Sunbeam: Suggested Solutions

Sunbeam: Suggested Solutions

This is a complex case and these questions are for guidance. Students will provide a wide range of answers, and all good suggestions should be rewarded appropriately. There may also be some cross-over between the various parts. Whilst the same answer/example should not be rewarded twice, equally, credit should be given where these examples/answers add depth and richness to the solution. Below follows a skeleton outline of the key points. This is neither a catch-all list nor a complete answer. For full marks, a student is required to add some explanation.

1. Summarise the key components of the proposed financial strategy of Sunbeam under the new stewardship/management team. Note any inconsistencies, if applicable.

[15 marks]

• Focus on Core / Divest Non-core
• Manufacturing: Increase efficiency & Expand Distribution Channels
• Aggressive growth plan for the period ending 1999: Double revenues, Increase Operating Margins to 20% (from 17.5%, Increase ROE (from 1% to 20%)
• Cost-cutting
• R&D investment
• Internationalisation
• Brand development / management
• Bring in Scott Paper Turnaround Management Team to replace existing management team

1. Assume you are a strategic consultant looking at this suite of proposals, (i) list and explain TWO features which are convincing about it, and (ii) TWO features which you see as being possible problems and pitfalls regarding its implementation?

[20 marks]

Should the plan be achievable, there are many positives. However, whether it is convincing or not is another issue.

• Growth comes from product development
• Growth comes from internationalisation; overcome seasonality and jurisdictional limitations
• Some degree of cost-cutting is probable/inevitable – new team, striving to achieve
• New management team, new ideas, experience of turnaround situations etc.

There are however some notable problems and seeming contradictions

• What will be the cause of this growth and how soon is it achievable? New products take time to come on line, R&D costs today are not recognised in turnover immediately.
• What are these new products? This is a mature industry with some fairly standard, staple products e.g. toasters, kettles, and so forth. This is not the technology sector.
• Is it possible to cut costs and grow revenues at the same time? Yes, but it is difficult. We must assume that the firm was very inefficient to begin.
• Simultaneously achieving top line and bottom line growth, cutting costs and investing is almost impossible. What about if new products are launched as loss leaders? It is an empiric phenomenon that COGS and SG&A typically move in opposite directions. It is rare they both go down.
• Is it possible to grow and de-lever? When we get to the financial analysis, we will see that ROE is a function of: Asset Turnover * Profit Margin * Financial Leverage. Thus, the financial strategy appears challenging especially as the aim is to be debt free by end of 1997.

1. Drawing on the case details, list and explain THREE issues which you think provided the management team with opportunities for earnings management (accounting fraud). NB: At this stage, don’t look at the numbers but focus on the material issues.

[15 marks]

The strategy provides opportunities for earnings management. The key is to focus on the big issues and ignore the numbers at this stage, i.e.

• Restructuring is an opportunity to set up a provision, to ‘big bath’ (future) losses.
• Due to their subjectivity, impairment charges are a potential mechanism to bring forward costs (again allowing an opportunity for Big Bath accounting)
• Divestitures: How do we appraise the gains and losses on discontinued operations? What assets belong to continuing versus discontinued?
• Accountability is also an issue. First, there is the problem with management control. Who is going to say ‘no’ to the new CEO? Second, there are problems with segregation of duties with certain people undertaking more than one important function.
• Investor sentiment: The targets are high but there is (a) the new CEO effect, plus (b) the confidence in him to be able to do it. Therefore, investors are likely to give him space to achieve these targets. This might mean not digging too deep into how/why he’s doing it.
• Stock options: Vested immediately. There is an immediate incentive to raise the share price straight away. The system encourages short-termism.
• New products and new supply chains: this might simply mean more channels available to stuff i.e. if you’ve pre-booked sales to one customer, you can’t do it again. But if you now have 10 new customers, you have more opportunities available to you.
• International Expansion: wary of due diligence in jurisdictions where the governance is weaker.

1. Looking at the details of the case, describe and discuss the key issues that reconcile the reported financial numbers and the restated ones. You might like to include in your response any details of how the changes impact on the firm’s key financial ratios. You are not required to produce reconciling journal entries.

[45 marks]

Answers will be wide-ranging and will recall many of the same issues listed above. Some possible suggestions follow but see also the attached reconciliatory spreadsheet and proposed journal adjustments. NB It is difficult to place faith in the restated balances as being ‘correct’, therefore adjustments might have continued into the future to undo some of the problems.