MBA 306- FINANCIAL MANAGEMENT

Professor: DR. FELIX D. CENA, CPA

Financial Management (MBA 306)

Case Study 6:
Timing is everything

June 11, 2022

Cristy Valente
Michael Carl Libre
Axzl Rhod F. Canino
 MBA 306- FINANCIAL MANAGEMENT
Professor: DR. FELIX D. CENA, CPA

BACKGROUND OF THE STUDY

Advanced Outboard Motors has been in business for more than ten years. As the Vice President of
Finance, Matt Snow feels that the policy of level monthly output, which was implemented at the start of the
year, is the root of the problem. Having inventories pile up dramatically during lean months and then sit there
tying up the company's capital. Furthermore, with interest rates as high as they have been on short-term
borrowing, interest charges have been eating into Advanced Outboard Motors' profits. Mike Cooper, the
production manager from the other side concerns about what will be the effect to the workforce and employees
if their will be a shift on company policies

POINT OF VIEW

Advanced Outboard Motors Vice President of Finance, Matt Snow.

STATEMENT OF THE PROBLEM

Main Problem: Generally, this study aims to determine the exact reason why there is a decline in the earning
per share and profit margin even though there is a steady growth in the company’s sales.

Secondary Problem:

• What would happen if Advance Outboard Motors kept producing at the same rate as before?
• What impact will shifts in output have on the workforce's and employees' overall performance?
 MBA 306- FINANCIAL MANAGEMENT
Professor: DR. FELIX D. CENA, CPA

AREAS OF CONSIDERATION

Employer-Employee Relationship

Advanced Outboard Motors' treatment towards their employees are quite high in comparison with its
competitors. They value and care for their employees. Even in the face of adversity, they remember to consider
the impact of their decisions on their staff. Employees are, after all, a company's true and most valuable asset.

Seasonal Business Swings

Advanced Outboard Motors, which has been in operation for over ten years, is a seasonal business, with
the peak months being May-August. Seasonal business relates to business swings that occur in response to
seasonal changes. Season can be understood in this context to include a) seasons of the year and their
weather-related changes, b) holidays, and c) events. While most businesses endure seasonal swings, certain
businesses face substantial seasonal fluctuations and may even limit their operations to specific seasons.
Seasonality is crucial in the business world. It is frequently the cause of otherwise unexplainable sales rises
and reductions.

Working Capital Management

Advanced Outboard Motors should have an effective working capital management so they can give solution
to one of their problems, since in view to the fact that working capital management can help improve a
company's earnings and profitability through efficient use of its resources. Working capital is critical to the
health of every company, but efficiently managing it is a delicate balancing act. Companies must have enough
cash on hand to pay both anticipated and unanticipated expenses while also making the greatest use of available
resources. This is achieved by the effective management of accounts payable, accounts receivable, inventory
and cash.
 MBA 306- FINANCIAL MANAGEMENT
Professor: DR. FELIX D. CENA, CPA

Vice president of finance

VPs of Finance are frequently involved in the management of a company's finances. They're pulling up their
sleeves and putting controls in place, as well as ensuring timely payroll and balance sheet management.
Matt Snow is the vice-president of finance working under Advanced Outboard Motors. He believes that the
fundamental cause of the problem is the policy of level monthly production, which was established at the
beginning of the year. He stated that Advanced Outboard Motors is a seasonal business and yet the business
seems to be maintaining a level production rate of 600 motors per month, which resulted to having the inventory
build up to significantly during the lean months and sits there tying up the business' capital. Also, with interest
rates as high as they have been on our short-term borrowing, the interest charges have been killing Advanced
Outboard Motors' profit.

Economic Factors

Economic factors that commonly affect businesses include consumer

• behavior,
• employment factors,
• interest rates and banking
• inflation and overall economic indicators.
Understanding how Economic factors affect business is essential to making smart decisions and guiding your
company to greater heights. Economic factors are connected with goods, services, and money. Despite directly
affecting businesses, these variables refer to financial state of the economy on a greater level — whether that
be local or global. The reason for this is that the state of the economy can decide many of the important details
that come up in an operating company, including topics such as consumer demand, taxes and asset value.
 MBA 306- FINANCIAL MANAGEMENT
Professor: DR. FELIX D. CENA, CPA

ALTERNATIVE CAUSES OF ACTION

• Examine Superior Outboard Motors' monthly inventory turnover ratio to determine which months have
surplus and inadequate inventory in compared to sales.

The monthly inventory turnover ratio indicates how seasonal the sales are as compared to the level of
production rate of the business. It can be observed that there is significant volatility in the turnover figures with
September having the highest turnover. However, November through April account for very low turnover ratios.

The inventory turnover ratio, also known as the stock turnover ratio, is an efficiency ratio that measures
how efficiently inventory is managed. It shows how many times inventory is “turned” or sold during a period.
The ratio can be used to determine if there are excessive inventory levels compared to sales. It is important to
achieve a high ratio, as higher turnover rates reduce storage and other holding costs. It is vital for companies to
compare the ratios of each month to know when the business able to sell their inventories efficiently does and
when they are carrying or storing so much of their inventories. The higher the inventory turnover, the better,
since high inventory turnover typically means a company is selling goods quickly, and there is considerable
demand for their products. Low inventory turnover, on the other hand, would likely indicate weaker sales and
declining demand for a company's products.
 MBA 306- FINANCIAL MANAGEMENT
Professor: DR. FELIX D. CENA, CPA

Based on the table presented above, as we can observe, gives us the inventory turnover ratio. During
peak season of May to August, the inventory turnover ratio is 0.6x, 1.1x, 2.3x, 4.6x, respectively. A good
inventory turnover ratio is between 5 and 10 for most industries, which indicates that you sell and restock your
inventory every 1-2 months. So, even during peak season the business was not able to dispose or sell its
inventory immediately resulting to excessive inventory. The months with the lowest inventory turnover ratio
are January and February with no sales at all, with turnover ratio of 0 on both, which results to what we call
overstocking. Whereas, the highest turnover ratio is 16.7x during the month of September, only shows that the
inventory during this month has been efficiently sold, it implies that the business is either not overspending for
its inventory and/or they are not letting their inventory sit for a long time in their storehouse.

• Advance Outboard Motors has chosen to follow a practice of matching production output
to unit sales.

Under the terms of this agreement, Advance Outboard Motors will alter its present production
philosophy to determine how it affects overall growth in net profit margin and earnings per share.
This type of proposal arises from the fact that the company is regarded a seasonal business, which
means it is only open for operations during specific times of the year, and sustaining a monthly
output rate of 600 motors must not be overlooked. One of the features of working capital
management policy is that it maintains and provide sufficient liquidity to the firm. It concerns
with the firms’ current assets investment and financing decisions and the policy adopted by a firm
could dictate the magnitude of its effect on the firm performance.
 MBA 306- FINANCIAL MANAGEMENT
Professor: DR. FELIX D. CENA, CPA

Note **: Interest = $1,500,000 – 67,928

By aligning the production output with the number of units sold each month, the firm’s cash
outflow will change resulting in a decrease in short-term borrowing and interest expense during
the years that is:

Note: EPS = Net Income/Total Outstanding Shares

 MBA 306- FINANCIAL MANAGEMENT
Professor: DR. FELIX D. CENA, CPA

1 2
= $864,760/1,500,000 = $908,913/1,500,000

Earnings per Share (EPS) is a ratio that shows how much profit (return) obtained by investors or

Shareholders per share by dividing net income after tax with the number of ordinary shares
outstanding. As a result, EPS is critical for investors in determining management's effectiveness
in managing a company because it is used to estimate possible growth in future share prices, and
changes in EPS are frequently reflected in share price behavior. There is a $0.05 difference in EPS
between the current and aligned projections in the table above. However, while a $0.91 earnings
per share is preferable, this does not mean that the company should abandon its pursuit of a high
EPS; it is only a minor improvement from present output. Although sales have been positive, this
does not guarantee a company's profitability.

It's worth noting that the current Advanced Outboard Motors manufacture has an
appealing sales figure. If a client does not understand these concepts, they may believe that
investing in this company is a good idea. However, its $20,160,000.00 Cost of Goods Sold will
eat away the majority of those sales. This basically indicates that because the firm is producing
too much and is a seasonal business, there is a good chance that the items will be difficult to
convert into cash and will be stored, costing the company a lot of money in terms of refining
the quality of its product.
 MBA 306- FINANCIAL MANAGEMENT
Professor: DR. FELIX D. CENA, CPA

A net working capital analysis is one of the key areas in financial due diligence, in addition
to a quality of earnings, it measures a company’s short-term financial health. In other words, a
company’s ability to meet short-term financial obligations. In addition, the table shown above is
the net working capital figures of Advanced Outboard Motors. At first glance, notice that current
assets indeed exceeded the current liabilities which results to a positive NWC figure. Thus,
Advanced Outboard Motors is very liquid and can pay its short-term obligations. However, Andy
Burges have stated that the business is a seasonal with its peak season falling on May to August.
On the first half of the year, the company has a total net working capital of $8,687,200 due to the
short-term debt. On the next half of the year, it increased to a total of $28,426,288 due to the
absence of short-term debt and the timing of its peak season. From a high debt and high volume
of inventory during the lean months (possibly in preparation for its peak season), the company is
at a high risk of profit and ESP decline. The firm roughly used 47% to 84% of short-term debt to
fund its net working capital during the first half of the year. It then switched to 100% long-term
debt. Thus, it may seem to be following a restrictive policy of financing its current assets.

Furthermore, notice that the net working capital of the company is fluctuating, it is considered to
be a variable working capital specifically a seasonal variable capital. It is the increased amount of
working capital a business needs during the peak season of the year and may even have to borrow
funds to meet its working capital needs.
 MBA 306- FINANCIAL MANAGEMENT
Professor: DR. FELIX D. CENA, CPA

CONCLUSION AND RECOMMENDATION

The corporate finance has traditionally focused on the study of long-term financial
decisions. However, the short-term financial decisions are equally tactical and important for any
enterprise in order to carry on its business operations productively, consistently and efficiently
Working capital plays an important role in increasing profitability and creating shareholder value,
there are various decisions to be considered but none of these is more important than the other.
It is to be noted that decisions should have equal attentions since the firm strives to maximize its
value. In layman’s terms, working capital is what your customers owe you plus any inventory you
have built up minus what you owe your suppliers and employees Although, working capital
management decisions concern short-term assets and liabilities, they have both short-term and
long-term implications on the profitability and shareholder value which warrant careful
attention.

There are three approaches of current assets investment policy and financing decisions;
conservative, moderate and aggressive that is to be adopted by a firm relative to the benefit it
gives the firm which could dictate the magnitude of its performance. A company is categorized
as having a conservative working capital management policy if it has high proportion of its total
asset as current asset and low proportion of its current liability relative to its total capital. On the
other hand, an aggressive working capital management policy is where a company has low
proportion of its current asset as a percentage of its total asset and high proportion of its current
liability relative to its total capital. Thus, the more aggressive working capital policies are
associated with higher return and higher risk while conservative working capital policies are
concerned with the lower risk trade-off. It can be seen in Advanced Outboard Motors is using an
aggressive financing strategy wherein it uses short term funds to finance a huge portion of its
long-term assets. The heavy reliance of Advanced Outboard Motors on short-term financing
makes it riskier because of interest rate swings and possible difficulties in obtaining short-term
quickly when seasonal peaks occur.
 MBA 306- FINANCIAL MANAGEMENT
Professor: DR. FELIX D. CENA, CPA

Thus, the policy of level monthly production goes against the seasonal nature of the
business which affects the firm profitability due to the effects of high inventory build-up during
lean months and high interest rate because of the short-term borrowing to finance inventory that
sat around for months. Aside from Matt Snow’s suggestion of reducing expenses such as the
workforce, the company can also opt to negotiate discounts with its suppliers in order to
minimize the cost of goods sold and that will eventually increase the earnings per share.
However, Advanced Outboard Motors could stick to its VP finance’s recommendation in reducing
the company’s expenses especially laying-off employees and lowering salaries and other benefits
or lowering the production rate. Because of the company’s reputation towards their employees,
they should think thoroughly what available options is still at hand to solve this problem. The
proponents would recommend that since the production manager, Mike Cooper is eager on
keeping its people, they should come up with a long-term plan that the product they are offering
in the market will be sellable not only during its peak period but also during lean months. Indeed,
this will take time and will require a market study, but the benefit it will give to the company and
workers in the long run is enticing. Not only will it increase and further maximize the value of the
firm but it will no longer waste money on inventory without cash inflow. The reduction in
workforce is inevitable, it will only be for a temporary moment in time until the firm can improve
and valuate the aforementioned plan if changes are adhered this could be considered as a
preventive measure in order to avoid detrimental changes to the company.