YOUNG BRANDS (YB) is a manufacturer of sports clothing and teamuniforms. Its industry is quite competitive, so the management teamhas attempted to operate a modern operation with state-of-the-artproduction facilities. Careful cost management has been animportant factor in attaining profits. YB is considered a leaderfor its fashion sense, pricing, marketing, and product quality.
Professional and university-team uniforms and affiliatedproducts are sold by company salesmen to teams and to retail storesthroughout North America. YB currently uses a network ofmanufacturers' representatives to reach retailers in Europe, LatinAmerica, and Asia. (A manufacturer's representative [MR] is anindependent individual, sales agency, or company that sells amanufacturer's products to wholesale and retail customers inforeign countries.)
There is a large demand for licensed (approved) clothing withteam logos and colors, and premium prices can be charged to retailcustomers who buy for themselves as fans, for friends and relativesas gifts, or simply to affiliate with a local (hopefully winning)team. The licensed clothing line includes sweatshirts; caps;jogging suits; baseball, football, and hockey shirts; and variousaccessories (such as tote bags, scarves, and towels).
CHANGES IN YB'S GLOBAL MARKETING STRATEGY
About a year ago, the senior managers concluded that YB productsin global markets were “underappreciated” and that “sales could—andshould—be substantially higher.” See Exhibit C6.1 for recent globalsales results. They reasoned that trade shows in the majorinternational markets are a relatively inexpensive way to displaythe company's products and provide an opportunity to meet majorcorporate buyers face to face.
| Sales ($ millions) | Price–Earnings Ratio (times) |
| 2015 | $123.2 | 11.4 |
| 2014 | $ 111.3 | 13.5 |
| 2013 | $104.6 | 14.0 |
| 2012 | $ 101.0 | 14.2 |
| 2011 | $ 96.4 | 14.0 |
EXHIBIT C6.1 Recent Financial Results
That is precisely what happened. The firm's exhibits wereimpressive, former athletes were used as spokespersons, and thecompany made important contacts with Asian and European buyers. Thelong-term plan is to eliminate the use of MRs and to sell directlyto major retail chains. This will improve market saturation inmetropolitan areas and end the commissions paid to the MR network(currently about 6 percent of revenue on average).
As a result of this, YB's sales growth is expected to increasesharply in the next three years, and revenues are estimated to morethan double by the end of 2018. The marketing vice presidentforecasts worldwide sales of $160 million in 2016, $200 million in2017, and $250 million in 2018. Management is pleased with theforecast because it is evidence of what they have long believed:that the company manufactures quality products with global appealat a reasonable price. The downside is that such growth willundoubtedly require external financing and could causeadministrative and operational difficulties.
Although YB will explore a number of financing alternatives, itis recognized that the first step is to estimate the external fundsneeded for the period ahead. After all, before a financing optionis explored, a reasonable projection must be made of what needs tobe raised. And it is even possible that a portion of the expectedgrowth can be internally financed.
FORECASTING CONSIDERATIONS
In order to develop the forecast, the president, Henry Gilmore,called a group meeting of his senior managers. All agree that thesales projections are “quite reasonable” in view of the activityresulting from the trade shows and the global obsession with sportsteams and competitions, and may even be a bit low. They also decideto concentrate on the 2016 forecast at their initial meeting.
A few months ago, YB began implementing a number of cost-cuttingmeasures that are expected to generate a 32 percent gross margineach year of the forecast. Due to economies of scale, operatingexpenses are expected to increase less than proportionately withsales, and the manager group agrees to a 20 percent increase in2016. The relevant tax rate is 40 percent.
The purchasing vice president noted that the financial forecastneeds to consider the tighter credit terms offered by many of thefirm's suppliers. Company records show that two years ago, about 70percent of YB's purchases were on terms of 2/10, net 30. That is,most suppliers offered a 2 percent discount to customers who paidwithin 10 days, with full payment expected by day 30. “We alwaystook the discount when it was offered.”
Company records show that during the past year, about half ofthe suppliers offered the 2/10, net 30, discount. Fewer vendors arelikely to offer cash discounts in the future, which will impact thefirm's gross margin due to slightly higher prices paid formaterials. Therefore, he recommends that the gross margin estimatebe reduced to 31 percent, which the group accepts.
WORKING CAPITAL ISSUES
The discussion then turned to working capital management.Inventory control has been a problem for YB at times. Some in thegroup believe that inventory turnover can be increased to eighttimes mainly by using suppliers with shorter delivery times. Othersare skeptical, believing that it is unrealistic to think thatinventory management can be improved unless there is specificevidence to support this conclusion. The group finally concurs thatan estimate based on historical inventory patterns isappropriate.
Given the new global customer base, it is clear that the firm'shistorical experience with its accounts receivable will be oflittle help in predicting future receivables. For the purpose ofthis forecast, the group decides to assume that they will offercredit terms of net 30 and that 50 percent of customers will pay ontime and all other receivables will be received in 50 days. YBexpects that this experience will improve in future years.
The marketing vice president is tasked with the responsibilityof making payment terms clear to the new foreign buyers, and toworking with YB's banks to establish letter of credit facilities.(A letter of credit is a document issued by a bank ensuring paymentto a seller of goods, provided certain documents have beenpresented to the bank. These are documents that prove that theseller has performed the duties under an underlying sales contractand the goods have been supplied as agreed.)
The group expects that nearly all sales will be collected, andit estimates that bad debt expense will be “insignificant” and canbe ignored. The group also thinks that cash should be 4 percent ofsales. The firm's predicted 2016 spending on fixed assets is $35million. These expenditures partly reflect the replacement ofexisting equipment but mainly result from the new facilitiesnecessary to accommodate the growth in sales.
The note payable will require a 20 percent payoff in 2016. Othercurrent liabilities will increase at the same rate as sales.Existing bond debt and bank loans will require an average payoff of15 percent of the principal amount.
FINANCIAL ISSUES
YB will pay $1 million in dividends during 2016, the same amountas in 2015. Although this might appear stingy, the group believesthat most profits should be reinvested in the aggressive plans forglobal growth. Ignore any interest expense for the purpose ofcalculating the 2016 financial statements. The group realizes thatit is likely that most of any new required funds will be borrowed.The finance vice president says he has enough information todevelop an estimate for 2016.
| Income Statement 2015 | Other Financial Data 2015 |
| Sales | $123.2 | Beta | 1.20 |
| Cost of goods sold | 91.2 | Risk-free return | 1.0% |
| Gross margin | 32.0 | Market return required | 8.0% |
| Operating expenses | 14.0 | Dividend yield | 1.0% |
| Earnings before taxes | 18.0 | Growth in stock price over previous 3 years | 8.0% |
| Taxes (40%) | 7.2 | Earnings per share | $ 10.80 |
| Net income | $ 10.8 | Dividends per share | $ 1.00 |
| Balance Sheet 2015 |
| Assets | | Liabilities | |
| Cash and short-term investments | $ 2.6 | Accounts payable | $ 7.1 |
| Accounts receivable | 13.0 | Notes payable | 2.4 |
| Inventory | 13.0 | Other current liabilities | 3.7 |
| Current assets | $ 28.6 | Current liabilities | $ 13.2 |
| Gross fixed assets | $ 55.0 | Bonds and bank debt | 21.0 |
| Net fixed assets* | 39.8 | Owners' equity | $ 34.2 |
| Total assets | $ 68.4 | Total liabilities and owners' equity | $ 68.4 |
* After accumulated depreciation.
EXHIBIT C6.2 Financial Statements ($millions)
| Current ratio | 3.1 times |
| Quick ratio | 1.5 times |
| Debt ratio | 46.8% |
| Times interest earned | 10.6 times |
EXHIBIT C6.3 Selected Industry Ratios and OtherFinancial Data
Question: Develop the 2016 pro forma balancesheet.
