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• To understand the pattern of current assets and cash flows • Highly seasonal sales (80% of sales between August and
in a company with seasonal sales, and how these are November)
affected by the choice of production plan
• Current production follows sales, and thus is highly seasonal.
• To understand the trade-off between profitability versus
risk and liquidity in choosing between level and seasonal • Question: should the company smooth production over the year?
production
• Examine pro-forma monthly statement of cash flows for 1994,
• To practice the mechanics of basic financial analysis constructed with base on pro-forma tables reported by company
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COMM 371, Lecture 7 COMM 371, Lecture 7
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COMM 371, Lecture 7 COMM 371, Lecture 7
o What is the financing need under level production? • Actually, most critical month is July
o Is the current credit limit enough to cover this need? o Current assets are mostly inventory in July, whereas for
September accounts receivable increase substantially.
o Are there any risks involved in level production? o The risk of not collecting is less than the risk of not selling!
Construct MONTHLY Pro-forma Financial Statements • So level production is more risky (can end up with unsold
inventories) and requires more financing (now yet available)
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COMM 371, Lecture 7 COMM 371, Lecture 7
Net pre-tax savings 253,000 • Higher risk: if sales forecasts were not accurate, then the firm
may end up with unsold inventory (dollar sales of particular
Taxes (34%) 86,020 products can vary 30-35% from year to year), while having to
repay a larger loan.
Net savings 166,980
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COMM 371, Lecture 7 COMM 371, Lecture 7
• However, AP are $250 per month, so even if credit is • Trade-off between profitability and liquidity
extended to 90 days, this would only generate payables of o Level production increases profitability
$750. Would suppliers extend credit? o But involves the risk of committing funds to inventory
in an amount that exceeds the firm equity!
• A production plan half way between seasonal and level
production.
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