Polar Sports, Inc.

Estimating Financing Needs for a

Seasonal Business

Gailen L. Hite

Where does Polar Sports fit in the course?

With seasonality, an annual pro forma misses the
peak funding need during the year
Exhibit 1 Balance Sheets under Seasonal Production
Actual Pro Formal
12/31/11 12/31/12
Accounts payablee 966 1,170
Notes payable, bank 826 847
Accrued taxesf 139 111
Long-term debt, current portion 100 100
Current Liabilities 2,031 2,228
Long-term debtg 1,000 900
Total liabilities 3,031 3,128
Shareholders' equity 6,929 8,076
Total liabilities and equity 9,960 11,204
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1
What is the seasonal plan?
• Wait until orders arrive to produce
• Maintain constant inventory throughout the year
– no inventory accumulation
∴ Annual Production = Annual Shipments

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Seasonal Production
5,000

4,000

3,000
NP bank

Production

Shipments
2,000

1,000

0
Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

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2
Funding Requirements: Seasonal Production
• Financing "Receivables" Oct-Dec
– Financing R/M purchases
• Pay in 30 days
– Finance labor costs
• Pay in current month
– Collect AR in 60 days
• Finance expenditures for 1-2 months total

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What is the level production plan?

Equal monthly production
Excess (production - shipments) goes to warehouse
– Inventory builds up until October
– No Inventory accumulation Dec 2011-Dec 2012
∴ Annual Production = Annual Shipments

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3
 Level Production
5,000

4,000

3,000
Production

Shipments

2,000

1,000

0
Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

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Funding Requirements: Level Production

• Finance "Inventory Accumulation"
– Finance R/M purchases
• Pay in 30 days
– Finance labor cost
• Pay in current month
– Sell 6 months later
• Collect AR in 60 days
• Finance expenditures for 7-8 months total

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4
Overview
Savings From Level Production
Benefits: Overtime wage premiums 480,000
Other direct labor savings 600,000
Costs: Increase in storage cost 300,000
Increase in interest expenses ?
Reduction in interest income ?

Must do the pro formas to estimate monthly loan balance:

1. Determine the adequacy of $4.0 million line of credit
2. Estimate extra interest charges
3. Estimate lost interest on cash balances

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Original Plan: produce as orders arrive

Seasonal %Sales annual
Sales 18,000

Cost of goods sold 66% 11,880

Raw materials: 0.5 CGS 33% 5,940
Prod exp (old): 0.5 CGS 33% 5,940

Operating expenses (old) 24% 4,320 360/mo

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5
Revised Plan: equal monthly production
Level %Sales annual
Sales 18,000
Raw materials 33% 5,940

Production expenses (old) 5,940

─ Over me wage premiums 480
─ Other direct labor savings 600
Production expenses (new) 27% 4,860
Cost of goods sold 60% 10,800

Operating expenses (old) 4,320 360/mo

Additional storage cost 300 ? 25/mo
Operating expenses (new) 4,620

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Projection Assumptions
Other Assumptions
Credit & cash sales 70%/30%
Collection period 60 days
Payment for raw materials 30 days
Tax rate t 34%
LTD rate rLTD 8%
Borrowing rate NP rNP 6%
maximum NP @ 6% rate threshold 2,000
Penalty rate rpenalty 5%
Rate earned on cash rcash 2%
Minimum cash balance Cash @ min 500
Note: interest is computed on prior month's balances

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6
Monthly pro forma income projections
Income Jan Feb Mar Apr
Net sales 702
COGS: 60% 421
Gross profit 281

Oper exp: 4,320/yr 360 Equal monthly allocation

S&H: 300/yr 25 Equal monthly allocation
Int LTD & CPLTD: 8% ? December balance
Int NP bank: 6% ? December balance
Add'l int NP bank: 5% ? December balance
Int income on cash: 2% ? December balance
Profit (loss) b. tax
Income taxes: 34%
Net income

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Interest Income and Expense

Table B Balance Sheet at Dec 31, 2011
Cash 500 2%
Accounts receivable 5,245
Inventory 1,227
Current assets 6,972
PP&E 2,988
Total assets 9,960

Accounts payable 966

Notes payable, bank 826 6%
Accrued taxes 139
Long-term debt, CP 100 8%
Current liabilities 2,031
Long-term debt 1,000 8%
Total liabilities 3,031
Shareholders’ equity 6,929
Total liab and SH equity 9,960
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7
Monthly pro forma income projections
Income Jan Feb Mar Apr
Net sales 702
COGS: 60% 421
Gross profit 281

Oper exp: 4,320/yr 360 Equal monthly allocation

S&H: 300/yr 25 Equal monthly allocation
Int LTD & CPLTD: 8% 7 December balance
Int NP bank: 6% 4 December balance
Add'l int NP bank: 5% 0 December balance
Int income on cash: 2% 1 December balance
Profit (loss) b. tax -115 -196 -223 -239
Income taxes: 34% -39 -67 -76 -81
Net income -76 -129 -147 -158

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Project cash
Uses Jan Feb Mar Apr
Cash @ min 500 500 500 500
AR ?
Inventory ?
Current assets
NP&E ?
Total assets

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8
Project Accounts Receivable
Accts. Receivable Jan
AR beg 5,245 = 0.70 of Nov & Dec sales
+ Credit sales 491 = 0.70 of Current sales
= sum 5,736
− collections 3,195 = 0.70 of Nov sales (60 days)
= AR end 2,541 = 0.70 of Dec & Jan sales

Table C Monthly Sales

Sales Proj Sales
2011 2012
Jan 702
Feb 486
⁞
Nov 4,564
Dec 2,928
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Project Inventory
Inventory Jan Annual
Inv beg 1,227 Inventory (beg)
+ Production ? 900  Production
= available 2,127  available
− CGS 421 − CGS
= Inv end 1,706  Inventory (end)

Annual CGS
Pr oduction 
CGS = 0.60 · 702 12
10,800
  900
12

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9
 Inventory by month
7,000

6,000

5,000

4,000

Average inventory = 3,914

3,000

2,000

1,000

0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

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Storage & Handling: alternative allocation

Inventory Jan … Jul Aug … Dec
Inv end 1,706 5,907 6,483 1,227
fraction of average 0.44 1.51 1.66 0.31
month's S&H 11 38 41 8

• Allocate in proportion to ending inventory?

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10
Project net PP&E
net PP&E Jan
nPP&E beg 2,988
+ CAPEX ? 25
= sum 3,013
− Deprec 25
= nPP&E end 2,988

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Project Uses of Funds & Sources

Uses Jan Sources Jan
Cash @ min 500 Acc'ts Payable
Acct's Receivable 2,541 NP, bank
Inventory 1,706 Acc tax
Current assets 4,747 LT Debt, CP
net PP&E 2,988 Current liabilities
Total assets 7,735 LT Debt
Total liab
SH equity
Tot liab & equity

Surplus (Deficit)

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11
Project Accounts Payable & Purchases
Acc'ts Payable Jan Annual
AP beg 966 Raw Materials (beg)
+ Purchases ?495  Purchases
= sum 1,461  available
− Payments 966 − Usage
= AP end 495  Raw Materials (end)

RM Usage
Purchases 
12
5,940
  495
12

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Project Accrued Taxes

Accrued Taxes Jan Feb Mar Apr
Acc tax beg 139
+ current tax -39 -67 -76 -81
= sum
− Tax Pmts ? ? ? ?
= Acc tax end

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12
Tax Payments
1. Taxes due at year end (accrued taxes) 139
Payable in Mar

2. Estimated tax payments (safe harbor)

Previous year’s tax liability 462
Number of payments ÷4
Minimum Quarterly payment 116
Payments in Apr, Jun, Sep, and Dec ≈ 120

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Project Accrued Taxes

Accrued Taxes Jan Feb Mar Apr
Acc tax beg 139 100 33 -181
+ current tax -39 -67 -76 -81
= sum 100 33 -43 -263
− Tax Pmts 0 0 120
= Acc tax end 100 33 -181 -383

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13
Project Sources of Funds
Sources Jan Feb Mar Apr
Acct's Payable 495
Automatic
Acc tax 100 sources
NP, bank Financing
decisions
LT Debt, CP 100
Current liabilities 695
LT Debt 1,000
Total liabilities 1,695
SH equity
Tot liab & equity

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Project Equity
SH equity Jan
SH equity beg 6,929
+ NI -76
= sum 6,853
− Dividends ? 0
= SH equity end 6,853

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14
Project Sources of Funds
Sources Jan Feb Mar Apr
Acct's Payable 495 Automatic
Acc tax 100 sources
NP, bank Financing
decisions
LT Debt, CP 100
Current liabilities 695
LT Debt 1,000
Total liab 1,695
SH equity 6,853
Tot liab& equity 8,548

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Funding Gap
Funding Gap Dec '11 Jan Feb Mar Apr
Total assets 7,735 6,634 7,084 7,681
Tot liab & equity 8,548 8,352 7,991 7,632
Surplus (Deficit) -826 813 1,718 907 -50
monthly CF ?1,639 906 -812 -956

• What was the cash flow for January?

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15
Financing Activities
Notes payable Dec '11 Jan Feb Mar Apr
NP beg 826 0 0 0
+ new borrowing 0 0 0 50
= sum 826 0 0 50
− repayment 826 0 0 0
= NP end 826 0 0 0 50

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Level Production
5,000

4,000

3,000
NP bank
Production
Shipments
2,000

1,000

0
Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

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16
Project Cash Balance = minimum + XSCash
Cash Dec '11 Jan Feb Mar Apr
Cash beg 500 1,313 2,218 1,407
+ monthly CF 1,639 906 -812 -956
= Cash b. financing 2,139 2,218 1,407 450
+ New borrowing 0 0 0 50
− Debt repayment 826 0 0 0
= Cash end 500 1,313 2,218 1,407 500

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Compare funding requirements

Funds Needed
Month Seasonal Level
Jan 0 0
Feb 0 0
Mar 0 0
Apr 0 50
May 0 1,003
Jun 0 2,151
Jul 0 3,227
Aug 0 4,251
Sep 0 4,537
Oct 785 4,728
Nov 80 2,258
Dec 847 903
average 143 1,926

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17
 NP Comparison
5,000
4,728

4,000
Limit

3,000

Level
Penalty rate threshold
2,000

1,000

Seasonal
0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

• Level peaks at 4,728 in Sep

• Level exceeds borrowing limit in Aug thru Oct
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Compare funding requirements

Seasonal production Level production
NP peak in Dec ($847) NP peak at in Oct ($4,728)
NP exceeds credit limit of $4,000

• Should he even ask for a higher limit?

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18
Is it worth switching, if they get extra funding?
∆NI from Switching Seasonal Level Diff
Overtime wage premiums 480
Other direct labor savings 600
Labor Cost Savings 1,080

Storage cost 300

Interest expenses 94 239
− Interest income 32 16
Net interest expense 63 224 161
Extra Costs 461

Net pretax savings 619

Less tax at 34% 211
Net savings 409
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Polar Sports

Appendix:
(almost) Statement of Cash Flow (Jan)

Gailen L. Hite

19
(almost) Statement of CF (Jan)
Actual Projected
Uses Dec 31, 2011 Jan 31, 2012 Change
Cash (total) 500 1,313 813
AR 5,245 2,541 -2,704
Inventory 1,227 1,706 479
Current assets 6,972 4,747
NP&E 2,988 2,988 0
Total assets 9,960 7,735

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(almost) Statement of CF (Jan)

Actual Projected
Sources Dec 31, 2011 Jan 31, 2012 Change
AP 966 495 -471
Acc tax 139 100 -39
NP, bank 826 0 -826
LT Debt, CP 100 100 0
Current liabilities 2,031 695
LT Debt 1,000 1,000 0
Total liab 3,031 1,695
SH equity 6,929 6,853
Tot liab& equity 9,960 8,548

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20
(almost) Statement of CF (Jan)
Statement of Cash Flow
Operating Activities
Net income -76
+Depreciation 25
less: Adjustments
+ ∆A/R -2,704
+ ∆Inv 479
− ∆A/P -471
− ∆Acc Tax -39
= Total adjustment -1,714
CF from operations 1,664
Investing Activities
less:CAPEX -25
CF before financing 1,639
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(almost) Statement of CF (Jan)

Statement of Cash Flow
CF before financing 1,639

Financing Activities
∆NP, bank -826
∆LT Debt repaid 0
CF from financing -826

Cash Flow 813

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21