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Teaching Notes Synopsis This case describes a conversation between Joe Melaney, the owner of the Toro distributorship in Galveston, Texas, and his son, Joe Jr. The immediate subject of the conversation is to decide on the spring season order for the entire irrigation line. In the course of the conversation, other issues emerge, ranging from the proper inventory level for specific parts to the future ownership of the distributorship. Purpose This case can be used at two levels. At the first level, the case is an exercise in the development of an effective system for managing independent demand inventory, taking into account the particular problems faced by a distributorship. At the second level, the case can be used to demonstrate the importance of inventory management as a policy variable. Since Southern Toro is a distributorship, profitability depends heavily on inventory management. Discussion Questions 1. 2. 3. What would you recommend that Joe Jr. do, assuming he takes control of Southern Toro? Evaluate the importance of inventory and inventory management of Southern Toro Distributorship, both for irrigation products and spare parts. Should the inventory be cut back? Evaluate the current inventory management system at Southern Toro. What inventory management system would you recommend?
Analysis Joe Jr.'s course of action if he takes control of Southern Toro certainly depends on a financial analysis of the company. Exhibit TN-1 shows some of the common financial ratios for the fiscal years 2000, 2001 and 2002. Southern Toro Distributorship has been steadily increasing in net worth over these years but the return on invested capital has been low. Furthermore, the future outlook is potentially disturbing. As Exhibit TN-1 shows, the distributorship is highly leveraged, with a sharp increase in 2002. This will increase the cost of any future financing. Liquidity is decreasing, particularly quick liquidity, suggesting that the company may be forced to seek additional financing unless other action is taken. The company's activity is decreasing also; this is particularly noticeable in inventory turnover. As might be expected, the ROA of the distributorship, never very high, has been steadily declining over the last three years.
The system was installed in October of 2001. one month of safety stock results in 4 turns.the most critical constraint being the supply lead time imposed by Toro.2%. It was necessary to increase notes payable by $371. an abnormally dry year. This was an increase of $400. it appears that the distributorship is likely to encounter difficulties if present trends are allowed to continue.000 in June of 2002. Inventories need to be reduced to improve the turnover ratio and to increase liquidity once again. A rough idea of the amount of inventory required to support this business can be calculated by using the relationship: average inventory = Q/2 + safety stock where Q is the order size In this case the order size (Q) will be four months of sales. but ending inventory increased by 67%. The average inventory will therefore be 2 months + safety stock. Safety stock will merely reduce this turn rate. For example. particularly quick liquidity. If there is no safety stock.000 in ending inventory. . From FY 2000 to 2001. the company "stocked out of most goods" yet had ending inventories of $1. based on the above analysis. Future plans for Southern Toro must be based on good inventory management. The new inventory computer system does not appear to be successful. In FY 2002. the company must plan to be flexible to accommodate irregular sales patterns. Since the current turns are 4. The Southern Toro Distributorship must seek to reduce this supply lead time or seek additional sources of funds.000 to finance this increase. Liquidity. we turn to the next problem of designing an inventory control system. sales declined 10. and safety stock assumptions -. lead time. yet inventory levels do not reflect sales levels. to decide whether or not the return can be enough to satisfy him. Assuming this can be done. Since the sale of irrigation equipment is heavily dependent on the weather.The return may be improved with better management. since orders are placed three times a year.3% while ending inventory was reduced only 3. sales increased 20%. must be re-established and maintained to ensure Southern Toro's ability to pay off its short-term obligations without relying on the sales of inventories.000. preferably from Toro in the form of notes or accounts payable to support larger inventories. It is for Joe Jr. Between FY 2001 and 2002.0. but will probably never become extremely high. The majority of Southern Toro's assets are in inventory. it is clear that it will be difficult to reduce inventories while meeting current demand. the inventory will turn 12/2 = 6 times per year. However.
the following coverage times can be determined: Order Placement Coverage Until Oct. This is borne out by the case. from golf courses and other commercial installations. A reorder point for each item is therefore inappropriate.Feb.June 30 December and Jan. is completely unsuited to Southern Toro's situation.The software package. 30 August and Sept. . Exhibit TN-2 shows such an analysis for the irrigation products.Oct. Large turf orders.7 months Feb. a C item. cause irregular demand "peaks".8 months 6 . The exhibit also shows the current inventory as a percentage of FY 2002 sales.7 months For the approaching October order. sufficient inventory must be ordered to cover the order period plus the lead time. The following points should be raised: (1) (2) (3) (4) Southern Toro has three preset ordering and delivery times each year. 15 . Order Period Plus Lead Time 7 . as described. 6 . The forecasts for individual items. and possible understock of a B item valve. A mechanical forecast of the affected products is inappropriate. An ABC analysis is needed to center attention on crucial inventory items. 15 . the products are unequally stocked with stocks ranging from 9% to 80% of sales. There are three separate ordering cycles each year. demand must be forecast for the period until May and June. It may be appropriate to adjust the forecast based on weather predictions for the period. when February's orders will be received. In general. may be adjusted manually. Southern Toro must order at the set times sufficient inventory to last until the next period's delivery. Development of an appropriate inventory system for Southern Toro must begin by examining the specific circumstances. with the resulting risk of stock out. 30 May and June June 15 . A forecast of usage based on average monthly demand is insufficient. primarily come from A and B items. where concern is shown for possible overstock of a Monitor Controller. An EOQ is irrelevant. where larger orders are expected. This suggests that the inventory investment is overly weighted with C items and that the inventory turns. Demand for irrigation equipment is seasonal. As can be seen. Based on Exhibit 6 of the case. the A and B items are less heavily stocked than the C items. Although the periods and lead times are irregular.
A forecast for each item should be produced from analysis of past data. A service level should be established for A. The order sizes should be converted to dollars and the resulting inventory levels projected on a monthly basis into the future. A items. then perhaps Joe Jr. and C items. a new software package should be developed which is carefully tailored for Southern Toro. Based on the service level. 3. If these expenditures and inventory levels cannot be financed or are considered excessive. should be carefully monitored and the computerized system adjusted based on experience and knowledge. and possibly some of the critical B or C items. At this point it will become apparent how inventory levels can be reduced. and to some extent B items. If the desired service levels are ultimately incompatible with investment and sales goals. then service levels should be revised or other assumptions modified (lead time) to achieve the total aggregate financial levels desired. For A items. The total purchasing dollars required and the future projected inventory levels should be examined for business feasibility on a total dollar basis. The software package should be used to automatically manage C items. and return on capital invested increased. it may be possible to bring the inventory levels into overall conformance with business goals. If this system is followed. the forecast should be carefully examined and adjusted. The average demand and standard deviation should be forecasted through the lead time plus review period. Order sizes should be determined to bring the inventory up to the desired target levels. 4. based on marketing information available. liquidity improved.Although an exact inventory system cannot be suggested. both products and spare parts. 2. should consider looking for other business opportunities. The new system should be based on the following principles: 1. . a target inventory level can then be established for each item. One of several different models could be used provided that seasonal factors and trends are included in the model. forecasted average demand and standard deviation. B.
87 3.inventory current liabilities 2.05 net profit net worth .4 .82 4.83 .02 net profit total assets Return on net worth .0 Inventory turnover: Cost of Goods Sold average inventory Day's Receivables: 54 days A/R x 365 sales Total asset turnover 2.8 sales average assets Profitability: Return on Assets (ROA) .5 4.14 1.03 44 days 62 days 4.26 Current: current assets current liabilities Quick: .54 2002 2000 2001 3.EXHIBIT TN-1 FINANCIAL RATIOS Ratio Liquidity: 2.49 .33 2.98 Activity: 4.05 .88 Leverage: Debt to equity .03 .04 .59 current .
EXHIBIT TN-2 AN ABC ANALYSIS FY 2002 FY 2002 Item % Sales in Product Description $ Sales % Sales Class Inventory Free Controllers Series 150 .8 + 11 67 Monitor Controllers Series 176 .11 + 23 58 3/4" + 1" Valve Glove/angle in-line 59 1-1/2" + 2" Valve Glove/angle in-line 10 Brass Valve Glove/angel in-line 57 Pop-up Bodies 26 570 Series Nozzles 20 Stream Rotors Series 300 9 Rain Pro Series 320 46 Gear Driven Rotary Series 600 45 Gear Driven Rotary Series 620 54 Gear Driven Rotary Series 640 42 Gear Driven Rotary 77 68 144 26 22 39 194 15 12 26 78 62 7 8 7 15 3 2 4 20 2 1 3 8 7 1 B B A C C C A C C C B B C .4 + 8 80 Custom Controllers Series 123 .
Series 670 20 TOTALS 180 $950 19 100% A .
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