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TOY WORLD, INC.
I. Executive Summary

Toy World, Inc. which was a manufacturer of plastics toys for children, founded in 1973 by
David Dunton. Its product groups included toys cars, trucks, construction equipment,
rockets, spaceships and satellites, musical instruments, animals, robots, and action figures.
The products are a wide range of designs, colors, and sizes.
Toy World, Inc. had experience relatively rapid growth since its founding and had enjoyed
profitable operations each year 1976. Sales had been approximately $8 million 1993, and
on the strength of a number products, sales were projected at $10.0 million for 1994. Net
profit had reached $270,000 in 1993 and was estimated at $351,000 in 1994 under seasonal
production.
The quick ratio in 1993 and 1994 is 3.15, 3.06 times respectively which means that the
abilities to pay back its short-term liabilities with its short-term assets are very high. In
addition, working capital increases considerably and average daily operating costs are
increasing. That means company is pretty liquid and involving many business activities
which may diversify capital and investment of the company. It is axiomatic that Toy World,
Inc.s performance is in good situation, gets a gain profit and has an upward tendency in
the next years.
However, the company also has to confront with many difficulties. The manufacture of plastic
toys was a highly competitive business. The industry was populated by a large of
companies, many of which were on capital and management talent. Since capital
requirements were not large and the technology was relatively competitive simple, it was
easy for new competitors to enter the industry. On the other hand, design and price and
competition were fierce, resulting in short product lives and a relatives high rate of company
failure. In recent years, competitive pressures on smaller firms had also intensified due to an
influx of imported toys produced by foreign toy manufactures with low labor costs.
In general, Toy World has been facing two basic issues: The first one is if it has to change
to a level monthly production and the second area of concern is the financial arrangement
with the bank.
Based on the date that provide above, I would recommend that the company should:
- Not adopt the policy of level production due to extremely high operating costs
- Negotiate with the bank to reduce its cash balance to lower the loan requirement
- Negotiate with the bank to reduce its cash account below the prescribed minimum
- Use permanent use cash flow if the liquidity is low

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II. Analyzing and Evaluating Performance
1. How liquid is the firm?

Liquidity ratio refers to the ability of a company to interact its assets that is most readily
converted into cash. Assets are converted into cash in a short period of time that are
concerns to liquidity position. However, the ratio made the relationship between cash and
current liability.
1993 1994
Current ratio 3.15 3.06
Quick ratio 2.65 2.64
Working Capital 2519 3450
Interval measure 704 636.62

The current ratio of Toy world is very good because it was approximately (more than 3
times). It means that the proportion of liabilities equals one-third to the proportion of assets.
The ratio is mainly used to give an idea of the company's ability to pay back its short-term
liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The
higher the current ratio, the more capable the company is of paying its obligations. A ratio
above 1 suggests that the company would be able to pay off its obligations if they came due
at that point as well as show the company is in good financial health.
For quick ratio, in 1993, Toy world had very little inventory. This proves that, the company
had great sales in that period. It is vital that a company have enough cash on hand to meet
accounts payable, interest expenses and other bills when they become due. The higher the
ratio, the more financially secure a company is in the short term. A common rule of thumb is
that companies with a quick ratio of greater than 1.0 are sufficiently able to meet their short-
term liabilities. A high or increasing quick ratio generally indicates that the company is
experiencing solid top-line growth, quickly converting receivables into cash, and easily able
to cover its financial obligations. Such companies often have faster inventory turnover and
cash conversion cycles.
In conclusion, current ratio and quick ratio are quite stable while working capital increases
considerably and average daily operating costs are increasing. That means company is
pretty liquid and involving many business activities which may diversify capital and
investment of the company.
2. Is management generating adequate operating profit from the firms
assets?

1991 1992 1993 1994
Total asset turnover 1.64 2.26
Inventories turnover 9.52 11.95
Receivables turnover 2.74 2.94
Fixed asset turnover 6.77 8.50
Profit margin 0.05 0.01 0.03 0.035
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Days sales in receivables 53.88 829
Days sales in inventories 38.35 30.54
Gross profit margin 0.31 0.28 0.3 0.3

Look at the table above, we can see that Toy world has a high total asset turnover and low
profit margin. Toy world uses strategy that is to sell many products at low prices and rely on
high sales volume to create profits. This strategy requires a company to be efficient,
because a low profit margin leaves little room for inefficient operations. Management,
analysts and investors study financial ratios to assess how well a company operates. Asset
turnover and profit margin measure efficiency and profitability. The company has high asset
turnover, it extracts good sales volume from its assets -- in other words, it is efficient.
Profit margin percentage measures how much profit your company can earn from its sales.
A low profit margin is a way to attract cost-conscious consumers with low prices. Companies
that sell commodities have the lowest profit margins, because customers look to pricing over
other factors.
It has high inventory turnover ratio may indicate that it is enjoying strong sales or practicing
just-in-time inventory methods. High inventory turnover also means the company is
replenishing cash quickly and has a lower risk of becoming stuck with obsolete inventory.
Because fixed assets require a significant amount of investment capital, a business wants to
squeeze as much sales revenue out of them as possible. A higher fixed-asset turnover ratio
shows that the company has been more effective in using the investment in fixed assets to
generate revenues. A strong ratio can also give you a competitive advantage. Because you
require less money for fixed assets, you have more flexibility to spend on items such product
development that can improve your business. However, the fixed assets ratio here is too
high (6.77), so, the company is likely operating over capacity and needs to either increase its
asset base (plant, property, equipment) to support its sales or reduce its capacity.
A high inventory turnover ratio (9.52) in 1993 then continually increase in 1994 (11.95)
implies either strong sales or ineffective buying (the company buys too often in small
quantities, therefore the buying price is higher).A high inventory turnover ratio can indicate
better liquidity, but it can also indicate a shortage or inadequate inventory levels, which may
lead to a loss in business. High inventory levels are usual unhealthy because they represent
an investment with a rate of return of zero. It also opens the company up to trouble if the
prices begin to fall.
In addition, the higher receivables turnover, the better it is that company has account
receivables at lowest possible level. Therefore, in 1993, Toy world sells their merchandises
as fast as they can (54 days). However, in 1994, according to forecasting, their business
may be slowed down (829 days).
On the other hand, there is an optimistic signal in the days sales in inventories, the number
decreasing significantly point out that cost of goods sold is higher than inventory many times
which related to the sales of goods.
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This chart gives information about the proportion of net profit compared to net sales through
the years. In 1991, profit margin reaches 4.7% which is the highest ratio among 4 years.
However, this figure decreases significantly in 1992 (1.3%) then goes up gradually in 1993.
This proves that Toy world, Inc. is having a gain profit (all profit margin ratios are greater
than 0) and in the forecast of 1994, it will continually increase more a bright point in the
forecast ratios.
Generally, management is generating adequate operating profit from the firms assets. Toy
world Inc. is taking a stable profit which climbs in 1994.
3. How is the firm financing its assets?

1991 1992 1993 1994
Debt ratio 0.48 0.26
Time interest earned 18.45 8.33 25.57 19.04
Equity multiplier 1.48 1.36
Debt/equity ratio 0.12 0.13
Cash coverage ratio 25.57 61.03

The debt ratio of less than owners' equity (0.48) means that the business is positively
geared, the external lenders are bearing less risk than the owners, and the owner has a
stronger financial interest in the business than external lenders.
Time interest earned is the number of times indicates how well the firm meets its interest
obligations. The higher the number, the better the firm can pay its interest expense on debt.
Thus, this ratio reaches the highest figure in 1993 (25.57) then increase to 61.03 in 1994
which show that Toy world absolutely has ability to meet its interest expenses on debts.
Cash coverage ratio is very high and increases in 1994 means that earnings before taxes
also go up significantly through the years Toy world id doing a roaring trade.
4,7
1,3
3,40
3,51
0
0,5
1
1,5
2
2,5
3
3,5
4
4,5
5
1991 1992 1993 1994
Profit Margin (percentage)
Profit Margin
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Equity multiplier in 1994 lower than in 1993 shows that company is using less debt to fund its
assets and it is a desirable figure. However, debt/equity ratio also climbs a little bit in 1994;
this may be caused by the loan $2,000,000 Toy world want to borrow from the bank.
However, in forecast 1994, debt ratios changed so much among months. We took examples
of long term debt to total asset ratio and long term debt to stockholders equity ratio. Long
term debt to total asset ratio goes up gradually from January to July, and decreases from
August to December, it totally depended on seasonal prevalence or production and
purchase.



Similarly, long-term debt to Stockholders Equity had the same trend with long-term debt to
total asset.

0,000
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0,040
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Long-term debt to total asset 1994
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Long-term Debt to Stockholder's
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long-term Debt to
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Comparing to the years, most of ratios was pretty the same, they reflects stability in
performance of BOD. They could not be breakthrough to obtain higher level. Especially,
fluctuation between months in 1994 is very considerable. If BOD controlled badly, it is easy
to put company in risk, or developing unsustainable.
Overall, Toy world is financing its assets closely and logically. It has high capacity in settling
borrowings on interest.
4. Are the Owners Receiving an Adequate Return on Their Investment?

1993 1994
ROA 0.06 0.08
ROE 0.08 0.11

ROA tells you what earnings were generated from invested capital (assets). ROA for public
companies can vary substantially and will be highly dependent on the industry. This is why
when using ROA as a comparative measure, it is best to compare it against a company's
previous ROA numbers or the ROA of a similar company.
The assets of the company are comprised of both debt and equity. Both of these types of
financing are used to fund the operations of the company. The ROA figure gives investors an
idea of how effectively the company is converting the money it has to invest into net income.
The higher the ROA number, the better, because the company is earning more money on
less investment.
ROE ratio indicates how profitable a company is by comparing its net income to its average
shareholders' equity. The return on equity ratio (ROE) measures how much the shareholders
earned for their investment in the company. The higher the ratio percentage, the more
efficient management is in utilizing its equity base and the better return is to investors.
The ROE ratio as high as possible demonstrates the effective use of the company's
shareholder equity, which means the company has a balance between shareholder capital
with which borrowers to tap their competitive advantage in the process of seeking funding,
expansion. So the higher ROE ratio, the more stock attracts to more investors.
Furthermore, ROA is less than ROE means that Toy World is having debts or loans.
Based on the information above, we can conclude that Toy World has ideal ROA and ROE
that proves the company is in the prosperous period of business.
III. Seasonal Production vs. Level Production

1. The current (seasonal) production plans
Production is approximately equal to sales (production in response to customer
orders). Cost and benefit of the seasonal production plan:
Inventory
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Inventory is minimized and the funds necessary to finance inventory is
minimized
Inventory risk is minimized
Costs
Overtime premiums in high season ( reduce profits)
Difficulty in scheduling production runs and shorter production runs
Fixed capital is underused part of the year and then run to capacity
Seasonal financing requirements
Primarily receivables financing during the collection lag after the
months of peak sales (lag is 60 days)
The firm stays comfortably within its current credit line (it owing $752
thousands at the end of 1993, and the bank is willing to extend credit
line of up to $2 million in 1994)
Cash balance stays at a minimum required to finance operation

2. Level production plan
Benefit
Eliminates overtime premiums
Other direct labor costs savings
Cost
Higher inventory and handling cost
Need to commit funds to finance inventory accumulation in the off
season
Analysis of pro-forma financial statements
The required financing exceeds the maximum credit available ($2 million) for
all months in the period June-November.
Maximum financing needed in September doubles the available credit
Actually, most critical month is July
Current assets are mostly inventory in July, whereas for September
accounts receivable increase substantially.
The risk of not collecting is less than the risk of not selling
So level production is more risky (can end up with unsold inventories) and
requires more financing (now yet available)
Under level production:
Requires much more bank financing
Required bank borrowing from June to November is above the $2 million limit
set by the bank.
So loan renegotiation is needed. Need to convince the bank that the firm can
repay the loans.
Higher risk: if sales forecasts were not accurate, then the firm may end up
with unsold inventory (dollar sales of particular products can vary 30-35%
from year to year), while having to repay a larger loan.
From the banks perspective, the firm becomes riskier.
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However, Toy World is approaching full capacity during seasonal production
peak. The adoption of level production postpones the need for additional
investment in fixed assets
Changing to level production these costs can be reduced in $490,000, which is reflected in
the cost of goods sold, instead of be a 70% of sales, and now is 65.1 % of sales.
But a portion of these savings would be offset by higher storage costs that are $115,000.
This will increase the operating expenses in $10,000 approximately each month. (Exhibit 1)
The biggest problem of changing to a level production is the cash flow. As it changes
to a level production, it will produce 542 dollars each month. However, the first seven
months it is not selling more than 160 dollars each month (it is selling less than it is
producing). The money that is obtained from sales is not enough to cover production
expenses. This is going to cause problems with the cash flow as the company
doesnt have enough money to continue producing. They have to borrow money from
the bank.
IV. Recommendation

1. Should Toy World adopt the policy of level production?
Dave Hoffman estimated that a savings of about $225,000 would result of the adoption of
the level production method. These savings would be a result of overtime wage premiums.
Overtime wages wouldnt need to be expended for in the peak months from August through
December under level production. It is understood that more hours may need to be worked
by employees during non-peak months to compensate for less toys being produced during
peak months. This results in a savings for the company because Toy World is now playing
employees under regular hourly rates rather than overtime hourly rates.
The next savings that Toy World would encounter by adopting the Level production method
over the Seasonal production method is an additional $265,000 from direct labor savings.
By leveling the production of toys throughout the year it allows for employees not to be
overworked in any given month, resulting in more effective and efficient employees. With
more effective and efficient employees results in fewer errors in the production of toys as
well as decreasing hours and wages paid to employees would be higher.
Although, level production plan brings many advantages like above, the company should
have to start level production in the early years instead of this time when the company
is in the orbit of operation, to build up product for the peak sales. This early production
would have to be financed, costs would be incurred early, sales and collections would follow
much later. If the funds were to be borrowed, the credit line would be much larger than
what we have discussed thus far. Another drawback to leveling out production is that toy
sales are somewhat unpredictable, so it is better to wait for orders before producing.
Characteristic of the toy manufacturing industry is seasonal prevalence of production and
purchase that produces a different amount each month, based on the season, inventory
costs are lower and operating costs are higher. It would be a big mistake to produce a lot of
a particular type of toy back in the spring and then have kids turn away from that toy with
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your warehouse full of them. Toy world is a toy maker company while everybody usually
buys toys in the special occasion such as mid-autumn, Christmas, birthday, and New Year.
Therefore, adoption of seasonal production plan is completely reasonable rather than level
production that inclines toward producing the same amount each month; inventory costs are
higher in spite of lower operating costs.
2. Alternatives to prove Toy worlds well-performance
Furthermore, our group also suggests the alternatives for the financial performance of Toy
World, Inc. related to banking and investment issues in order to apply the level production
plan efficiently.
Sell receivables or offer them as collateral for a bank loan.
Also tighten credit policy to customers to induce quick repayment.
However, in July when financing needs are highest, accounts receivable
are only $300, so not much collateral can be offered.
Tighter credit to customers can reduce sales
First, it might negotiate to reduce its cash balance, which would lower the loan
requirement. Also, it might start paying its suppliers more slowly, thus "stretching" its
trade credit; this would be particularly feasible if the company is currently taking discounts.
Factoring or pledging accounts receivable, or pledging inventories, would also be worth
considering. Commercial paper might also be used, but that may not be feasible given the
size of the company and the fact that the ability to obtain bank credit is a prerequisite to
accessing the commercial paper market.
During the months of heavy sales and production, when cash needs are greatest, Toy
World would need a larger target cash balance, hence more financing from the bank or
other sources. However, during slower months, Toy World's lower target balance would
free up cash for investment in short-term earning assets. Under the current loan terms,
compensating balance requirements would constrain Toy World's actions, because the
company would not be able to reduce its cash account below the prescribed minimum. This
is a point that could and should be negotiated with the bank. In today's banking climate, the
bank would probably relax this constraint.
Alternatively, the company could take down more of its credit line on days when it was
writing lots of checks (or expecting checks to clear). Actually, the company probably ought
to see just how close to zero it could keep its cash balance, and then have a line of credit
which permitted quick cash infusions as needed. Still, the maximum line of credit must be
forecasted.
Because the amount of funds involved here is not large in relative terms, a money market
mutual fund might be the best choice. Otherwise, short-term securities could be
purchased with maturities that match anticipated cash needs. Larger firms that can
economically justify their own cash management personnel typically use the same selection
criteria (liquidity and safety, and the highest return that is consistent with those criteria), and
they invest in the same types of securities, but directly rather than through a mutual fund
intermediary.
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If a firm's cash flows are in the thousands rather than in the millions, the investment of
excess cash would still be beneficial, but not as critical. Indeed, for very small firms it is
even possible that the returns would be insufficient to recover the costs of transactions.
Here a money market account would be the preferred alternative.
Finally, if liquidity becomes less of an issue, the firm should consider permanent uses of
the cash flows, including share buybacks, higher dividends, repayment of long-term debt,
merger activity, and the like. Longer term investments typically yield more than shorter term
investments, and this fact should be considered.
V. Conclusion

Overall, Toy World had been experienced a prosperous operating activities. This was shown
by stable current ratios and quick ratio, the increase in the working capital and average daily
operating costs. That means company is pretty liquid and involving many business activities
which may diversify capital and investment of the company. Management is generating
adequate operating profit from the firms assets. Moreover, Toy world is financing its assets
closely and logically. It has high capacity in settling borrowings on interest and ideal ROA
and ROE that proves the company is in the prosperous period of business. However, the
manufacture of plastic toys was a highly competitive business and the company also has to
cope with lots of difficulties. To maintain stable operating activities, the company shouldnt
adopt the policy of level production due to extremely high operating costs and try to
negotiate with the bank to reduce its cash balance to lower the loan requirement.