The O.M. Scott & Sons Company

A Case Study on O.M. Scott and Sons Company

CASE CONTEXT

The company is facing a good economy as evidenced by the increase in sales. Industry is investing in research and development of products. Competitors are slowly entering the market.

O.M. Scott and Sons Company is a business in the lawn care and garden product industry. Currently, the company is reviewing the results of 1961 and preparing plans for the 1962 selling season. Sales were increasing and so is net income except for the year 1960 to 1961.

Presently, the company is using a combination of traditional seasonal dating plan and trust receipt plan to encourage and enable as many dealers as possible to be well stocked in advance of seasonal sales peaks. Also, this combination was used to retain security interest in merchandise shipped.

PROBLEM DEFINITION

With the current internal complications, what must O.M. Scott and Sons Company do to be able to decrease cost of sales and operating expenses? How will the company keep up with its goal of a 25% annual growth rate in sales and profit considering the current policies? How should the company finance its current policy of combination of seasonal dating and trust receipt plan?

FRAMEWORK FOR ANALYSIS

➢ To assess the current financial position of O.M Scott & Sons Company, key ratios are computed and a Dupont analysis is prepared.

➢ A proforma income statement is prepared to project the company's target sales that will conform to the company's 25% annual growth rate goal.

➢ A further analysis of the financial statements and the notes is made to evaluate the company's condition and the needed financing for the current policies of seasonal dating and trust receipt plan.

ANALYSIS

Financial Ratio Analysis

Liquidity

The overall liquidity of the company seems to exhibit an inconsistent trend. The company's liquidity seems to be okay since the recent ratios are not too large from that of the past. Also, the company is a business with relatively predictable cash flow so its current ratio is quite acceptable. With regards to its quick ratio, its inventory is typically sold on credit which means that it becomes an account receivable before being converted into cash so the quick ratio of the company is relatively high.

Activity

The company's inventory appears to be in poor shape. Its inventory management seems to have not improved because from 1960 to 1961, its inventory turnover deteriorated. The company may be experiencing some problems with accounts receivable. The average collection period crept up over the past few years. O.M. Scott and Sons Company appear to be slow in paying its bills; it pays nearly 32 days slower compared to that of 1960. Although overall liquidity appears to be okay, the management of receivables and payables should be examined. Total asset turnover reflects a decline in the efficiency of total asset utilization. This means that the company's operation have been financially inefficient.

Debt

Indebtedness increased over the 1958-1961 period and this increase in the debt ratio could be cause for alarm. The company's ability to meet interest payment obligations deteriorated from 1958-1961. The company's indebtedness in these periods apparently caused the deterioration in its ability to pay debt adequately. In summary, it appears that periods 1958-1961 were off years showing that the company's inability to pay debts does not compensate its increased degree of indebtedness.

Profitability

O.M. Scott and Sons Company's profitability relative to sales was increasing. Although the gross profit margin was better in recent years than those in the past, higher levels of operating and interest expenses appear to have caused the recent year's net profit margin to fall below that of the past.

The company's earnings per share deteriorated in 1961 which probably is because of the decrease in net profits. The value of the ROA indicates a poorly managed or ineffective management in generating profits with its available assets. The company appears to have a rapid expansion in its assets during 1958 to 1961 which caused the drop or deterioration in ROA. The low 1961 level of ROE suggests that the company is performing poorly. The return earned on the common stockholders' investment in the firm was not better for the owners.

DuPont System of Analysis

Doing the DuPont System of Analysis in Exhibit 2, we can trace the possible problem back to its cause: O.M. Scott and Sons Company's ROE is primarily the consequence of slow collections of accounts receivable and poorly managed inventory which resulted in high levels of receivables and inventories and therefore high levels of total assets. The high total assets slowed the company's total asset turnover, driving down its ROA, which then drove down its ROE. By using the DuPont system of analysis to dissect the company's overall returns as measured by its ROE, we found that slow collections of receivable and poor management of inventories caused ROE to drive down. Clearly, the firm needs to better manage its credit and inventory operations. Also, the company is financed primarily through the use of debt as shown by the high value indicated by the leverage ratio.

In Exhibit 3, the projected sales for 1962 are based on O.M Scott & Sons Company's goal of up to 25% annual growth rate of sales and profits. Through the years, the company has increased its sales but during the year 1961, profits decreased by 12% even if sales increased at the same rate. It can be observed that even though there is an increase in annual sales and profits, the profit remains to be only 2-5% of sales. This shows that the company's costs and expenses are very large resulting to a small profit. To increase profit, the company could probably cut cost. The projected sales for the next