2

Introduction
Polar Sports, Inc. is exploring the strategic shift from a seasonal inventory schedule to a model
of level production. While the company has traditionally adhered to a seasonal inventory
approach, our comprehensive analysis and calculations recommend the transition toward level
production as a strategic move due to the calculated total net savings of $428,980.

In order to calculate these net savings we created pro forma financial statements using the
stipulated assumptions provided as well as keeping factors like Economic Risk, Market Risk,
Inventory Risk, and Counterparty Risk in mind.

Some of the most significant changes noted between seasonal and level production included
the inventory breakdown, additional storage costs, short-term financing, and interest expenses.
All of which will then be used in the financial statements to determine the underlying net
savings.

Factors to Consider
Before shifting to level production, we highlighted key risk factors that should be taken into
consideration: Economic Risk, Market Risk, Inventory Risk, and Counterparty Risk.

All calculations are based on projected sales for 2012. Therefore any significant deviation from
the projected sales due to economic slowdown could lead to the company seeing a significant
decline in sales numbers. Because inventory production will be level, inventory purchases will
still be made by cash. This could lead to having to take on more than anticipated short-term
financing in order to meet a $500,000 cash minimum.

Another factor to consider is market risk. Historically, under a seasonal approach, the company
could afford to adopt a “wait-and-see” approach in regard to trends in the ski wear fashion
industry. Under the level production approach, significant research must be conducted to ensure
that products produced every month align with the current industry fashion trends. Failure to
identify significant trends could lead to inventory levels being higher than anticipated, also
known as inventory risk. Resulting in high storage costs throughout the year and even leading to
discounted sales.

The last factor that needs to be considered is counterparty risk. In our current recommendation,
the company will need to secure short-term financing in order to meet its 500,000 minimum cash
balance. Our forecast assumes the company will be able to secure funding but the risk of the
bank not approving the short-term financing cannot be ignored.

As it currently stands under seasonal production, the bulk of stress and responsibility falls under
the operations division, factory machinery, and purchasers of inventory. Shifting to level
production, that stress responsibility will shift to the Financing, Marketing/Sales, and Research
divisions as they will need to ensure the company has proper financing, marketing, and correctly
anticipates industry fashion trends.
Inventory Breakdown
 3

See Figure 4. Under level production, COGS will decrease from 66% of sales to 60% of sales.
Based on forecasted sales per month, the total estimated amount of COGS for 2012 is
$10,800,000. In order to meet that yearly total, the company would need $900,000 of purchases
per month under level production. Once purchases per month are known, the ending Inventory
for each month can be calculated (Ending Inventory = Beginning Inventory + Purchases -
COGS) as shown in Figure 4.

Additional Storage Costs

Under level production, the company estimated that it would incur an additional $300,000 in
storage costs related to its ending inventory per month. All other operating expenses will remain
unchanged. See Figure 5. In order to find the additional storage costs, first the percentage
allocated toward the total Storage costs was calculated by taking the ratio of the ratio between
the Ending Inventory and the total estimated storage costs of $300,000. From there, the
percentage to be allocated to storage cost for every month was multiplied by the total
anticipated storage costs to get a monthly storage cost. See Figure 5b and Figure 5c. Total
operating expenses were the sum of storage costs per month and the unchanged operating
expenses of $360,000.

Short-Term Financing
Under the current forecasts for level production in 2012, the company will need to take out
substantially large bank loans to meet the financial requirements associated with level
production as well as a $500,000 cash minimum each month. See Figure 1. In order to meet
these increased demands, Polar Sports will need a maximum outstanding balance on its loan
balance of 4.74 million in October.

This raises a significant concern that has been thoroughly deliberated in our comprehensive
analysis: Is it necessary for Polar to secure short-term financing exceeding 4 million dollars in
any given month? Succinctly put, the answer to this question is affirmative. Subsequently, a
pivotal inquiry emerged regarding the willingness of the bank to extend credit beyond the 4
million-dollar threshold. According to the loan covenant, the outstanding balance on the line of
credit was not to exceed two-thirds of accounts receivable and inventory combined. Our
analysis conclusively demonstrates that Polar is poised to meet this requirement and,
importantly, remain in compliance with the 66% covenant threshold. See Figure 7.

After confirming that Polar will meet the stipulated requirements, it was time to analyze the
effects of taking the additional loans.
● Interest Expense (figure 6 below)
In our analysis we were able to find slight increases associated with the additional loan
requirements. These increases were partially due to the additional funding required which then
had a 6% interest rate associated with it, as well as an additional 11% added to June-November
due to the stipulation of going above a 2 million dollar credit withdrawal. Due to the necessity of
taking out increased loans to meet the high demands of level production, the increased costs
associated with them will total 162,310. This can be broken down into 146,170 associated with
 4

the increased interest expenses as well as a decrease of 16,140 associated with the decreased
cash available each month.
● Accrual of Taxes (figure 8 below)
The accrual of taxes will remain pretty constant regardless of seasonal or level production.
However, we did notice that the taxes due in the winter months will increase due to the
increased net income return in those later months.

Credit Extension Consideration

If I were a banker there are a lot of factors to consider when making this decision. You have to
factor in their past financial records to make sure this company is in good financial standing.
Also consider their product and industry, which is very competitive and seasonal. I would also
consider the covenant loan agreement. I would be willing to extend the line of credit to more
than 4 million dollars to Polar Sports Inc. to finance their move to level production. Although
level production does come with its own risks, I think this is a profitable move for both parties.
The reason is that it’s only for the short-term period that they’ll need financing (3 months) for
their level production schedule in 2012. There is an added benefit to extending this line of credit,
as a banker I can receive a higher interest income. Switching to level production would increase
overall production efficiency for the business. I would also consider the forecasted increased
demand projection for the coming year. The pro forma level income statement indicates that a
higher net income will come from a shift to level production. As a banker, I can see this
extension being mutually beneficial to both parties.
When comparing the financial ratios between Level Production and Seasonal Production, it is
evident that there are significant differences between the two. Level Production is more
profitable and efficient, boasting an ROE of 19% compared to previous ROE of 14%, a profit
margin of 9%, which boosts an increase of 3%, and an ROA increase from 12% to 14%. This
indicates that they generate profits more efficiently from both equity and assets. Furthermore,
Level Production has superior liquidity ratios, indicating a robust short-term financial position. In
contrast, Seasonal Production excels in financial leverage, with a ratio of 1.39, a Times Interest
Earned ratio of 19.06, and an Inventory Turnover of 9.68. This implies that they manage their
inventory efficiently and possess a strong ability to cover interest expenses. However, this
comes with increased leverage, reflected in their higher debt ratios (D/A: 0.28, D/E: 0.39),
indicating a potentially higher financial risk. See Figure 9. Overall, while Level Production
generally outperforms in terms of profitability, efficiency, and liquidity, Seasonal Production
exhibits better inventory management and ability to cover interest expenses, albeit with higher
leverage.

As a borrower, it’s crucial to understand the loan covenants outlined in your loan agreement.
Polar Sports, Inc. is required to ensure that the outstanding balance on their line of credit does
not exceed two-thirds of the combined total of their accounts receivable and inventory. Failing to
comply with this covenant will result in the lender calling the loan and demanding immediate
repayment in full. To stay in compliance with this covenant, Polar Sports did a good job
managing its operations and finances to not exceed the threshold of credit. There were some
months where it appeared Polar Sports was close to that line but managed to not exceed their
limit of two-thirds
 5

Net Savings
Net savings are one of the most important factors to consider when switching from seasonal
production to level. Polar Sports Inc. was able to achieve $428,980 in savings from switching to
a level production schedule according to our data. The company had a total COGS savings of
6% which equated to $1,080,000. Although Polar Sports Inc. incurs new expenses in the 2012
year due to the increased costs, it does help lower their tax bill. The company will incur an
additional 146,170 associated with the increased interest expenses as well as a decrease of
16,140 associated with the decreased cash available each month. Even with these additional
expenses and reduced interest income, it still produces a positive net savings by switching to
level production.

Conclusion
In conclusion, our in-depth analysis has underscored the strategic importance of Polar Sports,
Inc. transitioning from a traditional seasonal inventory schedule to a model of level production.
This shift is not only supported by rigorous calculations but also aligns with the company's
long-term financial objectives. The calculated total net savings of $428,980 serves as a
compelling incentive for this strategic move.

Our approach to calculating these net savings was founded on the creation of pro forma
financial statements, meticulously crafted with due consideration of key assumptions and a keen
awareness of factors such as Economic Risk, Market Risk, Inventory Risk, and Counterparty
Risk. These factors were carefully factored into our calculations to ensure a comprehensive and
accurate representation of the financial implications of this transition.
Among the most notable changes identified in our analysis were shifts in inventory
management, additional storage costs, adjustments in short-term financing requirements, and
changes in interest expenses. These elements have been thoroughly integrated into our
financial statements, allowing us to arrive at a clear understanding of the anticipated net savings
that will result from adopting a level production model.

In light of the compelling financial evidence presented, it is our recommendation that Polar
Sports, Inc. seriously consider and plans for the transition to level production. Doing so will not
only enhance the company's financial stability but also position it for sustainable growth in the
dynamic business landscape.
 6

References
Figure 1

Figure 2
 7

Figure 3

Figure 4

Figure 5

Figure 5b
 8

Figure 5c

Figure 6

Figure 6b

Figure 7
 9

Figure 8

Figure 8b

Figure 9