Play Time Toy Co

Play Time Toy Company

I. Introduction

Background

Play Time Toy Company is a plastic toy manufacturer. It has experienced rapid growth since founding, recently expanding its operations to allow further growth. From 1973 until the early 1990's, the company specialized in seasonal manufacturing, producing in direct response to customer orders. However, in early 1991, the president of Play Time Toy Company, Jonathon King, was considering a change from seasonal to level production in the upcoming year.

Regardless of which method is used, the company's sales are seasonal with 80% of dollar volume sold between August and November. Under seasonal production, the cost of goods sold is 70% of sales. However, under level production, the cost of goods sold would slightly decrease to 61.16% of sales. With either production method, operating expenses will likely incur evenly throughout each month.

Under seasonal production, the company produces in response to customer orders. From January to August, sales are low; therefore, production runs at only 25-30% of capacity and the workforce is contracted. However, during the peak season, August through December, equipment is run at maximum capacity and the workforce is put on overtime, with premiums amounting to $165,000 annually.

Because of recent operation expansion, Play Time Toy Company has experienced a strained working capital position. For instance, the company's accounts receivables do not coincide with their account payables. The company allows 60 days to receive payment, but promptly retires their trade debt after only 30 days. These mismatched cash in- and outflows caused a strained cash position. In 1990, the year-end cash balance of $175,000 was considered the minimum cash needed for operations. During that year, the company took out a $680,000 loan, still outstanding at year-end. Their bank had agreed to extend a secured line of credit up to $1.9 million in 1991. Interest of 11% would accrue and any further advances would require renegotiations.

The president of the Play Time Toy Company feels that much inefficiency currently exists under seasonal production. For instance, overtime reduces the company's profits. He estimated that by switching to level production, a cash savings of $200,000 would result by eliminating overtime premiums. In addition, he noticed that seasonal expansion and contraction of the workforce results in high training and quality control costs. Also, machine idleness for seven months followed by heavy usage for five months contributes to labor inefficiencies. King believes that direct labor savings of $235,000 will result from orderly, level production. However, higher storage and handling costs of $100,000 will slightly offset the savings.

Industry Background

The toy manufacturing industry is highly competitive. It is populated by a large number of companies. The relatively low capital requirements and simplicity of production allow for easy entrance into the toy manufacturing industry. In addition to the high number of companies, design and price competition is also intense. One company can easily gain market share by designing a popular, fad product. That company will continue to reap the profit margins until the competition comes out with a similar product. Recently, the toy manufacturing industry has become significantly more competitive with the entrance of foreign, low-cost toy manufacturers.

Macroeconomic Background

Since the middle of 1989, there have been signs that the economy may be weakening. For instance, employment in manufacturing declined steadily during the 1989 into 1990. Also, real orders for manufactured goods and real consumer spending also declined. In addition to signs of a weakening economy, data affecting future consumption indicates a possible decline in consumption of goods. For instance, hurricane Hugo, a west-coast earthquake, and the threat of war increase the possibility of reduced future consumption and a weakening economy.

Case Question

The purpose of the Play Time Toy Company case is to determine whether level production is more profitable than seasonal production, given the financial forecasts and industry and macroeconomic backgrounds. To make this decision, a proforma balance sheet and income statement must be constructed. We will examine whether level production is feasible given the company's presently strained working capital position. In doing so, we will determine the company's necessary line of credit under level production, compared with the credit line associated with seasonal production. By examining proforma financial statements before and after level production and comparing both lines of credit, we will recommend the more favorable production decision.

II. Solution

To determine whether level production would be more profitable than seasonal production, we constructed a cash budget, proforma balance sheet, and income statement. To construct the cash budget, we subtracted our cash outflows, current accounts payable, cost of goods sold, operating expenses, notes payable, current L-T debt, tax payment, and prior accounts payable from our cash inflows. Our cash inflows consist of accounts receivable from sales 60 days prior and the beginning cash balance. We used the ending cash amount on the cash budget for the beginning cash account on the balance sheet.

We constructed the balance sheet by taking the