Dutch Glass Company is in the business of manufacturing glass for residential ho

Question

Dutch Glass Company is in the business of manufacturing glass for residential home construction. In recent years, the company has suffered working capital problems caused by plant asset acquisitions and the increase of receivables due to the economic downturn and slower-paying contractors. The president, John Dutch, has tried to increase working capital by borrowing money; however, because of their deteriorating financial condition, they have been unsuccessful. The loan officer at their current bank has explained that no additional loans will be approved until they demonstrate the ability to generate positive cash flows. John considers the problem and suggests to you that to generate positive cash flows, the company could sell some of its accounts receivable and liquidate much of its raw material. These actions would be detrimental to net income but would generate a positive cash flow. What are the ethical issues related to John's ideas? As the CFO for Dutch, how would you respond to John?

Explanation / Answer

Answer

Dutch Glass Company is in the business of manufacturing glass for residential home construction. In recent years, the company has suffered working capital problems due to mainly two reasons.

(1) It is caused by plant asset acquisitions: So here short term funds have been used long term purpose which have ultimately reduced working capital funds needed to run the business and to fund current liabilities. Company should have acquired plant assets either through long term own funds i.e. equity or long term borrowed fund i.e. term loan with maturity ranging from 5 or more years. Using sort term funds for acquisition of plant assets have reduced current ratio (i.e. current assets available to finance current liabilities)

And

(2) The increase of receivables due to the economic downturn and slower-paying contractors: Here Increase in receivables have taken place due to overall economic downturn. It is macroeconomic factor. It is not caused by wrong financial decision taken within company.

The president, John Dutch, has tried to increase working capital by borrowing money. But borrowing money for working capital will increase current liability further and will deteriorate current ratio further and it will also reduce operating profits due to increased interest burden of newly borrowed money.

John considers the problem and suggests to you that to generate positive cash flows, If the company could sell some of its accounts receivable and liquidate much of its raw material. But this action will not ease the liquidity because selling of accounts receivables and raw material will result in some increase in cash but overall current assets will not increase which is necessary to finance current liabilities. Moreover selling of raw material will disturb all other production operations and will ultimately affect sales revenue growth due to shortage of finished goods inventory which is necessary to generate positive operating cash flows and to run business successfully in long run.

So here, John has tried to solve working capital problems in general by his transparent mind set, so here John’s ideas have no any ethical issue. But his ideas are not financially sound and logical and it will ultimately work against business interest of the company.

As the CFO for Dutch, my recommendations are as follows

Company needs to bring back short term funds used to acquire plant assets either through

(1) Long term equity

Or

(2) Long term unsecured loans from directors or their relatives or group companies or third parties

Or

(3) Long term refinance term loan from other bank/NBFC against existing newly acquired plant assets.

Related Questions

Navigate

• Browse (All)
• Browse D
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.