Topic: Comprehensive financial statement analysis Level of difficulty: High The headquarters and plant of Bizerte Home Furniture Company (BHF) are located in the tax-advantaged industrial zone of Bizerte, Tunisia. BHF manufactures a complete line of high-quality home furniture and sofas for distribution through relatively exclusive retail stores strategically located within selected high-end marketing area. These wholesale customers, all over the Mediterranean basin, comprise specialized independent home furnishing retailers, regional specialized chains, as well as department stores. The retailers carry products from a few other different brands than BHF in their showrooms. They promote locally the BHF products and those of competitors, take orders, and provide delivery service. BHF does not engage in retail sales itself, but promotes its brand in the various markets where its presence is significant through its distributors. Unlike Tunisian furniture importers, who, often, either offer long delays for delivery, or have to carry a large inventory of finished products, BHF has invested both in a modular approach to furniture and sofas design and in sophisticated flexible manufacturing equipment. BHF has a significant inventory of imported kiln-dried woods in various grades and various veneers, and carries a wide selection of fabrics and foams. This inventory allows BHF to manufacture 70 percent of its products to order for rapid delivery (less than two weeks ex works, on average) and 30 percent for stock for immediate delivery when an order is received from a retailer. The critical success factors of any furniture product line are, of course, design, brand name and quality. But visibility and availability are the most critical of all variables. Retailers carry a large inventory of a manufacturer’s product in their showroom only if the supplier finances most of the inventory. Credit terms granted by BHF (and its competitors) are therefore crucial to the continued success of their brand. In May X3, Leila Smaoui, credit analyst for the Bizerte Home Furniture Company (BHF), is revisiting, as she does yearly, the credit situation of all customer accounts. The economic slowdown has seriously affected the overall furniture market. BHF’s sales have been down almost 25 percent for the first quarter of X3 over the same quarter a year earlier and the last quarter of X2 had not been particularly good with an overall shipment decline of 5 percent over the same quarter a year earlier. The situation of two retailers, representing, together in X3, about 10 percent of BHF’s Tunisian sales and 4 percent of its overall sales, seem to raise urgent questions as to whether BHF should continue supplying them and extending supplier credit: Galleria Group SA, based in Tunis, and Le Grand Marche´ , based in Sfax. Galleria Group is a young upscale retailer of quality home furnishings. It operates in three locations, one in downtown Tunis, one in Hammamet (over two thirds of the sales of the Galleria store in this resort-town are from contract sales to hotels) and the third, opened in late X1, in Les Berges du Lac (new upscale, very large and rapidly growing, suburban development of Tunis with a mix of retail stores, light industry and services, business headquarters and offices, private residences and hotels). The BHF brand represents about 60 percent of the Galleria Group sales revenue. The Galleria sales manager insists that his sales force require a 20 percent cash deposit to confirm an order and the rest of the payment should either be paid cash upon delivery (this applies to 75 percent of the sales) or the remainder of the invoice should be paid in up to six-month instalment terms. Galleria had been a customer of BHF Company since the opening of its first store in downtown Tunis about seven years ago. It has, until recently, handled its relations with BHF in a most satisfactory manner. Le Grand Marche´ (LGM), although long-established, is a comparatively new customer of BHF, having opened an account only three years ago. A sizeable furniture store in Sfax, Le Grand Marche´ is well known regionally for its extensive lines of home furnishings, serving the needs of a wide range of clienteles, institutional, as well as upmarket and down-market individual residential customers. Its institutional customers are essentially the many hotels in the nearby resort island of Djerba. BHF products represent only about 40 percent of its total sales. Its payment history to BHF has been satisfactory through late X2 but, since then, many overdue invoices have accumulated. LGM requires only 10 percent down payment from their customers when they place an order. The remainder is generally paid in equal instalments over two months after delivery. However, lately, more and more customers have asked for, and obtained, extensions of one to two months of additional credit. Sales by BHF to both these wholesale accounts are on the standard commercial terms for the industry in Tunisia: a discount of 1 percent if the invoice is paid within less than ten days of receipt, or net invoiced price due no later than 30 days after delivery. The CFO of BHF, Souad Mahmoudi, and Leila Smaoui, in agreement with the sales manager have previously established a 130,000 Tunisian Dinars (TND) credit limit on Galleria Group and a 105,000 TND limit on Le Grand Marche´ . Whether these limits are still appropriate is one of the questions Leila is debating. Given BHF’s own needs for liquidity and growth to occupy the fixed capacity of the plant, Souad Mahmoudi has asked Leila Smaoui to stay on top of the financial status of all customers. Leila is reviewing all situations annually on the basis of financial statements provided, at her request, by the customers, and switches to a semiannual analysis if she feels the situation of a client is deteriorating such as when the balance of overdue invoices exceeded 10 percent of the credit limit. Both Galleria Group and Le Grand Marche´ have hit and exceeded their limit. In early May X3, Leila Smaoui received the unaudited X2–X3 annual reports of Galleria and Le Grand Marche´ (both firms close their annual accounts on the last Saturday before March 31). These statements, and the equivalent documents for the two preceding years, are provided as Exhibits 1 to 4. In the early months of X3, demand for home furniture has remained weak, although the drop in retail sales has not been as dramatic as it had been in the second half of X1 and first half of X2. Retail stores have placed fewer orders than anticipated, especially on new product lines, and have reduced their reorders of more classic products. BHF’s sales force has mentioned that store showrooms were quite full, all over the network of distributors. The traditional end-of-year sale has not cleared the showrooms as it usually does to make room for the new collection. The dilemma for BHF is to find the balance between maintaining sales to distributors (which requires extending credit) and keeping the receivables within acceptable limits, both in terms of balance and risk. Required 1 Analyze the financial statements of Galleria and Le Grand Marche´ to understand how each reacted to the downturn in the market. Base your analysis on facts logically derived from the financial statements, such as selected ratios, longitudinal analyses, or any other relevant information contained in the case. Explain your selection of the metrics used in your analysis. 2 What recommendation(s) would you suggest to the management of BHF regarding these two clients, and especially whether it is appropriate to extend their credit limit and continue to ship to each or either?