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Surecut

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Surecut

To: Michael Stewart, Senior loan officer, Hudson National Bank of New York

From:

Date: February 12, 2006

Subject: Credit analysis for SureCut Shears, Inc

Introduction

SureCut Shears, Inc. is a manufacturer of household scissors and industrial shears. Because of a policy of level production and a seasonal sales pattern, the company has to borrow funds under a line of credit to cover its seasonal buildup in inventory and receivables. During 1995-96, sales began to fall from projected levels due to a retailing downturn. However, the company may have been slow to react resulting in an accumulation of excess inventory and related inability to repay its bank loan prior to the next seasonal increase in demand. We were given both forecasted and actual financial data.

A diagnosis of why the company cannot repay its bank loan should be made to decide whether to renew the outstanding loan.

The following is the course of loan requests from SureCut during 1995-96:

1. June 1995 - $3.5 million – Until December 1995

2. Another $1.2 million by June 1996 (For Plant modernization - finish est. August 1995)

3. September 1995 – Additional $0.5 million until December 1995 (Total $1.25 million)

4. January 1996 – Extending loan funds until April 1996 (retailing downturn ? sales down)

5. April 1996 – Extending until June 1996 (again, retailing recession)

The plant modernization program is, in essence, a long term investment, and is expected to return $900,000 per year ($75,000 per month) in manufacturing costs.

Pro Forma Assumptions

It is obvious that Mr. Fischer made wrong assumptions when constructing the pro forma financial reports. He assumed that sales would continue to be steady, while actual sales were about 86% of the forecast.

In a retrospective view it was not hard to forecast decrease in sales in 1995 and 1996 as US economy was in a recession. Failing to take this consideration into account led to unrealistic forecast of sales volumes. An example of widely available recession forecast is mentioned in the following example:

“In Octobr [1995], the first month of the fourth quarter, retail sales fell 0.2 percent and industrial production fell 0.3 percent. With relatively high consumer debt loads and weakened consumer spending, early indications are that a somewhat below average Christmas selling season will have resulted. 1996 forecast: look for more of the same.”

Taken at Feb 12 2006 from: http://gatton.uky.edu/cber/Downloads/usecon96.htm

Inventory Management

Another crucial factor that led to the current state of the company was the inability to respond quickly enough to changes in demand. Inventory levels of raw materials, work in progress and finished goods remained more or less steady during the whole period (July 1995 to March 1996). Actually, a careful examination shows that the company ended each month with more inventories that was forecasted when at the same time sales were approximately 86% of the same pro forma forecast. This shows us that inventory-wise the company did not react at all to the recession. This is not a case of slow response, but a case of no response at all.

Cash Budget Analysis

For the cash budget analysis we will forecast SureCut’s expected cash requirements for the remainder of 1996. To achieve that, we have assumed the followings:

• Due to the continued recession, project sales are at 86% of previous monthly projections. Recession is assumed to begin at Sep 1995 and is calculated as an arithmetic average of previous months beginning in Sep 1995.

• Actual materials and labor costs are assumed to be 60% of the sales. Actual overhead costs as well as S&A costs are assumed to be the arithmetic average of previous months since Sep 1995.

• On the balance sheets we took cash, accounts receivables, net plant, accounts payable (trade), misc. liabilities, mortgage, and common stocks from the pro forma balance sheets as we did not see any significant differences.

• Purchases of raw material for April to June are assumed to be the same as in March because peak season will not start before next month (July).

• Bank Loans Payable was calculated as the following: Total Assets – (Accounts Payable + Taxes + Misc. Liabilities

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