Sure Cut Shears
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SureCut Shears, Inc. is a manufacturer of household scissors and industrial shears located in Savannah, Georgia. Their products are sold through wholesalers to specialty and high end hardware and department stores as well as to large discount and variety chains. SureCut has been a highly profitable company boasting a solid track record of profitability since 1958. A company in this position is actively pursued by bankers who want to lend money to and vie for their bank deposit relationship. Hudson National bank prospected SureCut for many years and successfully won their business. SureCuts lending needs were typically of a short term working capital line of credit used to increase inventory production. The company uses their line of credit to fund its peak seasonal sales which occur during the months of July through December for “back to school”, seasonal yard work, and holiday sales. They have always maintained sizable deposit balances and showed promise for continued growth.
In 1995, Hudson Bank extended a credit facility in the form of a $3.5 million line of credit to cover the seasonal sales peak with the agreement that the loan was to be paid in full by the end of the year. In early September, the client requested an additional $350,000 because their expenditures for plant renovations were higher than expected. In January 1996, sales were showing a decline from the forecasted projections and an economic downturn and retail recession was hurting the once profitable company. The pro forma statements also forecast that the company may need an additional $1 million by June to fund a plant modernization project which was already half completed. After completion, the company would recognize approximately $900,000 per years in savings on their manufacturing costs.
Hudson Bank loan officers have been notified that SureCut Shears will be unable to repay the outstanding balance of the line of credit in accordance with the loan term and agreement, and is asking for an extension until June. The Bank officer is concerned over the decline in sales.
Current Financial Health:
SureCuts level production and seasonal sales spikes, caused inventory levels to build and account receivables to increase, prompting the need of a working capital line of credit to cover their cash flow.
Recently, SureCut has been experiencing a decline in sales due to an economic slow down and added pressure from overseas competition. Priced to flood the markets are foreign products which will also cut into future profits. Sales have declined, while production remains the same, and inventory levels are high. This reduces the companys cash flow by having too much inventory on the shelf at any one time. The inventory could become obsolete if it remains on the shelves for too long, as foreign competitors will strive to improve product and rush into our economy.
When the current loan officer Mr. Stewart reviewed his forecasts on SureCuts sales, he used reasonable assumptions based on former trends. He showed a peak in sales during the fall and holiday season, and a return to normal activity. Cash flow projections showed there was adequate liquidity to repay the debt. What happened is that the projections were off from what actually occurred. Sales fell by 25%, inventory levels remained the same, and production costs remained the same. SureCuts financial condition has worsened causing the bank to have concerns over its ability to cover its liabilities. SureCut is unable to pay its bank loan on its due date, due to cash flow constraints from a slow holiday season.
Analysis:
SureCuts June 1995 balance sheet reflected a healthy company. Cash balances were $2.121 million, with a current ratio of 10.88, a quick ratio of 3.71, and a debt ratio of 35.5%.
The profitability of the company has significantly decreased since October 1995. Profit margins are negative for March. Both ROA and ROE ratios have shown instability and continue negative trends. There has not been a significant reduction in overhead and expenses. Over $6 million in upgrades were completed on the plant, but the benefit is not happening. It appears they lost money in doing the modernization project because the plant is not up and productivity has not increased. The outlook for the market is a slow down in the economy. Profitability will benefit from the modernization project in the long run. This should