Case 4: Financial Forecasting: Growing Pains
"We are growing too fast," said Mason. "I know I shouldn't complain, but we better have the capacity to fill the orders or we'll be hurting ourselves." Vicky and Mason Coleman started their oatmeal snacks company in 1998, upon the suggestions of their close friends who simply loved the way their oatmeal tasted. Mason, a former college gymnastics coach, insists that he never "intended to start a business," but the thought of being able to support his college team played a significant role in motivating him to go for it.
After considerable help from local retailers and a sponsorship by a major bread company their firm, Oats 'R' Us, was established in 1998 and reached sales of over $4 million by 2004. Given the current trend of eating healthy snacks and keeping fit, Mason was confident that sales would increase significantly over the next few years. The industry growth forecast had been estimated at 30% per year and Mason was confident that his firm would be able to at least achieve if not beat that rate of sales growth.
"We must plan for the future," said Vicky. "I think we've been playing it by ear for too long." Mason immediately called the treasurer, Jim Moroney. "Jim, I need to know how much additional funding we are going to need for the next year," said Mason. "The growth rate of revenues should be between 25% and 40%. I would really appreciate if you can have the forecast on my desk by early next week."
Jim knew that his fishing plans for the weekend had better be put aside since it was going to be a long and busy weekend for him. He immediately asked the accounting department to give him the last three years' financial statements (see Tables 1 and 2) and got right to work!
Table 1 Oats 'R' Us Income Statement For the Year Ended Dec. 31st 2004
2004 2003 2002
Sales 4,700,000 3,760,000 3,000,000
Cost of Goods Sold 3,877,500 3,045,600 2,400,000
Gross Profit 822,500 714,400 600,000
Selling and G&A Expenses 275,000 250,000 215,000
Fixed Expenses 90,000 90,000 90,000
Depreciation Expense 25,000 25,000 25,000
EBIT 432,500 349,400 270,000
Interest Expense 66,000 66,000 66,000
Earnings Before Taxes 366,500 283,400 204,000
Taxes @ 40% 146,600 113,360 81,600
Net Income 219,900 170,040 122,400
Retained Earnings 131,940 102,024 73,440
Table 2 Oats 'R' Us Balance Sheet For the Year Ended Dec. 31st 2004
Assets 2004 2003 2002
Cash and Cash Equivalents 60,000 97,376 48,000
Accounts Receivable 250,416 175,000 150,000
Inventory 511,500 390,000 335,000
Total Current Assets 821,916 662,376 533,000
Plant & Equipment 560,000 560,000 560,000
Accumulated Depreciation 175,000 150,000 125,000
Net Plant & Equipment 385,000 410,000 435,000
Total Assets 1,206,916 1,072,376 968,000
Liabilities and Owner's Equity
Accounts Payable 35,000 151,352 128,000
Notes Payable 275,000 275,000 250,000
Other Current Liabilities 43,952 50,000 46,000
Total Current Liabilities 453,952 476,352 424,000
Long-term Debt 275,000 250,000 300,000
Total Liabilities 728,952 726,352 724,000
Owner's Capital 155,560 155,560 155,560
Retained Earnings 322,404 190,464 88,440
Total Liabilities/Owner's Equity 1,206,916 1,072,376 968,000
1. Since this is the first time Jim and Mason will be conducting a financial forecast for Oats 'R' Us, how do you think they should proceed? Which approaches or models can they use? What are the assumptions necessary for utilizing each model?
2. If Oats 'R' Us is operating its fixed assets at full capacity, what growth rate can it support without the need for any additional external financing?
3. Oats 'R' Us has a flexible credit line with the Midway Bank. If Mason decides to keep the debt-equity ratio constant, up to what rate of growth in revenue can the firm support? What assumptions are necessary when calculating this rate of growth? Are these assumptions realistic in the case of Oats 'R' Us? Please explain.
4. Initially Jim assumes that the firm is operating at full capacity. How much additional financing will it need to support revenue growth rates ranging from 25% to 40% per year?
5. After conducting an interview with the production manager, Jim realizes that Oats 'R' Us is operating its plant at 90% capacity, how much additional financing will it need to support growth rates ranging from 25% to 40%?
6. What are some actions that Mason can take in order to alleviate some of the need for external financing? Analyze the feasibility and implications of each suggested action.
7. How critical is the financial condition of Oats 'R' Us? Is Vicky justified in being concerned about the need for financial planning? Explain why.
8. Given that Mason prefers not to deviate from the firm's 2004 debt-equity ratio, what will the firm's pro-forma income statement and balance sheet look like under the scenario of 40% growth in revenue for 2005 (ignore feedback effects).
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