Sure Cut Shares
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Executive Summary
SureCut Shears is a producer of household scissors and industrial shears. In June 1995, the company’s treasurer arranged a line of credit worth $3.5 million with the Hudson National Bank. The company requested a further $350, 000 in September, 1995. Later on in the year the company experienced a problem with repaying its loan. This problem continued into the following year as the company was faced with declining sales and a retailing downturn. Mr. Stewart, a senior loan officer at Hudson National Bank agreed to extend the company’s loan, although he requested a meeting to analyze the organization’s problem and determine the cause and/or causes.
Introduction
SureCut Inc manufactures household scissors and industrial shears. The corporation experienced steady profit and sales growth since the year 1958. This was made despite the existence of severe competition in the industry, especially from foreign companies. Senior loan officer, Michael Stewart, had pursued SureCut for several years prior to 1995. His reason being, that SureCut Shears usually kept sizable deposit balances in its principal banks. In the month of June 1995, SureCut’s treasurer, Mr. David Fischer, arranged a line of credit of $3.5 million with Hudson National Bank. The purpose of this loan was to cover the company’s requirements for the fall. A financial forecast given to Mr. Stewart also highlighted a need for $1 million by June 1996 to help fund an ongoing plant modernization program. This program was expected to improve efficiency and result in savings of $900,000 per year. Subsequent to June 1995, Mr. Fischer requested two other loan extensions and in early April 1996, Mr. Fischer informed Mr. Stewart of the company’s inability to repay the short term loan of $1.14 million before the seasonal upturn in funds requirements in June. Mr. Stewart did not see a reason why he shouldn’t accommodate SureCut Shears.
Discussion
What assumptions did Mr. Fischer make when he prepared the forecast shown in case Exhibit 1 and 2? Were these assumptions reasonable?
Looking at Exhibit 1 and 2 it appeared that Mr. Fischer assumed that SureCut’s sales would increase steadily during the months of July and December as was the trend of the organization. Based on this prediction, Mr. Fischer would have also believed that the company would have been able to repay its loan from Hudson National Bank as scheduled, by December 1995. Exhibit 2, the forecast, also showed the organization’s cash balance remaining steady with a huge increase in December. To make such a prediction, it is obvious that this has been the trend in the sale of shears for SureCut, which makes these assumptions reasonable to a large extent. It should not have been taken for granted, however, that the sales of a company, especially one that is cyclical in nature, are somewhat unpredictable. A cyclical business is one in which sales and profits are determined largely by the fluctuations of business conditions or the business cycle. The shears industry is not cyclical in nature but the sales of SureCut Inc. are, and this should have been taken into consideration by Mr. Fischer.
Why was SureCut Shears unable to repay its bank loan by March 31, 1996, as originally forecast?
The problem SureCut is being faced with is its inability to repay the loan that they borrowed. This problem was brought about by several factors. One of the major factors can be seen by calculating a couple ratios. These are the Current ratio and the Quick (Acid- test) ratio. Both of these ratios are considered liquidity ratios. The Current ratio measures the firm’s ability to meet its short term obligations and the Quick (Acid-Test) Ratio which is similar to the Current Ratio except that it excludes inventory. The formulas for these two ratios and their calculations for SureCut Shears are shown below for both the forecasted and the actual report in the month of December 1995.
Current Ratio= Current assets
Quick Ratio= Current assets- inventory
Current liabilities
Current Liabilities
Forecast:
$11,952/ $1,697 = 7.043
$11,952- $5563/ $1,697 = 3.765
Actual:
$12,716/ $3,465 = 3.661
$12,716- $6,502/ $3,465 = 1.793
Liquidity refers to a firm’s ability to satisfy its short-term obligations. These figures, both the forecast and the actual, are indicators that SureCut is experiencing a liquidity problem. The difference between the Current Ratio and the Quick Ratio highlights that a substantial amount of cash is being tied up in inventory. Another contributor to SureCut’s inability to pay also came from a recession taking place in the market along with a reduction is their sales. Even though sales slowed down it is seen in the company’s records (Exhibit 4) that it continued to purchase raw materials in the months leading up to, and in December 2005 causing an inventory pile up. Dividends are periodic distributions of earnings to the stockholders of a firm. Despite the fact that they were experiencing problems repaying its initial loan on time and there was a fall in sales, SureCut still paid out dividends of $300,000 in the months of September and December in 1995 and in March of 1996 . Since dividend payments can be postponed until the company is financially stable, paying them at those times displayed an inefficient use of funds. The development of the plant modernization program also added to SureCut not being in a position to repay its loan as planned. A probable cause of this is that expenditure