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Toy Producers Inc Case Study. Clive Vlieland-Boddy . Group Discussion. Summaries the risks and rewards of switching to linear production?. Key Issues. What is the Company? What is the Industry? What is the decision to be made? Who is to make the decision?. The Company. Toy Manufacture.
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Toy Producers IncCase Study Clive Vlieland-Boddy
Group Discussion • Summaries the risks and rewards of switching to linear production?
Key Issues • What is the Company? • What is the Industry? • What is the decision to be made? • Who is to make the decision?
The Company • Toy Manufacture. • Makes plastic toys. • Seasonal Trading with peak Aug - Dec. • Long Established • Well run. • Successful. • Reaching max production on a cyclical basis. • Some Working Capital constraints. • But YoYo profits!
The Industry • Products difficult to differentiate unless related to Film or known characters. • Otherwise low cost with often foreign cheap low cost products. • Low entry barriers.
What is the decision to be made? • To continue with seasonal production or • To switch to monthly level production. • Will they need additional funding from the bank. • If so…. How much?
Who is to make the decision? • The management of the company. • Mr Mc Gregor.
The Task • We need to compare the financial projections if the company continues with seasonal production to the financial projections based on level production. • Then we need to establish the level of required additional funding.
Table C • This clearly shows the seasonal trading position. Peak sales are from August to December. • Sales from January to July are minimal. • Maintaining production close to these minimises funds tied up in inventories. • But means that high overtime premiums have to be paid. (COGS under seasonal is 70% and under level it is 65.1%)
Rewards Savings on Overtime. Savings in some other costs especially set up. Possibly better staff relations. Risks High Inventories. Production no longer matched with orders increases risk of unsold goods. Increased borrowings to fund inventories means increased costs. The Risks and Rewards of Switching to level production.
The Key Risk • We will be producing against expected sales and not against firm orders. • Our projections will therefore be for what we think we will sell. • Whilst our forecasting has been good in the past, we have never had to forecast demand before. We have only reacted to demand. • This is therefore a new discipline that we need to develop!
Table C Projected Income under seasonal production. • This shows Sales of $10m with profits after overtime premiums of $350k.
Lets do a profit forecast for level production. Assumptions • 60 days AR (Dec 2003 collected in Jan & Feb 2004) • 30 days AP (Dec 2003 paid in Jan 2004) • Gross Margin 65.1% • Operating Expenses will be increased by $115k. • Interest at 9.625% on the net borrowings. Assume $7k Jan. • Tax Rate is 34%.
Summary of Profitability. • Present Production per Exhibit 2 = $353k • Under level production = $530k • Benefit of level production = $167k • What about risk and sensitivity
Then a cash flow. • To Establish Level of Funding. • Therefore the cost of borrowing. Note: Tax payments should be calculated based on paying the 2003 balance in March and $35k in April, June, Sept and Dec. Loan Repayment of $25k in June & Dec.
Return to the Profit Forecast • Insert the cost of borrowing.
Cash Flow Issues • Required Borrowings would climb to over $4,000k. • This is over $2,000k in Excess of current bank facilities. • Exposes the company to large debts with no orders. • Essentially inventories would climb to about $3,730k in July before the expected demand starts to reduce this.
Sensitivity Analysis Look at the “what if scenarios”.. • Say level production from May onwards. • Or outsourcing peak demand to avoid Overtime Costs. • Or sales demand reduced. • Or Interest rates increase. How would these impact cash and profits?
How else could this substantial increase in Working Capital be financed? • Factor Accounts Receivable! • Introduce incentives for early payment by Accounts Receivable. ( However this would not make much difference until August) • Press Accounts Payable for more credit. (Again this would make only a small impact into the required additional funding).
Bank Funding appears the only real alternative! • So what do you think the bank would say? • They are going to be concerned at the concept of production against no firm orders. • There is therefore a risk of over-production and thereby obsolete inventories. • The company is financially sound….. • But the required funding would well exceed the Shareholders funds.
Are there any other options for production to avoid the need for additional Working Capital? • What about some level production. • What about outsourcing some production.
How could we reduce the risks? • The bank is now lending up to $4m against Inventories and not Accounts Receivable. • We increase profits by $179k. • Leverage will move from 2:1 to 1:1. • What other risks are there????
So what factors should Mr. Mc Gregor consider? • Is it really his decision?
How certain are the forecasts? • Consider the fact that there have been Yoyo profits in the past!
If you were the bank manager would you agree to the increased loan?
Assignment - 4 (10% of the Marks) • Evaluate individually this case. • Take the downloadable budgets and evaluate them • Apply sensitivity analysis to the forecasts. • You can make what ever assumption you feel appropriate. • The objective is to explore alternatives that might reduce risk and / or maximise profits. • Bring in your evaluation. • We will review this next session.
Assignment 4 • You are expected to hand in the assignment by the agreed date. • It should include reworking the Profit and cash flows with your assumptions clearly stated. • It should also include a pro-forma Income Statement with your concluding position.
