Surecut Shears, Inc.
1 - Surecut Shears, Inc. introduction. In his predictions, Mr. Fisher assumed that growth of sales in the year (July 95 till June 96) would be -0. 4% – which in the case of a company that has shown sustainable growing profits since 1958 should reflect some negative economic expectations that would be confirmed by the retail industry downturn – with monthly values for 1996 similar to homologues registered in 1995; production would be constant, so as the cost of goods (60% of sales); and sales seasonal peak is placed between July and December.
However, it happens that from August 1995 in beyond, the cost of final goods were supposed to decrease as result of productive efficiencies inherent to the plant modernization program, allowing to save about $ 900,000 per year before taxes in manufacturing costs, assuming these as materials and labour.
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In fact, this cost should likely be 58% of the sales, instead of the affirmed 60%, with the year total value of those inputs equal to $18. 000, the saving value resultant from the gains of efficiency since the end of August 1995 until June 1996 equal to $ 750,000, and a total amount of sales of $ 30,000,000 (($ 18,000,000 – $ 750,000) / $30,000,000 = 57. 5%). For this reason we do not think this was a reasonable assumption to take.
2. Comparing the Pro Forma Income Statement with the effectively verified Income Statement for the period of July 95 till June 96, the first of the cause and effect relations that we can establish to explain the incapacity of SureCut Shears to repay its bank loan on March 31 is the Retail downturn, and consequent decrease on sales, which end up to register values 12. 24% under the forecasted. Directly related to that is also the verification of a higher lag sales collection period than the predicted (from the 45 estimated days to 50. 8), explained, for instance, by the high market power of large retailers, who constitute a considerable part of the companies’ clients. In the other hand, that was not actually compensated with an increase of the payment period, which in fact almost maintained equal to the predicted, in the order of 30 days. We computed both for every month, by multiplying the number of days (30 in average) respectively by accounts receivable and accounts payable divided by, once again respectively, sales and purchases, and from there we calculated the average until March.
Consequence of the sales decrease was, by its turn, the increase of the inventories, again comparing to the advanced by the Pro Forma Balance Sheet, which shows 108 days of average permanence of inventories in storage before being sold, against the real performed average of 125 days. 3. Although financial conditions had become worse during the analysis period, with the decline on the sales and all the referred consequences for the company, we cannot say that it has crossed a sustainability mark, since it still presents a positive current ratio in March: 5. 5. Therefore, one can say that Mr. Stewart has no motivations to be concerned with the loans due by SureCut Shears, Inc. , once the company still has capacity to accomplish with its obligations. 4. We are clearly facing different kinds of problem.
If, in the first case, the Clarkson Lumber, Co. was increasing its inventories due to a rise in demand, now what happens with SureCut Shears, Inc. s that inventories have increased as result of two distinct reasons: a downturn in the retail sector and seasonality that also influences sales once the policy followed is to maintain a constant production, which does not configure an optimal solution and forces readjustments. Thus, what happens is that in the first case loans were needed to finance the company’s growth, while in the current case discussion is in turn of the need of financing the short of liquidity. Joao Pinto # 224