Superior Outboard Motors: How long are the firm's operating and cash cycles? Using a suitable diagram show the breakdown of the firm's operating cycle into its relevant components.

Need help with question 3 (see attached)

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3. How long are the firm's operating and cash cycles? Using a
suitable diagram show the breakdown of the firm's operating
cycle into its relevant components. What do your findings
indicate?

"We have done it again," said George Brash, the president and
chief executive officer of Superior Outboard Motors, to his group of
senior managers at their January meeting. "Our sales for this past year are
up over 8% compared to the previous year, but our net profit margin and
earnings per share are down! The shareholders are understandably upset
and are demanding answers. It won't be long before the analysts change
their recommendations. We better come up with some explanations and
strategies to rectify the problem."

Superior Outboard Motors, headquartered in Tampa, Florida, had
manufacturing facilities in Blaine, Washington and Elkhart, Indiana. It
specialized in the manufacture of outboard motors of various capacities,
for small to medium sized boats. The average selling price of its motors
was $4000 and the cost of production was $2800 per unit. The company
had been in business for over 10 years and was well respected in the
industry.

In particular, analysts had rated its after-sales service, consumer
relations, and treatment of employees pretty high in comparison with its
competitors. The company's stock (SOMI), which traded in the over the
counter market, had appreciated significantly up until the first quarter of
the current year. After that, however, the company had reported a drop in
EPS for three quarters in a row causing the stock price to go down and
the shareholders to make frantic calls to the consumer relations office.

"I think I know what the problem is, George," said Matt Snow,
the vice-president of finance. "I have taken a look at our financial
statements (see Tables 1 and 2) and inventory figures for last year (see
Table 3). While most of the expenses seem to be reasonable, I strongly
believe that the policy of level monthly production, which was
implemented at the start of the year, is the main culprit. Ours is a
seasonal business with the peak season being during the months of MayAugust.
Yet, we seem to be maintaining a level production rate of 600
motors per month. As a result, our inventory builds up significantly
during the lean months and sits there tying up our capital. With interest
rates as high as they have been on our short-term borrowing (prime rate
plus 3%, i. e. 9% plus 3%), the interest charges have been killing our
profits.

"As you can see in this cash budget that I have prepared (Table
4), our short-term debt varied between $2.09 million and $7.09 million
during the first six months of the year. We ended the year with no shortterm
debt, but ended up paying almost $290, 000 in interest expenses for
the year. That's money that was spent primarily to finance inventory,
which I might add, sat around for a few months. I recommend that we
drop the level production policy and align our monthly production output
with the forecasted sales for the month. I haven't worked out all the
numbers yet, but I am quite sure that we will be able to boost our
earnings quite a bit by making that change."

"Wait a minute," said Mike Cooper, the production manager,
from the other side of the room. "Have you considered the effect of that
change on our workforce and employee morale? We will have to lay off
people during lean times and scramble to hire more workers during peak
production periods. That will have a negative effect on our operating
efficiency and will result in some additional costs for training and
orientation. My staff and I are in contact with these folks on a daily
basis. I would hate to have to tell some of these 'nice' folks that they
were being laid off for a few months, especially when our annual sales
have been going up. There's got to be a better way!"

"Gentlemen," said George Brash, sensing that that the arguments
were getting rather heated. "Let's not jump to any conclusions here. I
think you both have expressed valid points. On the one hand, we can't
lose sight of the fact that we value our employees and must continue
caring for them. Yet on the other, we have a responsibility to our
shareholders. We cannot let our earnings and stock price keep on
dropping, especially considering the fact that our sales have been going
up on a consistent basis. As you all know, the market can be merciless,
once the analysts change their tone. Matt, why don't you do the necessary
number crunching and present the results at our next meeting. Let's
analyze all aspects of our working capital management policies and try
and come up with the best possible alternative. I think this experience
clearly proves that in our business, as in most businesses, Timing is
everything!"

Table 1

Superior Outboard Motors
Income Statement

Sales $ 28,800,000
Cost of Goods Sold 20,160,000
Gross Profit 8,640,000
Overheads 4,809,600
Depreciation 1,000,000
Earnings before Interest & taxes 2,830,400
Interest 1,500,000
Earnings before taxes 1,330,400
Taxes 466,400
Net Income 864,000

Table 2
Balance Sheet

Cash 918,280 Accounts Payable 1,680,000
Accounts Receivable 129,600 Short-term Debt -
Inventory 4,060,000

Total Current Assets 5,107,880 Total Current Liabilities 1,680,000

LTD 10,820,000

Net Fixed Assets 13,152, 120 Total Liabilities 12,500,000

Equity (1 million shares) 5,760,000

Total Assets 18,260,000 LiabilitieOwners Equity 18,260,000

Table 3
Monthly Sales (units), Production Output (units), and Inventory Values
Beg. Inv. Production Sales End. Inv Value @ 2800 Ea

January 1450 600 0 2050 5,740,000
February 2050 600 0 2650 7,420,000
March 2650 600 200 3050 8,540,000
April 3050 600 600 3050 8,540,000
May 3050 600 1200 2450 6,860,000
June 2450 600 1500 1550 4,340,000
July 1550 600 1640 510 1,428,000
August 510 600 1000 110 308,000
Sept 110 600 700 10 28,000
Oct 10 600 200 410 1,148,000
Nov 410 600 106 904 2,531,200
Dec 904 600 54 1450 4,060,000
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