Covington Building Supply is a company that deals with building repairing and re-modeling. The company deals with people that want to remodel or repair their houses or with other businesses, public or private, buildings that need repairing. The main market for this company is the housing market along with the private business centers market, resorts, etc. but Covington Building does not only assist you in repairing your building after damage, but it can also offer you a remodeling option for your house, for example.
As mentioned above, its clients can range from individual homeowners to big companies wanting to repair or remodel their property buildings. Since from the income statement we find that most of the revenues, sales, of the company are done in the second and third quarters, we can imagine that its clients see the services offered by this company as something they can use during the vacation season. For example, people tend to remodel their homes during summer when they can take a period off from their jobs. The same can be said for business companies wanting to repair their buildings. During spring and summer, it is better to do that.
The very nature of the business explains to us that the main suppliers for Covington Building Supply are companies that provide raw materials needed for the repair works. Covington Building Supply is in a comfortable position for the moment because the correctness of Mr. Covington in doing business with them has formed a positive image. This has helped build confidence and now Covington Building can rely on high-quality suppliers. This situation will ultimately benefit the Covington company itself.
The main concern of a bank when it credits a company is the ability that this last has to repay the debt. Banks primarily want to know if you are capable of generating enough income to repay their debt on time. The second thing they look for is if you will be so successful as to require more credit to expand your business so that they can finance you again. Thus it is imperative in our case to see some key parameters of Covington Building Supply. The first is their debt-to-equity ratio. That is the contrasting of their total liabilities with their total assets. But what is important is the value of the long-term debt that a company has.
This is because long-term debts can harm companies in the future. A high debt-to-equity ratio means that the company is being aggressive in investing through borrowed liquidity. if income is going to remain at a level above that required to repay the cost of debt (its interest), then the company will benefit from it. Thus we have to go to the financial data of the company and see its revenues for the past years, its operational costs, and its net profit after taxation. If the costs of Covington Building Supply are decreasing over time, or the company manages to keep them as low as possible, this is a good start.
If also, the revenues, the sales, of the company are increasing year after year, that is also very positive. The decreasing value of the company’s expenses, operational costs, combined with the increasing value of its sales, revenues, will give as a result an increasing value of gross profit before taxes. Of course, this will result in an increase in profit after taxes, the net profit.
It is this net profit that should be contrasted then with the interest rate value the company has to pay to the bank. If this profit value is greater than that of the interest to be paid, and with a growth tendency, then the company is in excellent health and it is worth crediting it. In this case, Covington Building Supply has been gradually increasing its revenues over the last three fiscal years. In Section 3 we will deal with it in detail demonstrating the data backing this claim.
A final consideration could be made about the fact that MR. Covington is not taking advantage of the 2% discount offered by its suppliers if the invoices are paid within 10 days. This is due to the fact that he wants to have some liquidity in the company. He has to pay the loan already part of the company’s expenses and the fee of the purchase of the shares from his brother-in-law. If he pays the invoices immediately he will leave the company almost “dry” of liquidity. To be more precise, the number of days he is taking to pay is determined by the ratio: accounts payable/average purchases per day.
By looking at the financial data (in thousand $) we see that for 2004 this was: 575 / (5964/365) = 35.2 days. For 2005 we have: 918 / (7368/365) = 45.4 days. For 2006: 1015 / (9663/365) = 38.3 days.
The business strategy of MR. Covington is to gradually expand his business from a local level to a state level. The first factor demonstrating this is the fact that he builds his building facilities near an interstate highway. This will help the company reduce significantly transportation costs. By forming a very good relationship with its suppliers, MR. Covington has assured his company of fast and high-quality supply materials. This will have a positive impact on creating a brand image among consumers. The backing of his business by well-known and established banks is a further positive factor for Covington Building Supply. All of the above-mentioned factors do help the company gain a sustainable competitive advantage.
Also, we must mention specifically that Mr. Covington is relying on bank credit investments, loans, for a few reasons. First of all, this way he guarantees his company a considerable cash flow, liquidity. This makes him not use the cash gained from the net profit to invest for the company and thus can use that cash to pay the purchase of the shares of his brother-in-law. That is a second reason. Also, another reason is that by relying on banks he increases his positive perception of the market. Since banks have confidence in their company then consumers and other investors will view this as a reliable company. This helps build consumer and investor confidence.
Regarding the profitability of Covington let us see the net profit value year after year. From 2004 to 2006 it has gone from 162 to 207.9 (thousand $). So, in 2005 the company had a 13,33% increase compared to 2004 and in 2006 a 13,23% increase compared to 2005. Similarly, the net sales have been growing these three fiscal years. In 2005 the company increased the sale by: (9337.9-7886.7) / 7886.7 x 100% = 19,03%. In 2006 the increase was: (12201.3-9337.9) / 9337.9 x 100% = 30,66%.
These two factors combined demonstrate that Covington Building is a profitable company. The increase in sales is a positive factor which shows that the company’s profit will remain high and thus it will be able to repay the loan. The stance of the net profit of the company above the level required to repay the loan, and its constant growth, demonstrate that Covington will be able to repay the bank for its loan.
As one of its suppliers wrote, Mr. Covington has been very conservative regarding cost control. So, we have to provide some financial data to back up the decision of the giving of the loan. From the financial data provided we see that the increase in gross profit is higher than that of the operating expenses. For 2005 the gross profit increase was: (2276-1941) / 1941 x 100% = 17,25%. Instead the operational cost was: (1936-1679) / 1679 x 100% = 15,30%.
For 2006 the gross profit was: (2957-2276) / 2276 x 100% = 30,09%
The operational costs instead were: (2538-1936) / 1936 x 100% = 31%.
Even if in 2006 compared to 2005 the gross profit has increased less than the operational costs, anyway the gap is relatively close. In order to have a clearer picture, we must see the data regarding the total assets and the long-term debt. In 2005 total assets were increased by 3124 – 2481 = 643 or 25,91%. In 2006 they increased by: 4420 – 3124 = 1296 or 41,5%.
The debt-to-equity ratio were:
For 2004: 1121 / 2481 x 100% = 45,18%
For 2005: 2120 / 3124 x 100% = 67, 86%
For 2006: 3208 / 4420 x 100% = 72,57%
But we can have a clearer picture if we see the values of long-term debt. Instead of increasing, long-term debt was reduced from 378 in 2004, to 324 in 2005 and 270 in 2006. Respectively, in 2005 we had a 14,28% decrease from 2004 and in 2006 a 16,66% decrease in comparison to 2005. Thus, as mentioned above, the stance of the net profit of the company above the level required to repay the loan makes it an attractive customer for the bank.
The major risk factor for the company would be the increase in the cost of supply materials and the decrease in demand in the market. Since the services offered by the company tend to be viewed as ‘luxury’ expenses, as is the remodeling of the homes for example, in difficult times many people tend not to remodel their homes due to financial difficulties. This would have a negative impact on the company’s revenues, sales, and thus decrease its profits. And if the profits are decreased it will be less able to repay the loan to the bank.