Pearson’s Air Conditioning & Service
The Pearson Air Conditioning and Service is a business that is based in Dallas. The business is owned by a father and his son; Scott and Bob Pearson respectively. Scott is the president of the business while Bob is the general manager. The firm engages in selling general electric equipment, carriers, York air conditioning and heating systems. Their main customers are local customers although the firm also sells to commercials.
Strengths of the business
The business makes good profits
The firm’s equity state is well above the initial status when it was acquired
The business maintains a balance of $15,000 which makes the principals a bit comfortable.
The firm has never suffered substantial losses from bad debts
The company still experiences some working-capital problems.
The firm lacked financial advisory services on inventory management and record keeping
The firm lacked does not have a good book keeping practice
The firm has a reputation and it can have access to funds at any time need arises.
QUESTION 1: Evaluate the overall performance and financial structure of Pearson Air Conditioning & Service.
ROE (Return on Equity) = net income/shareholders’ equity
Current ratio = current assets/current liabilities
Acid test ratio= liquid assets/current liabilities
Liquid assets= cash+ debtors
$85542/$84980 = 1.006
Debt to asset ratio= total liabilities/equity
The current ratio and debt to asset ratio are high showing that the company is able to meet its short-term debt obligations. The ROE indicates that the firm is able to make profits with the money shareholders have invested.
QUESTION 2: What are the strengths and weaknesses in this firm’s management of accounts receivable and inventory?
Strengths in managing accounts receivables and inventory
Doubling of the debtors during the year shows the firm’s management improves its impending to raise revenues.
The cases of bad debts being written off which is a loss to the company were reduced. The debtors were not aged because they were given 30 days to pay the net amount failure to which they paid extra charges of 1/10 of 1 percent. An expense of cash discount is not offered which reduces on the firms expenses.
The introduction of perpetual inventory system will enable the firm to know its stock levels throughout the year. The new computer software will reduce the man-hours per person in carrying out a task.
The firm lacks precise information on the sum of accounts in arrears; also instant payment by the customer on completion of work was not always possible.
The firm used annual physical control of the stock which made it hard in calculating the profits and hey faced difficulties in determining stock levels in precision. Also the cost of acquisition and maintenance of the system acquired posed a greater challenge the firm.
QUESTION 3: Should the firm reduce or expand the amount of its bank borrowing?
Debt to equity ratio = total liabilities / shareholders’ equity
$136211/$126625 = 1.076
Since the ratio is high it shows that the firm has been using debt to finance its growth which results in additional interest expense. Bankruptcy can result in cases where the cost of debt financing may be more than the returns the firm generates on the debt through investment. The business activities become a challenge for the firm to handle and the shareholders will not gain.
The firm however is able to generate more earnings if it uses more debt to finance its improved operations than it would have without this financing. The shareholders will benefit if the earnings exceed the interest expense because the more earnings are divided among the same number of shareholders.
QUESTION 4: Evaluate Pearson’s management of accounts payable.
The firm should use the discount received because it reduces the cost related with the acquisitions and increase the net profit of the firm. Discount received helps the firm regulate its operations and pay their debts within 30 days to avoid pressure from their suppliers.
(2/10, net 30), means that the supplier will offer the firm a 2 percent discount if it pays its bill in 10 days. If the firm doesn’t take that discount, then the bill is due in 30 days.
Discount Percent/100 - Discount percent X 365/Days Credit is outstanding - Discount period = Cost of Not Taking the Discount
2/100 -2 *365/30 - 10 = 37.2%. This is the cost of not taking the discount by the firm and it can get a loan from the bank which is inexpensive.
Paying for the goods once sold will be convenient for the firm since the firm does not incur any extra costs on the good if it is not purchased.
QUESTION 5: Calculate Pearson’s cash conversion period. Interpret your computation.
Cash conversion is the total time that elapses from the time a sale of a good or service is made and time of receipt of cash for the good sold.
Cash conversion period=days in inventory + days in AR - days in AP
Days in inventory = 365/ (COGS/inventory)
365* (466562/89562) = 70 days.
Days in AR= 365/ (sales/AR)
365* (727679/56753) = 28 days
Days in AP = 365/ (COGS/AP)
365* (466562/38585) = 30 days
Cash conversion period is 70+28-30 = 68 days.
This shows that the company will suffer from liquidity risk as they pay suppliers before they collect from a debtor. The company may be increasing its investment in resources to improve on sales, the cash amount drops.
QUESTION 6: How could Pearson Air Conditioning & Service improve its working-capital situation?
The firm should also pay its debts on stipulated time to avoid incurring high interest rates; also they should take advantage of cash discount which releases their expense. Circularization of debtors to minimize bad debts being written off which will reduce working capital. These will ensure there is enough working capital for the company to run its activities. Also by not giving cash discounts to the customers will increase the firms’ working capital.
Longenecker, Justin G.; Petty, J. William (2011-09-30). Small Business Management: Launching and Growing Entrepreneurial Ventures, 16th Edition (Kindle Locations 22848-22852). Cengage Learning. Kindle Edition.
Schweitzer, K. (2013). How to Write a Case Study Analysis. Retrieved 03 27, 2013, from Case Study: http://www.businessmajors.about.com/cd/casestudies/hc/HowToWriteCaseStudy