PART 1 - There are a number of interesting differences between Sunbeam's 1997 and 1996 balance sheets (e.g., receivables increased by $82 million, inventories increased by $94 million, and pre-paid expenses decreased by $23 million, while long-term productive assets and liabilities remained relatively unchanged), and between its 1997 and 1996 income statements (e.g., during 1997 the company engaged in a number of "buy and hold" transactions, gross margin increased dramatically and SG&A declined).
a) (maximum 7 points out of 13) - Adjust Sunbeam's 1997 Earnings before interest and taxes for one-time events and apparent (e.g., doubtful accounts, depreciation expense and, etc.) changes in accounting policy. You may want to compute some comparative ratios to facilitate your analysis. Be sure to provide the details of and clearly label any computations.
b) (maximum 4 points out of 13) - Utilizing your adjusted numbers from 1)a. (above) re-compute Sunbeam’s operating cash flows for 1997 (i.e., compute a new cash flows amount based on your adjustments to the original data). Clearly label the components of your computations.
c) (maximum 2 points out of 13) - Summarize your findings in 1)a. and 1)b. (above), paying particular attention to any evidence of fraud (be careful not to let 20-20 hindsight – i.e., information that you are aware of, but is not included in this case – influence your conclusions).
PART 2 – We discussed, the four factors that Michael Porter identifies as influencing and directing competitive strategy.
Required:
a) (maximum 1 out of 7 points) identify each of those specific factors.
b) (maximum 1 out of 7 points) provide specific examples of accounting information that might be useful for assessing each factor. Be sure to explain (briefly) how each example might be used.
Full Answer Section
2. Assessing Impact of Other Changes:
- Receivables: A significant increase in receivables suggests potential bad debt or delayed collections. We need to consider the historical data on bad debt expense and collection period to assess the impact on EBIT.
- Inventories: A large inventory increase can indicate inefficiencies, overproduction, or obsolescence. We need to compare the inventory increase to the cost of goods sold (COGS) and sales growth to understand if it's an efficient increase.
- Prepaid expenses: A decrease in prepaid expenses might artificially lower expenses in the current year, leading to higher EBIT. This needs to be analyzed in context of historical trends and future expectations.
3. Data Limitations:
Without detailed financial statements, it's impossible to accurately adjust EBIT for one-time events and accounting policy changes. However, the provided information raises red flags about potential manipulation of financial statements.
b) Recomputing Operating Cash Flow:
Due to the limitations noted in Part a), we cannot accurately recompute the operating cash flow. However, we can identify potential adjustments:
- Adjust for inventory changes: If the inventory increase doesn't reflect actual sales growth, we need to add back the excess inventory value to cash flow from operations.
- Adjust for receivable changes: If the increase in receivables signifies bad debt, we need to subtract the estimated bad debt expense from cash flow from operations.
c) Summary of Findings:
- The significant changes in balance sheet accounts (receivables, inventories) and income statement items (gross margin, SG&A) raise concerns about potential manipulation of financial statements.
- The lack of information regarding "buy and hold" transactions and limitations of the case data prevent a conclusive analysis. However, the available information suggests red flags requiring further investigation. We should avoid drawing definitive fraud conclusions based solely on this limited information.
Part 2: Michael Porter's Five Forces
a) Porter's Five Forces:
- Threat of New Entrants: This refers to the ease with which new competitors can enter the industry.
- Bargaining Power of Suppliers: This refers to the ability of suppliers to influence prices and terms.
- Bargaining Power of Buyers: This refers to the ability of buyers to influence prices and terms.
- Threat of Substitutes: This refers to the availability of alternative products or services that can satisfy the same customer needs.
- Competitive Rivalry: This refers to the intensity of competition among existing firms in the industry.
b) Using Accounting Information to Assess Porter's Forces:
- Threat of New Entrants:
- Capital expenditures: High fixed costs or research & development (R&D) expenses can create barriers to entry.
- Profit margins: Low average industry profit margins might deter new entrants due to low potential returns.
- Bargaining Power of Suppliers:
- Supplier concentration: A few large suppliers may have more bargaining power.
- Cost of goods sold (COGS) as a percentage of revenue: A high COGS suggests dependence on suppliers, potentially indicating stronger supplier bargaining power.
- Bargaining Power of Buyers:
- Customer concentration: A few large buyers may have more bargaining power.
- Concentration of sales to specific customer segments: Dependence on a few customer segments can increase buyer bargaining power.
- Threat of Substitutes:
- Presence of close substitutes: Analyzing competitor products and identifying potential substitutes.
- Market share of substitutes: Tracking the market share growth of substitutes can indicate their threat level.
- Competitive Rivalry:
- Market share concentration: High market share concentration by a few firms indicates intense competition.
- Marketing and advertising expenses: High marketing expenses can suggest intense competition for customer acquisition.
This is not an exhaustive list, and specific accounting ratios and metrics can be used to further analyze each force depending on the industry and context.
Sample Answer
Part 1: Sunbeam's Financial Analysis
a) Adjusting Earnings Before Interest and Taxes (EBIT):
1. Adjusting for "Buy and Hold" transactions:
Since "buy and hold" transactions resulted in inflated revenue without a corresponding increase in cash flow, we need to exclude them from EBIT. Unfortunately, the case doesn't provide the specific amount of "buy and hold" sales. Therefore, we cannot definitively adjust EBIT for this factor.