Mr. Fischer the Forecasts Sales

Question 1

When preparing the forecasts shown in Exhibits 1 and 2, Mr. Fischer expected seasonal sales peak in the period between July and December 1995, following the same cyclical trend in 1996. Therefore, with the increasing sales between June and December, Mr. Fischer supposed the company would be able to pay off its short-term debt by December 1995. SureCut would have no short-term debt between December 1995 and May 1996 and it would contract short-term debt again in June 1996 when the sales rate would again turn positive. Mr. Fisher made the assumption that there should always be a minimum cash reserve of $736,000; since it usually pays its short-term debt in cash, once it reaches the $736,000 cash level, the company should consider contracting additional short-term debt. We can also see through the tax payable accounts in the balance sheet that the company pays its taxes every three months. Furthermore, Mr. Fisher assumed the accounts payable amounts would remain constant throughout the year. The numbers of the second part of exhibit 2 show that SureCut attempted to produce at an even rate during the whole year.

As for the income statement, SureCut anticipated a 60% sales ratio for materials and labor costs, and constant amounts regarding overhead and selling and administrative expenses ($300,000 and $270,000 respectively). The company also accounted for a 36% profit tax rate and projected a payment of dividends every three months. Finally, SureCut expected a $900,000 savings on manufacturing costs as of September 1995, which are not transmitted in the COGS and inventories accounts.

Some of these assumptions proved to be unreasonable. First of all, there was a 25% fall in sales level between July 1995 and March 1996, whereas the production costs in relation to sales have increased towards the end (84% in February and 85% of sales in March 1996). Since SureCut was unable to meet its forecasted sales and it continued its raw materials purchases as if sales were going to pick up, the inventory kept on rising and remained excessively high compared to the sales level. In addition to this, the profit margin has significantly decreased as opposed to the Mr. Fisher’s forecasts, switching to negative numbers in March 1996. In the second part of 1995, SureCut’s sales levels have consistently been lower than forecasted. SureCut started having a huge discrepancy in the cash amounts starting from December 1995, when the company was expected to have paid off its short-term debt. (See Appendix 1 for graph comparing estimated and actual values)

Question 2

By the end of December when SureCut was supposed to repay the bank loan it couldn’t. By the end of December Bank loans payable had a credit balance of $2,279,000 dollars. The two main reasons to this failure to pay back debt were the fact that they could not collect their receivables and inventory management.