Financial Analysis and Forecast of Sweet Dreams Inc Essay

new Dream Incorporated (SDI) is a manufacturing alliance focused on mattress and nook spring production for large retailers and hotel chains. With two facilities at their disposal, SDI manufactures over 20 diametric styles of bedding for their consumers. SDIs founder and president, Douglas May, has contacted our consulting firm with regards to current monetary problems between himself and SDIs assert, First International Bank. Due to the build up in assert failures in the early 1990s First National has become extremely highly culture medium to problem brings (loans which show ratio performances infra the industry standard). Unfortunately, SDI has had poor runniness and debt ratios for the past three historic period which has caught the banks attention. After a ph whiz call from the bank Doug has realized that SDI is in even worse anguish than the bank thinks. He has just signed a 9.5 one thousand thousand dollar contract to expand the line of products which was allege dly being loaned from the bank.Seeing as how the bank is debating closing Doug down it doesnt look presum fitting that they would want to front him a nonher 9.5 million. Following a brief meeting with his senior managers, Doug and his team contumacious that this 9.5 million dollar loan from the bank is the precisely way to obtain their business alive. They have discrete to reverse their current policy of aggressive price drops and easy ascribe, reduce their administrative, selling and miscellaneous expenses, non acquire any new fixed assets or sell common stock, decrease accounts buckle underable, stop nonrecreational dividends, and freeze executive salaries. All this is an attempt to prove to the bank that sassy Dreams Inc. is taking their financial circumstance very seriously and that the bank should strongly consider giving SDI the 9.5 million dollar loan. Doug has asked us to insure the banks evaluation of his guild, predict the expected performance of odorous Drea ms Inc. for 1996 and 1997, and prepare a tend of SDIs strengths and impuissancees. All of these requests get away be used to influence the bank to grant a 9.5 million dollar concisely- barrier loan to SDI as well as non forcing the bank to demand straightaway re- even offment of their loans. Sweet Dreams Incorporated (SDI) is struggling currently. With a current ratio of 1.9, SDI looks good up front. However the companys strain occupies close to 60 percent of its current assets.The quick ratio better shows SDIs performance. With a ratio of .77, SDI dissolvenot pay their short-term liabilities as they come due. This shows the first problem of Sweet Dreams Inc lineage Management. Also in Dougs efforts to spin his recent losses he has decided to change his tralatitious dividend payout from 25% to 0. This symptom cuts to the core problem that SDIs bottom line has suffered in the past years, partially because of economic downturns and partly because of managements response to th e economic downturn. Finally SDIs Z puddle poses a problem with the banks standards. An Altmans Z home run is calculated by combining five different ratios of a company.First National claims that a Z score below the industry standard shows impuissance in a firm and increases the likelihood of default. SDIs Altman score is 3.07 which is not enough to worry the bank, only if enough to put increased pressure on Sweet Dreams Inc. on that pointfore the problem here lies at minimizing costs and increasing revenues. To solve these problems SDI would need to focus their efforts on inventory management, company decisions, and effectiveness and efficiency. Regarding inventory SDI can lower the current level of mattress production to let inventory deplete to an acceptable contribution of current assets. As for company decisions when the economy is hurting companies should focus on cutting wages or hours to minimize costs, not reducing prices to increase sales. Finally the company needs to work on up their ratios. Strong ratios come from more selling and less spending which in turn will pebibyte to a better Altmans Z score.2) After finding the results of Question one, it is evident that SDI has more weaknesses than strengths as of 1995. If you look at the common size statements, submit 3, it shows that inventory increased as a circumstances of sales, which indicates that a smaller helping is being sold. All current liabilities increased as a percentage of total liabilities, which indicates that SDI is veneering more debt. Figure one overly clearly shows many of the weaknesses of SDI. Both liquidity ratios are below the industry average. Although the debt ratio appears to be above the industry average, it is actually a weakness because it indicates that SDI has more debt than equity. The only asset management ratio that is above industry average is the fixed asset turnover ratio, the rest are either equal to, or beneath their industry average. However, its not a ll bad Figure one also shows that SDI has managed to give way a payout ratio on dividends that is 5 percent above the industry average.3) Based on our analysis of historical data, I do not believe that the bank should lend the requested money to SDI. We believe SDI is unfit for the loan because they are below the industry average in a majority of financial ratios used to measure overall supremacy in the company. These include liquidity ratios, leverage ratios, asset management ratios and profitability ratios, all shown in Table six. The fact that SDI Is facing decreased demand resulting from the recent depression also adds to their adversity they are facing to be a successful retailer. The current financial situation they are in makes them very sensitive to any unexpected economic event, making the risk of lending to them even greater. We firmly believe that it would not be beneficial to the bank to grant SDI this loan. 5) SDI has determined that its optimal cash in balance will be 5 percent of total sales. In addition, all excess funds of this keep down will be invested in marketable securities, which in turn will earn a 5 percent sideline rate. Based on the forecasted financial statements, we have determined that SDI will be able to invest in marketable securities in 1996 and 1997. As shown in Table two, net sales for 1996 and 1997 are $330,386,000 and $371,684,000 respectively.Table one shows that in 1996, SKI had $55,276,000 in cash and marketable securities. With the optimal cash balance at 5 percent, only $16,519,300 of this amount will be in cash. The remaining $38,756,700 will go towards marketable securities. alike the figures in 1997, which exceeds $18,584,200, the 5 percent optimal cash balance. Therefore, SDI was able to invest $56,183,800 in marketable securities. A potential problem that our financial forecasts reveal is that we are investing a considerably larger amount of money into the marketable securities than we are holding in cash. Wh ile this money is earning interest, it may cause a future problem seeing as how at that place are so many loans that require cash to be remunerative off. With cash being the most liquid of all assets, it may be prerequisite to keep more on hand in order to successfully pay off short and long term loans that will accumulate as a result of the $9,500,000 increase in majuscule from the plant expansion.6) On the basis of previously developed forecasts, it does not appear that SDI will be able to retire all of its outstanding short-term loans by December 31, 1996. At this date, SDIs short term SDI has on hand at this time is only $16,519,300, as the rest of their cash will be invested in marketable securities as a result of the 5 percent optimal cash balance. 7) Should the bank decide to withdraw the entire line of credit and demand payment immediately, a few substitute options would be available to Sweet Dreams Inc. The first option is that Sweet Dreams Inc. would immediately file for bankruptcy. Along with this they will file for protection under Chapter 11 of the Bankruptcy Act. This will allow Sweet Dreams Inc. to run as a firm and raise new money under restricted circumstances. Sweet Dreams Inc. will also be able to sell off any liquid assets in order to cover routine expenses and legal fees involved in this process. However, filing for Chapter 11 Bankruptcy is not an easy way out because more often than not the bank is unable to recover its initial investment.Along with this, employee productivity and morale descends, and the company will begin to have difficulty obtaining credit in the future because of their soiled credit history today. Another option is that Sweet Dreams Inc. would sell current assets at market value to pay off the requested amount from the bank. Their short-term bank loan is equal to $26,610,000 and their long-term bank loan is equal to $16,248,000 in 1995. Combined, this will equal a total of $42,858,000. This amount will need to be paid off as soon as possible. Due to the fact that they cannot sell total assets, Sweet Dreams Inc. needs to sell their current assets first at market value. For this example, we will use 28% as a fair market value. At 28% of face value, the $127,028,000 expense of current assets would be worth $91,460,160 to the creditors. First, Sweet Dreams Inc. would pay back the bank because they are requesting those funds immediately. After the loans are fully paid off, Sweet Dreams Inc. would be left with $48,602,160. The next action would be to pay off the stockholders who are tranquillize entitled to money.This amount would total to $2,660,000, with 7million shares valued at $.38. This would leave Since Sweet Dreams Inc. with $45,942,160. Although they still have money, Sweet Dreams Inc. took a major financial hit and will most likely need to default regardless. 8. There are several circumstances that would affect the validity of the comparative ratio analysis. For example the text quo tes, SDIs problems began with the recession of the early 1990s, which caused a drastic decrease in demand from its retail and hotel customers, When outside sources such(prenominal) as a recession or an inflation occurs one can expect that the forecast would be altered. Unforeseeable events such as natural disasters can also affect the normality of the forecast, as these can affect potential sales. Also, if one makes a mistake in a forecast, and adds incorrectly or uses the price formula then the comparative ratio will be thrown off.When anticipate, one can only trust the facts of the past. For example, in this case study, SDI managers saw a decrease in demand from this recession. This caused many retail and hotel customers to steer away from purchasing new bedding. Although the sales from new homeowners were still there, hotels were not being strengthened in the Southeast. Even though SDI responded by lowering prices and increasing production, people were still not buy and sales never increased. Hence, the management forecast was not accurate, and sales hardly improved. In most cases, forecasting is a very effective tool in predicting what will occur in the future, but there must be some room for managers to be flexible in order to account for discrepancies in the data or unknown events. 10) Based on the Altmans Z-Score table we are confident that if a company is within 25% of expected sales they will still be close to the tokenish Altman score of 3.2.Therefore the company would have strong enough ratios to not be flagged by the bank for, Problem Loans. Also Cost of Goods Sold as a percent of sales and the Altman Z score are inversely related. This shows that the end results are sensitive to Cost of Goods Sold. 11) While looking at the pro-forma financial statements, we believe Ingrid should give Sweet Dreams Inc. the 9.5 million dollar loan. All of the ratios are above the industry averages which hold strong signs for the future of the company. That bein g said SDIs pro forma statements are of course, speculative. Ingrid should implement certain streak systems to monitor SDIs statements. For instance the bank should state in part of their indenture that SDI must keep 20% of their revenue in a savings account that the bank has access too. This serves the bank by holding 20% of their assets, but more importantly it lets the bank see how much money the company is making proportionately. The bank also has the right to use said assets as collateral until SDI is able to pay the bank back. With this contingency plan installed we believe that Ingrid would be justified in giving the loan to Sweet Dreams Incorporated.