Working Capital Management (Q 1 and 2 only)

See full case in attached file. I only need help with questions 1 & 2.

Working Capital Management

"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-resident 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 May-August. 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 short-term 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 manger, 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 hat 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!"
"Gentleman," 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!"
Questions:

1. Compute and comment on Superior Outboard Motors' net working capital, current ratio, and
quick ratio.
2. Examine the company's monthly inventory turnover ratio. What does it indicate?