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SureCut: Motivation
End of April, Mr. Stewart is going to Savannah. Why? Whats problem here? Whats purpose of trip?
SureCut: Setup
Complete line of scissors and shears Severe competition, particularly from overseas Sales/profits grown steadily, if not dramatically Level production, seasonal sales pattern Short term borrowings July Dec Borrowing for working capital
History
6/95: 3.5M line of credit Anticipated paid off by 12/95 9/95: Call Need 500K more primarily plant modernization plan 1/96: Call Havent paid because of sales decrease Unable to pay until 4/96 4/96: Call Unable to pay before seasonal requirements startup
Why No Repayment?
Why cant they repay as forecast? Compare Exhibit 2 and 4: Need 500 more in Sept. (3714 vs. 3270 forecast) Need 1256 more in March (1256 vs. 0 forecast) In Sept. says that its the plant: Potential Overruns Is it? Compare PPE:
Forecast 27554 27554 Actual 27848 27812 Difference 294 258
Sept March
Why No Repayment?
Compare differences between actual outcomes and forecasts for: Start with I/S Then do B/S Finally: Quasi Sources and Uses
Why is the difference column not a pure Sources/Uses statement? How should we interpret this table?
10 Finance Theory II (15.402) Spring 2009 Carola Frydman
Some analysis
Inventory (Asset) In 6/95 Inventory is 8106 Forecast for 3/96 is 6588 Was supposed to be source of 1518 But in 3/96, Inventory was 7374. So actual source of only 732 1518 732 = 786 less of a source than expected Asset higher than expected; Didnt go down as much MUST FUND THIS SHORTFALL!
TOTAL
2939
Source of Shortfall: Higher Assets and Lower Liabilities Funding Shortfall: Lower Assets and Higher Liabilities
15 Finance Theory II (15.402) Spring 2009 Carola Frydman
Is Management at Fault?
Sales decrease 11%, Profit decrease 21% Recall operating leverage argument How soon could they have forecasted decrease in sales? In September sales down only by 7% By October down by 10% How about purchases? Purchases forecasted at 777 per month Actual purchase of raw material greater than forecast until December! By then sales off by 15% Dont cut labor until February
16 Finance Theory II (15.402) Spring 2009 Carola Frydman
Consequence
Whats the result of all this? Lower sales, even labor, higher purchases Inventory!
Total Inventory Mar-96 Jan-96 Forecast 6588 5818 Actual 7374 6925 Difference 786 more 1107 more
Forecast 2701
Actual 4171
Response Rate?
Were they slow to respond? Fairly clear that sales decrease by October But purchases more at first, and decreases purchases below forecast only in Dec. Maybe getting discounts due to recession deal? Labor decreases in February Slow? Layoffs in Christmas Layoffs of skilled workers in face of temporary fluctuations in demand may not be best idea
Loan Repayment
Going to do an 85% of Proforma analysis Can they repay the loan if sales are set at 85% Proforma? Where did we get 85%? Other Assumptions: AR, AP, Inv at 85% of PF SGA unchanged Taxes 36% Dividend not cut
-149
-207
-229
-177
-51
147
493
765
491
36,970 + Cash
36,970 + 1432
How fast pull inventory down? Inventory 12/96 @ 85% = 4695 Work of excess by: Cutting purchases and labor
Inventory
End Inv = End Raw Materials + End Work in Process + End Finished Goods End RM. = Beg RM + Purchases Trans. to Work in Process End W in P = Beg W in P + Trans. to W in P + Labor Trans. to Finished Goods End FG = Beg FG + Trans. to Finished Goods - CGS End Inv = Beg RM + Purchases + Beg W in P + Labor + Beg FG CGS End Inv = Beg Inv. + [Monthly Purchases + Labor] - CGS
Wants to make sure that they bring production in line with sales. Afterwards, not much: Especially when sees that theyve done all this analysis
Is Loan in Danger?
Finished
Not really!
Bottom Line
SureCut needs to weather downturn and undertake period of inventory readjustment. Purchases and production will be at lower rate than sales in order to bring finished good inventories in line.
After this readjustment, every reason to believe that Surecut will be able to continue with policy of borrowing from bank only for seasonal needs
Comparisons
How would you compare Wilson, Playtime, and SureCut? Some ratios:
Wilson Current Ratio 1.6 NW/Assets 40%-45% Nature of Loan long-term Risk of Loan moderate-low
Summary
Talked about impact of expected case not occurring Mgt response to change in climate Sources and Uses Look at shortfall Both source of shortfall and funding of shortfall Pro Forma as forecasting tool For Firm For Bank Pro Forma as diagnostic tool Production calculations Ratio Analysis
37 Finance Theory II (15.402) Spring 2009 Carola Frydman