Polar Sports Case PDF

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This is a case analysis for Polar Sports....

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Connor Starr, Dearius White, Matthew Brown, Shravan Malaney Polar Sports, Inc. MBAF 6885 Decision Making Actg and Fin July 18, 2021

Executive Summary Under level production, net income increased by $372,000.00 for the year. Polar Sports would also save $371,580.00 switching to level production. The financing needs for Polar Sports would also increase significantly as Polar would require more than $4 million in short-term financing between May and October. Risk may be too high for a banker to extend the line of credit, and Polar Sports would need to investigate alternative scenarios to increase capital or find a way to be extended a line of credit. Seasonal production maintains a low and constant leverage ratio between 13-22%, and as a result. the credit would rarely be used. The level production leverage ratio fluctuates between 1154%, and the $4 million line of credit is not enough to finance. If sales predictions were to fall short, the accumulated inventory would remain in storage, storage costs would increase, and the overflow inventory would be sold at a discount. The lower number of products sold would lead to a decrease in cash flow and the net benefits of the costs savings would eventually be reduced. Polar Sport’s decision to change from seasonal production to level production is a decision that could save the company hundreds of thousands of dollars, outweighing any financial risk the change may entail. Introduction Polar Sports, Inc. is a fashion skiwear manufacturer based in Littleton, Colorado. Their production line consists of high-quality ski jackets, snow pants, sweaters, thermal soft shells and underwear, and accessories. The ski apparel design and manufacturing business was highly competitive as the industry comprised a few large players with a number of smaller firms. Several large producers were shifting their major production to Asia and Latin America to save on labor costs, but Polar did not follow the trend. Fierce competition in both design and pricing resulted in short product lives and a relatively high rate of company failures. Richard Weird, the president of Polar Sports needs to decide on changing its manufacturing process from seasonal production to level production. Under seasonal production, their workforce expanded and large amounts of overtime were paid due to the skilled labor required to manufacture their products. Machinery was also standing idle for half of each year and was being subjected to intensive use for the rest of the year resulting in high maintenance costs. Hiring and training new contract-based employees proved to be costly and many of these issues could be resolved with the adoption of level production. Mr. Weir will need to assess the pros and cons of changing to level production and determine if it would be the right decision to make for the business. Analysis The factors that should be considered by Mr. Weir when deciding if he should adopt level production are the changes in operating performance and cost savings. The goal of level production is not to increase sales, but to reduce costs. He will want to assess the change in net income along with the change in cash flow to see if he is receiving positive results from the cost reductions. Weir will also need to assess the risks of level production and maintaining the

minimum cash balance of $500,000. Apart from the changes in cash and overall profits, he will also want to look at the impact of level production on inventory, accounts receivable, and accounts payable. We developed pro forma financial statements to compare the benefits of level production against the benefits of seasonal production. Under level production, the net income was higher by $372,000 for the year. This is attributed to the $480,000 savings from eliminating overtime and reducing maintenance costs as well as the $600,000 savings from reduced hiring and training costs. The costs of goods sold decreased from 66% of net sales to 60% of net sales. Operating expenses increased $300,000 due to storage and handling costs but the benefits of the savings outweighed this increase. Interest expenses increased and interest income decreased due to the decrease in cash to the minimum level of $500,000 which resulted in a loss of $217,000 compared to seasonal production. After all these changes and a tax rate of 34%, the total savings for switching to level production comes to a total savings of $371,580. After creating the pro forma financial statements, we were also able to see the financing needs for Polar Sports change significantly from seasonal to level production. The notes payable increased significantly throughout the year for the business to be able to maintain the minimum cash level. Polar would require more than $4 million in short-term financing between May and October. This is a result of the company’s increase in inventory that reaches a high of nearly $6.5 million in August. As a banker, Polar still has positive operating income and cash flow. The seasonality of the business is a large reason for the extended credit line. Unfortunately, if forecast objectives were not met there could be large stock of unsold products that would result in a loss to operating income and cash flow. This would hurt the business’s ability to repay its debt and with the competitiveness and uncertainty of the skiwear industry, forecasts would have to be met to stay profitable. Polar remains extremely dependent of meeting its forecasts and therefore we think the risk is too high for the banker to extend the line of credit. If the line of credit were not to get extended, the first option for Polar Sports would be to reduce working capital. They could do this by lowering their receivables or extending their accounts payable. This reduction could be achieved by providing a discount to customers for paying within the first 30 days of purchase. The other option for the business would be to take on more debt by opening a new credit line at a different bank or by issuing new notes. However, it would be hard for Polar to receive any additional line of credit from a separate bank given their circumstances. After comparing seasonal and level production, we have been able to find some differences. Seasonal production maintains a low and constant leverage ratio between 13-22% due to the low amount of working capital. The credit line therefore rarely needs to be used and does not get near the maximum of $4 million. This provides a safe analysis for stakeholders such as the bank and the company itself. Level production has a fluctuating leverage ratio between 11-54%. This is significantly more than seasonal production and the line of credit is not enough to finance it. The business becomes highly dependent on meeting forecasts and results in a high risk situation for stakeholders.

If sales predictions were to fall short, the accumulated inventory would remain in storage. Storage costs would increase during the off-season and capital would be tied up. The inventory would still be able to be sold during the next season at discounts, but this would likely be below the cost of goods sold. The lower amount of products sold would lead to a decrease in cash flow and the net benefits of the costs savings would eventually be reduced. Conclusion Based on our analysis, Polar Sport’s decision to change from seasonal production to level production is a decision that could save the company hundreds of thousands of dollars. These savings can mainly be attributed to savings of $480,000 from eliminating overtime and reducing maintenance costs as well as the $600,000 savings from reduced hiring and training costs. Although this approach has the possibility of savings, there is a significant amount of risk involved. As skiwear is a seasonal product, Polar Sport would need to hold inventory throughout the year and guess on upcoming trends. This is risky from a competitive perspective but also financially as the company would need to take on more debt to maintain the minimum cash level. With higher lines of credit, the company would become extremely dependent on forecasts in order to maintain or increase lines of credit. With this, it is our opinion that the risks of adopting the level production method outweigh the cost savings that the method would create.

Exhibit 1 2012 Pro Forma Balance Sheets and Accrued Taxes Under Level Production (in thousands of dollars)

Casha Accounts receivableb Inventoryc Current assets Net PP&Ed Total assets

Actual Dec 31, 2011 500 5,245 1,227 6,972 2,988 9,960

Jan 1,327 2,541 1,706 5,574 2,988 8,562

Feb 2,249 832 2,314 5,395 2,988 8,383

Mar 1,456 630 2,966 5,051 2,988 8,039

Apr 500 554 3,639 4,693 2,988 7,681

May 500 378 4,442 5,320 2,988 8,308

Jun 500 239 5,234 5,973 2,988 8,961

Jul 500 391 5,907 6,798 2,988 9,786

Aug 500 643 6,483 7,626 2,988 10,614

Sep 500 2,457 5,601 8,558 2,988 11,546

Oct 500 3,843 4,989 9,332 2,988 12,320

966 826 139

495 0 104

495 0 43

495 0 -165

495 61 -439

495 992 -542

495 2,197 -844

495 3,263 -926

495 4,280 -990

495 4,678 -940

495 4,896 -751

100 2,031

100 699

100 638

100 430

100 217

100 1,045

100 1,948

100 2,932

100 3,885

100 4,333

100 4,740

1,000 3,031 6,929

1,000 1,699 6,862

1,000 1,638 6,744

1,000 1,430 6,609

1,000 1,217 6,464

1,000 2,045 6,263

950 2,898 6,063

950 3,882 5,904

950 4,835 5,779

950 5,283 6,263

950 5,690 6,630

9,960

8,562

8,383

8,039

7,681

8,308

8,961

9,786

10,614

11,546

12,320

139

139 -34 0 104

104 -61 0 43

43 -70 -139 -165

-165 -75 -199 -439

-439 -104 0 -542

-542 -103 -199 -844

-844 -82 0 -926

-926 -64 0 -990

-990 249 -199 -940

-940 189 0 -751

Accounts payablee Notes payable, bank Accrued taxesf Long-term debt, current portion Current Liabilities Long-term debtg Total liabilities Shareholders' equity Total liabilities and equity Accrued Taxes Beg. accrued taxes Accrual of monthly taxes Tax payments End. accrued taxes

Financials

a

Assumed maintenance of minimum $500,000 balance. Assumed 60-day collection period for wholesale sales and instant collection for retail sales. b

c

Assumed inventories maintained at December 31, 2011 level for all of 2012.

d

Assumed equipment purchases equal to depreciation.

e

Assumed equal to 50% of the current month's COGS for seasonal production; and was related to material purchases that accounts for 50% of COGS for 2012. This represents a 30-day payment period. Since inventories are level, purchases will follow seasonal production and sales pattern. f Taxes payble on 2011 income are due March 15, 2012. On April 15, June 15, September 15, and December 15, 2012, payments of 25% of each of the estimated tax for 2012 are due. In estimating its tax liability for 2012, the company uses a tax liability of $480,000. This implies a payment of $120,000 in April, June, September and December. g

To be repaid at the at rate of $50,000 each June and December

Exhibit 2 2012 Pro Forma Income Statement Under Level Production (in thousands of dollars) Jan

Feb

Mar

Apr

Ma y

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Total

Exhibit 3 2012 Pro Forma Cash Flow Statement Under Level Production (in thousands of dollars) Jan Operating Activities income NetNet sales Depreciation a Increase (Decrease) in Less: COGS A/R Less: Increase (Decrease) in Gross profit Inventory Operating expensesb Add: Increase (Decrease) in Storage A/P & Handling Costs Interest Add:expense Increase (Decrease) in c Accrued Taxes Interest income

Jul

Aug

-67 702 -118 486 -135 414-145378 -201162 -200 180 25 25 25 25 25 25 - 421 - 292 248 227 97 108 2,704 1,710 -202 -76 -176 -139

-159 378 25

-125 2,970 484 2,520 368 5,724 1,177 3,546 640 540 25 25 25 25 25

227 151

281 194 166 151 65 72 608 652 673 803 792 360 360 360 360 360 360

151 673 360

324 1,782 1,512 3,434 2,128 252 1,814 1,386 1,928 718 216 1,188 1,008 2,290 - 1,418 576 -882 -612 2,534 1,228 360 360 360 360 360

479 -471 -34

Profit (loss) before tax Cash flow from operations Income taxesd

1,677

NetInvesting income Activities Less: capital expenditures

Feb

11 0 11 -61 1

Mar

8 0 7 -208 2

Apr

May

Jun

7 0 6 0 3 03 7 7 8 12 4-274 2 -104 1 -302 1

- -205 - -305 101 179 220 302 947 -769 -992 -906 1,130 -34 -61 -70 -75 -104 103 -67 - -135 - -201 -25 118 -25 -25145 -25 -25 200

60 27 -82 1 1,04 241 1 -82

90 37 -64 1 -189 -992 -64

Sep

500 46 150

Oct

420 50 189 1

733

557

-373 249

-192 189

Nov

960 52 606 1 1,783 2,415 606

Dec

590 30 210 1

18,00 0 10,80 0 7,200 4,320 300 295 16

970 1,384 330

2,300 782

- -125 484 368 1,177 -25 -25 -25 -25 -25 -25 159 1,06 Cash flow from operating a Assumed cost of goods sold equal to 60%922 sales. -794 1,017 -931 1,155 6 1,017 -398 -217 2,390 and investing 1,652 b Assumed to be same for each month throughout the year. c 1,06 Cash available before 2% annualized rate of return on monthly cash balances. 6 1,017 -398 -217 2,390 financing activities 1,652 1,749 956 -61 -931 1,155 d Negative figures are tax credits from operating losses, and reduced accured taxes shown on balance sheets. The federal tax rate on all earnings was 34%. Financing Activities Less: bank note repayment 826 0 0 0 0 0 0 0 0 0 2,390 Less: debt repayment 0 0 0 0 0 50 0 0 0 0 0 Calculation of 1,06 Ratios Add: bank note issuance 0-7 0 0 61 6-8 1,017-4 398 0 -23 -27 -28 931 -39 1,205 -23 18 217 13 37 Interest 1,06 coverage: Cash flow from financing -826 0 0 61 931 1,155 6 1,017 398 217 2,390 (EBIT / Interest Expense) Total Cash Flow 827 922 -794 -956 0 0 0 0 0 0 0 Cash Flow to 1.52 0.86 -0.70 -0.85 -0.43 -0.35 -0.24 -0.19 -0.07 -0.03 0.68 Debt Ratio (Operating Cahs Flow / Total Debt)

640 -25

1,518

1,359

1,359

1,309 50 0 35 1,359

10

0 0.63 n. a.

Leverage Ratio: Total Debt / (Total Debt + Equity)

14%

14%

14%

15%

25%

35%

42%

48%

48%

47%

31%

21%

Leverage Ration: Total Debt / Equity

16.0 3%

16.3 1%

16.6 4%

17.9 6%

33.4 1%

53.5 5%

73.0 5%

92.2 3%

91.4 7%

89.6 7%

45.5 5%

26.0 0%

n. a.

Assumptions - 'Notes payable, bank', 'Long-term Debt' and 'Long-term Debt, current portion' are considered interest-bearing debt. All other liabilities are not considered interest-bearing debt. - Due to lack of market value of equity data, for the assessment of the leverage ratio, book value of equity was used....