Commercial Printing Inc. Key Performance Measure Case

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- What is the inherent flaw in CPI’s business model that creates a cash flow management challenge?

The inherent flaw in CPI’s business model is the differing rates of cash inflows and outflows. Customers receive the invoices 25 days after shipment on average, while terms are n/30. After the invoices are received, customers take on average 55 days to pay the invoice, resulting in a total cash collection process of 80 days. CPI’s cash outflows have a much higher rate of turnover, with payment taking around 20 days, which allows CPI to collect cash 60 days slower than it pays cash. With a rate of cash outflows much higher than cash inflows, CPI can be left without the necessary amount of cash to cover its cash outflows, or short-term debt obligations. After the improvements are made to the invoice sending process, the 25 day invoice process can be cut down to only one day. However, the process improvements did nothing to resolve the larger part of the cash inflow problem – the 55 days in which it takes customers to pay the invoice after receiving it. Therefore, the team failed to resolve the entire problem as CPI would still have a cash outflow rate of 36 days quicker than the cash inflow rate of 56 days, and would still experience the same cash flow problems. CPI’s lack of cash to cover cash outflows drives the high level of debt.

- Calculate the financial statement impact to CPI if the project team is able to improve the billing process and achieve its goal of issuing invoices within one day of shipment? You need to determine the sources of savings and quantify the amounts. You also need to determine if the savings are one-time events or annual recurring savings. (HINT: Keep separate the balance sheet savings from the savings affecting only the income statement).

If CPI is able to improve the billing process and issue invoices within one day of shipment, the company will see positive financial statement impact. This improvement will increase the average cash on hand of the company as well as decrease the average amount of accounts receivable. This is an annual recurring decrease in accounts receivable.

Avg. collection period = 85 = Accounts Receivable / Avg. daily sales avg. daily sales = $273,973

Avg. accounts receivable = $23,287,705

Avg. collection period = 55 = Accounts Receivable / Avg. daily sales avg. daily sales = $273,973

Avg. accounts receivable = $15,068,515

This reduction in average accounts receivable should generate $8,219,190 in cash flow.

On to the income statement, this improvement should lower expenses involved in the invoice shipping process as well as sales loss with customer disputes. This process reduces the invoice activity by 24 days, which must cut a large amount of expenses for the company, let’s say about $0.5 Million over the course of the year, resulting in a decrease of total period expenses from $35 million (40-5) to $34.5 million. With the sales loss due to customer disputes, if we generalize customer disputes to being 1.5% of sales, rather than just billings, we can calculate this effect on revenue and net income. For simplicity, let’s say the company eliminates all customer disputes with this process improvement. Sales would increase by 1.5% to $101.5 million, leaving a gross margin of $40.6 million. This is a $0.6 million increase in gross margin. Taking away the $34.5 million in generalized expenses, we can finish with a pretax income and profit of $6.1 million. This number does not take into account the decrease in expenses due to the process improvement to one day. This improvement will be a one-time decrease in expenses and increase in gross margin, however, these changes will be the same and become the new standard for future years.

- Goldman Sachs stated that printing companies normally sell for a multiple of 18x earnings. CPI plans to issue 10 million shares. If the billing project realizes the savings you estimate, what will be the offering price when the CPI completes its IPO. (Note: the corporate tax rate is 35%).

Earnings = $6.1 Million

18x $6.1 M = $109.8 M

$109.8 * (1 – 0.35) = $71.37 M

$71.37 / 10 M shares outstanding = $7.137/share