝑮𝑮𝑮 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 (%)
$𝟗𝟗,𝟔𝟔𝟔𝟔𝟔𝟔
= 𝟏𝟏𝟏𝟏.𝟏𝟏% = $𝟔𝟔𝟔𝟔, 𝟑𝟑𝟑𝟑𝟑𝟑
Bing then took the $68,391 and divided it by the gross revenue to show that to pay for the
new policy, the gross revenues need only grow by 0.3% of 2019 to make the whole discount pay for
itself. Further, the $20,128 in discounts was much less than the calculated savings from the
reductions in the receivables that had been calculated ($89,900) so this was a slam dunk in Bing’s
mind. With this put to rest, Bing described his policies for handling inventory as follows:
•
•
fuel – this inventory was 11x the size of the parts inventory so it was the most important one.
As such, Bing was proposing the following:
o use Moab’s purchasing power to get the wholesaler to go from two deliveries a month
to four deliveries a month, with each of the new deliveries at half the volume. This
should cut the average days between fill-ups from 15 to 7 and slicing the inventory
volumes by about half – from 55 to 27.5
o Bing had already run this by the wholesaler and the wholesaler agreed precisely
because Moab was such a large client and a reliable payer
parts – Moab would work with its Service department to determine which parts needed to be
in inventory in hand at all times and which could be ordered from the parts distributor:
o parts that were constantly being used would be kept as inventory
o parts that were used only sporadically would be ordered as needed
o the parts distributor agreed to expedite Moab’s orders as Moab was becoming an
increasingly larger client because of the activity it was experiencing in its business
o any orders that were needed immediately would be handled directly by the parts
distributor and would be picked up by one of Moab’s staff. While this was not
anywhere near the norm, Moab wanted to make sure that clients were not affected by
this
Case Questions
Use the Moab Aviation template to answer the questions posed in it. These questions reflect
the material covered in this case but keep in mind that the data are monthly and not quarterly as
shown here, so the student must adjust the formulas to a monthly (or 30 day) rate.
Page 8 of 8
in M$
Jan.
Feb.
2,512
2,833
Mar.
2,909
690
601
220
143
101
44
1,799
713
22
735
133
602
780
611
227
143
104
45
1,910
923
23
945
187
758
803
633
233
143
107
47
1,966
943
23
967
183
784
Key Ratios
Jan.
Feb.
Mar.
Operating Revenues
Operating Expenses:
Salaries, wages and benefits
Aircraft fuel and taxes
Landing fees and other rents
Depreciation/amortization
Maintenance and repairs
Other operating expenses
Total Operating Expenses
Operating Income
Other income/(expense)
Income before taxes
Income tax expense
Net Income
Days Receivable
Days Inventory
Operating Cycle
Days Payable
Cash Cycle
in M$
Cash and equivalents
Accounts receivable
Fuel inventory
Parts and supplies inventory
Prepaid expenses
Total Current Assets
Property, Plant & Equipment
Allowance for depreciation
Net PP&E
Goodwill
Other assets
Total Assets
Jan.
1,895
1,321
190
99
44
3,549
4,858
2,121
2,737
198
322
6,806
in M$
Feb.
1,951
1,422
203
101
45
3,722
4,949
2,168
2,781
202
329
7,035
Mar.
2,108
1,453
204
105
46
3,916
4,943
2,215
2,728
207
336
7,187
Accounts Payable
Air traffic liability
Accrued liabilities
Curr. maturities of LTD
Other current liabilities
Total Current Liabilities
LTD and lease obligations
Pension obligations
Deferred revenue
Non-current operating leases
Other long term liabilities
Stockholder’s equity
Total Liab. and equity
Jan.
370
605
97
88
22
1,182
253
423
245
401
104
4,198
6,806
in M$
Feb.
375
523
130
130
33
1,191
259
453
258
410
106
4,359
7,035
Mar.
381
543
132
140
33
1,229
264
463
263
419
109
4,440
7,187
a) Effective Annual Rate (EAR)
Notional purchase
Discount (%)
Days difference
Discount ($)
Rate (%)
Days difference in 1 year
EAR
1,000.00
0.25%
10
b) Average Collection Period
Gross revenue
Avg. receivables before new policy
% paying early
Avg. receivables after new policy
Change in receivables
Cost of capital
Projected savings in capital costs
minus: discounts
Projected savings net of discounts
Gross margin
Gross revenues must rise by:
– in dollars
– in percent
16,000,000
40.0%
7.5%
33.0%
Note: customers must pay within 20 days of invoice. To get the discount, they must pay within 10 days of invo
within 10 days of invoice.
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