Cut Shears, Inc. is a manufacturer of household scissors and industrial shears. Because of a policy of level production and a seasonal sales pattern, the company has to borrow funds under a line of credit to cover its seasonal buildup in inventory and receivables. During 1995-96, sales began to fall from projected levels due to a retailing downturn. However, the company may have been slow to react resulting in an accumulation of excess inventory and related inability to repay its bank loan prior to the next seasonal increase in demand.
We were given both forecasted and actual financial data. A diagnosis of why the company cannot repay its bank loan should be made to decide whether to renew the outstanding loan. The following is the course of loan requests from SureCut during 1995-96: 1. June 1995 – $3. 5 million ? Until December 1995 2. Another $1. 2 million by June 1996 (For Plant modernization – finish est. August 1995) 3. September 1995 ? Additional $0. 5 million until December 1995 (Total $1. 25 million) 4. January 1996 ? Extending loan funds until April 1996 (retailing downturn ? sales down) 5. April 1996 ?
Extending until June 1996 (again, retailing recession) The plant modernization program is, in essence, a long term investment, and is expected to return $900,000 per year ($75,000 per month) in manufacturing costs. Pro Forma Assumptions It is obvious that Mr. Fischer made wrong assumptions when constructing the pro forma financial reports. He assumed that sales would continue to be steady, while actual sales were about 86% of the forecast ————————————————- PRIMARY PROBLEM Mr. Fischer forecasted NOF of $4,492,000 but actually ended up being $3,465,000 due to a retailing downturn.
Higher-than-expected inventory was being carried through the peak season as well. This was their peak sales period and it was hoped that proceeds from this season would pay off the seasonal loan for the capital expenditure. SureCut Shears now faced a credit problem because they no longer expected to be able to pay off the seasonal loan. INTERPRETATION OF EXHIBITS Due in part to a slackening of sales, inventory at the end of March 1996, the amount of additional money tied up in inventory over the 9-month period of interest is almost double the forecast.
But by October 1995, it was apparent that sales were not keeping up with what was forecasted. Over the 9-month period, the Profit Margin is only 10%, far below the acceptable range of 15 – 30%. So one wonders why the planned orders with the manufacturer were not reduced to compensate. Instead, inventory was allowed to build. This tied up about $800,000 more than forecasted. It’s interesting to note that less money than forecasted was spent on the capital project during the 9-month period.
While we don’t have enough information in the case to draw conclusions, perhaps some savings could have been captured had the loan amount gone towards completion of the project. It is not known whether the project was behind schedule for operational or financial reasons. Perhaps money was diverted from the project to fund the working capital needs of the company through the peak season. In the same 9-month period, they have paid off much of their Accounts Payable. They forecasted that they would pay off $84,000 but they actually …