Problems and Risks
Problems/Risks
Production costs and expenses were increasing relative to sales. In 1997, production costs were 52% of sales and have been steadily climbing. Costs are expected to be up to 60% in 2002. Because of this increase in costs, shareholders equity is quickly declining. Equity accounted for 43% of sales in 1997 and will be down to only 26% by 2002.
Oleg has suggested expanding this to 90 days in 2001 and 2002. Consequently, while Germany accounts receivables have been steadily falling relative to sales, Ukrainian accounts receivable has been climbing. In 2001, Ukrainian accounts receivables are projected to be almost 2 million more than Germany, yet Ukrainian sales will only be half that of Germany’s.
Despite Oleg’s optimism, it’s still extremely risky to extend lax credit terms to these types of distributors. Oleg admits that most of these retailers cannot qualify for bank credit and that is the reason they need these terms. Three of the distributors have significantly lower operating profit/sales compared to the industry and all have large trade payable accounts. They carry little inventory and have longer day’s sales outstanding than the industry average. The only one of these distributors that Oleg should consider giving these terms to is Kiev.
Another symptom of these lax credit terms has been an increase in short term borrowing. Because Deutsche Brauerei is not receiving these payments form their Ukrainian sales, they have been forced into short term borrowing to finance there growth. Short term borrowing has gone from 5% of sale in 1998 to a projected 18% in 2002.
In this analysis, variable costs are 52.3 and unit, and fixed costs are 24.6 million. Units sell at 78.5. With 2000’s data, the break even point was 938,799. Deutsche Brauerei barely passed this mark, selling 1,173,000 units. With costs being so high and a capacity of 1.2 units, Oleg says they need new plant equipment to increase profit. However, it may be more feasible and beneficial in the long run to work on reducing costs.
Oleg’s forecast of bad debts accounting for only 2% of accounts receivable is too low.