Cape Chemical: Cash and Profits

Cape Chemical: Cash and Profits

Cape Chemicals was founded by Ann Stewart and located in Cape Girardeau, Missouri, and currently supplies liquid and dry chemicals to most of the South and Midwest. They gained the reputation of the most reliable supplier of industrial chemicals. Although, Stewart had limited experience in the accounting and financial side of the company, she was an expert marketer. With Stewart, sales had doubled; new product lines were introduced and profits have increased dramatically. Cape Chemicals had become known for providing customers with quality products and service at competitive prices.

Cape Chemicals was a very profitable and successful company, however they had many issues involving cash flows. They were not able to maintain enough cash to pay back debts and obligations by a specific time. Despite the cash flow issues, Cape Chemicals has been able to remain profitable for two major reasons: next day delivery service and their liberal credit policy. The "next day delivery service" requires them to maintain a high inventory, which incur high holding and carrying cost, but also allows growing sales. The other issue is their liberal credit policy, which allows customers to buy on credit and encouraging the firm to take a "soft approach" when collecting payments. Along with the cash flow issues, Cape Chemicals had maxed out there borrowing limits. Using fixed assets as collateral, they were able to acquire an additional long-term loan for $3 million plus an additional $1 million working capital loan. Since they had insufficient funds to pay back loans the bank began refusing them of loans. The current total debt ratio for the company was at 71%, which is below the acceptable 50%. Despite their cash flows issues, and the inability to acquire new loans, Stewart has been trying to acquire a specialty product chemical line. This acquisition would require a $4.2 million loan of which they will be able to receive, until they fix the financial state of chemicals.

In their current financial situation, Cape Chemicals managed to remain profitable while experiencing cash flow problems. They have done this by measuring profitability using an accrual accounting system that is based on the matching principle. Using the matching principle is just offsetting expenses by the accounts receivables. In other words, transactions are only recorded when they occurred instead of when cash was received. Also, earnings represent a change in asset value but not a change in cash. They continue to increase because buying assets increases sales, reduces cash, but doesn't affect income. Another reason they have been able remain profitable is because they have large amount in accounts receivables. This is an issue because Cape Chemicals isn't receiving the cash for the products they are selling in a timely manner.

Cape Chemicals had issues with their cash, most likely due to the fact that they do not have a Statement of Cash flows. Statement of CF tells you how much cash went into and out of a company during a specific time frame. In the table below, a cash flow statement for 2006 and 2007 has been generated. According to Table 1 below, the cash that Cape Chemicals does have has been put into accounts receivables, inventory and fixed assets. The company is not being funded by there own operations but instead by borrowing from the banks. Since they have been using the "next day delivery" service to increase the sales to double digits, inventory is extremely high, as well as account receivables. There lenient credit policy is not allowing them to generate the cash, as they should, therefore causing the working capital to be in the hands of customers.

Table 1: Statement of Cash flows for Cape Chemicals (2006-2007)

In order to calculate to return on equity, the extended DuPont equation was used. The DuPont analysis breaks the ROE into three parts: profit margin, total asset turnover and equity multiplier. This analysis helps point out the part of the business that is underperforming. As shown in Table 2, the calculation show that the ROE for Cape Chemicals is mainly affected by the equity multiplier, which is a measure of