Toy World Review Flashcards
What is the moral of Toy World case
Profitability does not equal liquidity
Quality of assets is important
- Three months of sustainable advantage
- Seasonal business
When should you want to minimize inventory?
If it is:
- Perishable
- It is subject to obsolescence (Value of something goes down over time)
- If holding cost is high
In the toy industry, what is it essential that you do?
You have to be able to “innovate”. If you do not innovate you will be crushed
What is a potential opportunity for Toy World?
They could make a toy that is counter-cyclical
Different season timings in different countries, could try to attack those markets during off-peak selling in US
What is happening to Toy World under seasonal production? Risks, big costs, etc
They are minimizing the amount of funds tied up in inventory
They have a huge risk of having their competitive advantage eroded. Any supply chain problem is detrimental
They have big costs with overtime premiums and a powerful learning curve during their 3 month boom
What is happening to Toy World under level production? Risks, big costs, etc
They can eliminate overtime wages/overtime premium
They risk having a pile up of inventory that is illiquid
-This inventory is illiquid because it is not guaranteed to sell. They have no purchase orders
They risk having to use debt to pay for the inventory
What are some fundamental business risks of the toy industry?
Toys are fad items
Demand is uncertain
Price is uncertain
Under seasonal production, what is happening financially? What asset is supporting debt?
A/R is supporting debt
The risk is if people are going to pay you back (Credit risk). However, you can counteract this risk by a demanding a “Letter of credit”
They only fund with debt when they know they can pay it back thru A/R
Does level production make financial sense?
They could save $490,000 (this is an inflow)
However, you will have more debt and interest expense
-You will have $100k more in debt
You will have increase storage costs for the inventory ($115,000)
If “Inflows - Outflows” = (+) Do it
You have a net income of $170,000 if you switch to level production
What is restricted cash when it comes to debt?
It is cash that you cannot move. You need this cash in order to sustain your line of credit
If you have lower than the restricted amount in your bank account (Checkings + Savings), then you will be notified immediately
What is the pecking order theory?
We always assume:
- Use excess cash first
- Then use debt
- Final resort is equity (most expensive)
What is a cash sweep?
Always use excess cash first
If you have excess cash, you won’t have inventory
What happens with Inventory with seasonal and level production?
Seasonal - You only have safety-stock
Level production - Inventory explodes in Q3 + Q4 and is funded with debt
What happens with A/P in level production?
It will stay flat. Firm is buying same amount of raw materials each month
Purchase order will get rid of the risk
What is the summary/final thought?
Under level production it seems the company would be profitable, but the business dies because they never have access to cash
