Advanced Medical Technology Corporation
The amount of times has decreased for AMT over the last three years down to 1. 43 which indicates that they are not managing their inventory efficiently. Inventory is part of the collateral for AMT. Raw material and finished goods are more valuable to the bank than work in progress. Currently AMT takes 8 weeks to complete the processing of production, which means there is 8 weeks’ worth of work in process inventory. This is a very long production process. The bank would like to see the reduction of this work in progress period which required increasing of productivity and efficiency.
Inv. Turnover| Year| Times| Inventory Turnover| 1983| 2. 06| | 1984| 1. 43| | 1985| 1. 43| Mr. Haskins foresees that AMT should continue to grow at a 30% rate but what he doesn’t consider is that while AMT may increase their sales that does not show any sign of their cash on hand increasing. To determine the amount of cash needed for AMT’s operations we should consider the difference between the cash outflow (current liabilities) and cash inflow (total assets) along with net worth. By doing so, we can compare AMT’s spending activity to the amount of cash coming in.
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See below the total amount AMT needs to borrow to meet the required cash for operations for the next three years: Year| 1986| 1987| 1988| Bank Note| 1,897 | 8,829 | 6,807 | Lastly, the net working capital also helps determine how much funding a company needs to run its operations. Below is the cash amounts needed for AMT to run its operations. | 1983| 1984| 1985| NWC| $4,652 | $1,314 | $7,758 | 3. Explain AMT’s borrow patterns relative to its industry over time. AMT currently has a credit line of $6 million with Sunnyvale Bank using both its accounts receivable and inventory as collateral.
AMT is a manufacturer of scientific medical instruments. AMT’S capital has been used up on heavy spending on research and development and rapid expansion of its sales force. Because of that, the company relies heavily on creditors’ money. AMT had maintained extremely low balances on the credit line, and has overdrawn its account several times. Looking at AMT’s balance sheet from 1983 to 1985, the company’s current ratio was 2. 6 in 1983, 1. 1 in 1984 and 1. 8 in 1985. It is estimated that the company’s current ratio would reach 4. 0 in 1986 and going forward (assuming AMT is growing at the same rate from 1986 to 1990).
In the same period of time, the industry median current ratio was 2. 5 in 1983, 2. 7 in 1984 and 2. 7 in 1985. AMT’s quick ratio ranged from 0. 9 in 1983 down to 0. 3 in 1984 and up slightly to 0. 5 in 1985. It is estimated by 1990, the company’s quick ratio will reach 2. 2. In the same time period, the industry median quick ratios were 1. 4 in 1983, 1. 2 in 1984 and 1. 3 in 1985. Both of AMT’s current and quick ratios were lower than the industry medians in the same time period. This indicates that AMT is not as liquid as the industry median.
The pharmaceutical manufacturing industry requires a great deal of cash and a high liquidity ratio because this industry invests heavily in R&D, which requires large capital investments. AMT’s quick ratios were much lower than its current ratio, which indicates the majority of the company’s current assets were not cash assets, but were parts of accounts receivables and inventories. The liquidity ratio is a direct indicator for banks making lending decisions – the lower the quick and current ratios, the less likely banks are to lend money to companies. AMT’s debt to equity ratios were 0. in 1983, 2. 7 in 1984 and 0. 9 in 1985. AMT’s debt-to-equity ratio was estimated to increase to 0. 6 in 1990. In the same time period, the industry median debt-to-equity ratios were 25. 6 in 1983, 61. 9in 1984 and 134. 4 in 1985. Compared to the industry average, the majority of AMT’s capital came from equity financing. It was not surprising that due to the low solvency ratios, it was hard for AMT to borrow money from the bank. The alternative way for the company to raise capital was through equity financing. AMT’s time interest earned was all negative from 1983 to 1985.
This pattern indicates that AMT must borrow money in order to pay back its debt obligations to the lenders. 4. How much will AMT need to borrow by year-end 1988? AMT has relied on outside financing in the previous years to support its sales growth. In 1985, creditors accounted for approximately 48% of AMT’s assets. Since then, the debt-to-asset ratio has decreased to approximately 20%. The times interest earned between 1983 to 1985 were all negative, indicating that the company must borrow money to meet its debt obligations since there is no operating income.
The sales growth rate and external financing need are positively correlated. As AMT’s sales growth continues to increase, external financing needed also increases. AMT will have a greater need for external financing with a projected sales growth rate of 30 percent. At a 30 percent growth rate, the sales level in 1988 is projected to be $67,773,000, increasing total assets to $39,652,000. Since total assets in 1987 were $30,501, AMT will need $9,150,000 in new assets. External financing needed is calculated by subtracting net income, increase in A/P, and increase in A/E from $9,150,000.
The values of these three components are: $1,471,000, $964,000, and $782,000 respectively. The external financing need for 1988 is $5,934. 000. AMT will also need to take into account the accounts receivable and inventory that will be used as collateral for external financing. Based on a 50 percent acceptance rate for accounts receivable and inventory, total collateral equals $10,677,000 in 1988. However, after AMT subtracts the note payable to bank in the amount of $12,128,000, AMT runs a deficit collateral of $1,451,000.
As such, the total external financing needed in 1988 is $7,385,000. Similar calculations for 1989 and 1990 results in external financing needs in the amount of $14,702,000 and $23,949,000 respectively. 5. Would you, as Mr. Winters, recommend a loan to amt? if so, on what basis? Several factors or recommendations would be essential if we were to consider making the loan to AMT. First, AMT would need to decrease operating expenses. Thus far, the company has not been able to generate profits due to excessive spending on R&D and SG&A.
AMT would also need to improve accounts receivable turnover. They are currently extending credit to over 3,000 hospitals, clinics, and doctors. These accounts were extended open lines of credit on net 30 terms without investigation. In addition, 27% of receivables are from foreign customers. We would recommend that AMT be more discerning about their lines of credit and their customer relationships. By qualifying their customer credibility more scrupulously, they might be able to diminish the amount of time in collections.
AMT does not have a proper procedure for checking its customer’s credit. AMT currently is offering credit to customers in order to increase its sales. In case of customer default, AMT would have huge cash flow problems because the majority of its overall sales has been credit based. AMT is currently using Accounts Receivable and inventory as part of its collateral. If Accounts Receivable is not collectable, or if the AR will be used as a write off towards the end of the year, AMT’s Accounts Receivable as collateral would have very little value to the bank.
In order for the bank to loan AMT the money they are requesting, AMT needs to provide the bank with its procedure on how to conscientiously approve customer credit. Inventory is part of the collateral for AMT. Raw material and finished goods are more valuable to the bank than work in progress. Currently AMT takes 8 weeks to complete the processing of production, which means there are 8 weeks worth of work in process inventory. This is a very long production process. The bank would like to see the reduction of this work in progress period which would require increasing productivity and improving upon operational efficiency.
As previously mentioned, based on a 50% acceptance rate for accounts receivable and inventory used as collateral for external financing, AMT runs a deficit in collateral beginning in 1988. In 1989 and 1990, the external financing needs of $14,702,000 and $23,949,000 far exceed the requested loan of $8,000,000. Therefore, the loan request, given their current collateral is nowhere near sufficient to sustain the business over the next 5 years and we would not be willing to grant approval. 6. How effective has mr. haskins been in managing his banking relations? Mr.
Haskins has not been very effective in managing his banking relations. His eagerness to maintain the sales growth and market share has resulted in operating losses from 1983-1985. Net losses for 1983, 1984, and 1985 were: $1,289,000, $1,176,000, and $1,487,000 respectively. SG&A and R&D are accountable for most of the heavy spending that resulted in negative earnings. SG&A spending accounted for 48% of sales in 1983, 53% in 1984, and 47% in 1985. Spending on R&D as a percentage of sales in 1983, 1984, and 1985 were: 9%, 13%, and 14% respectively.
AMT relied on external financing to cover the losses from heaving spending n SG&A and R&D. It is apparent that additional external financing will be necessary to support the heaving spending on SG&A and R&D. The Loan Officer at Sunnyvale, stated that he had a very unsatisfactory relationship with Mr. Haskins. He mentioned that AMT had often maintained very low balances on its accounts. In addition, there have been several occasions in which AMT overdrew on its accounts. Another Loan Officer at the Bank of San Francisco suggested that the quality of AMT’s assets was not enough to increase its credit line.
Mr. Haskins has not been able to prove that he can adequately manage costs or generate profits. Although sales are projected to grow by 30 percent, AMT is inefficient at managing operating expenses. Mr. Haskins’ inadequate and inefficient cost management makes banks reluctant to loan additional funds to AMT. If Mr. Haskins wants to improve his relations with the banks, he needs to prove that AMT can reduce the work in progress, improve accounts receivable turnover, and reduce operating expenses.