Marvel Soup And Earnings Management Case Study Solution
1.Pricing, Promotion & Inventory Decision
The sales team advised Marvel to keep the prices low so that the large volume of the cans could be sold. Vito had to decide about the exact price to be charged for the company’s products.
1.1.Quantitative Analysis
The quantitative analysis (See Appendix 2), shows that the company should keep the price of the cans to be 3.38 dollar per unit. It is in contradiction of the analysts’ recommendation of $1.83 per can. The reason is lower prices create large sales volume, and the production of such a large quantity involves greater cost of goods sold, which is $1,606,208. Though the sales have increased but the related costs too. So, the price for each can should be charged higher in order to compensate for the costs incurred by the company.
Secondly, the company can provide promotion of 15% additional inventory to the retailers, but the promotion is ending up with the extra inventory and the ratio of inventory is not in line with the industry standards i.e. the company maintains an inventory of 15% of sales, while the ratio for the industry is 12%. The promotion should be not be eliminated, because the promotion enables the company to create 35% of incremental sales, thereby generating a total sales of $1,627,830. However, the timing for the promotion timings need to be adjusted according to season, as the demand for the cans is seasonal, so these promotions should only be carried out by the Marvel Soup Company in summer. It would reduce the company’s cost of goods sold, ultimately leading to higher profitability levels. Lastly, the inventory levels should be reduced to 14%, as per suggestion of Vito, which would reduce the company’s costs without affecting the incremental sales.
1.2.Qualitative Analysis
From our analysis it is observed that the company is following the traditional linear regression techniques in order to derive annual demand of Dragon’s soup. Selling price of the soup is greatly dependent upon the production and it is expected that production cost of the soup will increase in future instead of using new machinery.Management of the company claims that they can sell their product at any price, therefore following the future expectancy of increase in production cost company should increase the selling price of the soup as minimum increase like from 1.83 dollar to 3.38 dollar will not affect the demand but it will surely enhance the value of the company by generating greater returns.
In addition to this company arrange an aisle display promotion with the collaboration of its suppliers which clearly helps the company by providing 20% cumulative growth in that week as compared to the normal week. As demand of the soup is seasonal and high during summers therefore continuing with the same promotional activity but with the accurate timing will help the company by increasing its value.
Although it is not increasing sales at customers end and it is also expected that it affects the growth of the company just after the promotional activity, but discontinuing such promotional activities could create a negative impact with respect to investors and dealers and they may prefer those companies who are facilitating dealers with such incentives.
Company is using LIFO method for the valuation of the inventory and it is expected that company is using conservative policy with respect to managing inventory levels. Company is using 15% to sales ratio for inventory levels while competitors of the company are using 12% to sales ratio for managing inventory. Therefore company have tied up greater cash into the inventory which could be used for maximizing value of the company, hence maintaining 12% inventory just like its competitors will be an appropriate level for the company for better utilization of working capital. This would enable the company to utilize the funds into the other key investments and operations, for the growing the business and increasing the company’s overall value.
2.Uncertain Accounts Receivables’ Decision
The other reason behind the scheduled meeting with Emma was to discuss about the status of a very import client. The company’s CFO noticed that that one of the company’s largest customers i.e. the distribution (J.N & C.) was delaying the payments continuously. The distributor was solely responsible for the 20% of the company’s total sales.
2.1.Quantitative Analysis
At the end of the previous year there was $300,000 in the account of unused provisions. It is expected that company has positive collection experience of last year which will further improve. Provision account consists of $150,000 related to the J.N.C., customer which is no more required as CEO is taking responsibility for that and projected write offs are of just $75000, therefore ending balance for provisions reduces from $300,000 to $100,000.
Additionally, the gross receivables are calculated as $866,452, from the allowance for bad debt of $100,000 is subtracted, resulting in collections of accounts receivables of $766,452. So, the financial analysis shows that the Chief Financial Officer should accept the guarantee form the CEO, which would reduce the bad debts portion over the financial statements and it would lead to improved accounts receivables and related collections. Ultimately, the investors would be able to see that the company’s liquidity position, there is no problem of cash in the company and the company is able to generate sufficient-cash form its operations.
2.2.Qualitative Analysis
Vito got informed that the distributor had been facing financial difficulty as a result of which he had been delaying the payments. Vito had to do something about these key accounts, as if the distributor goes bankrupt the company would not be able to recover such a huge amount. The receivable account of that customer is increasing by almost 100,000 dollars per year. Following this company is using greater provision estimates for allowances and bad debts.
The company needs to reduce the bad debt provisions, as it would create a negative signal to the investors that the company us facing liquidity problems. The investors must be given proper evidence of good cash lows and liquidity position, in order to get the required funding for maintain the operations or further expansion. Moreover, the company should try to generate cash from operations in order to support the key business activities, as it would reduce company’s reliance over the line of credits or other certain forms of generating capital. Reducing the bad debts provision would enable the company to meet its short term cash needs and it would create a positive signal to the investors about efficient production and good liquidity position.
In addition, for distributors like J.N.C, the company should implement receivable collections policies through discount options, which would make the distributor to pay for the payments on time by taking the discount facility. Vito should take the CEO’s guarantee about the distributor receivables, so that the company does not make any allowance for such a huge amount in its financial statements. However, for future, strict accounts receivables’ collection policies need to be implemented in order to keep the liquidity position of the company maintained and to keep the bad debt provisions as low as possible in the financial statements of the Marvel Soup Company.
3.Valuation or Sale of Securities
The other items, which caught Vito’s attention included the investment of the company in the shares and the mortgage backed securities. The asset side of the balance sheet of the company contains two held for sale investments which include shares and mortgage-backed securities. It is expected that investment in shares has increased from its original purchased vale by $25000 and while the current market value of the mortgage backed security has decreased by 50% of the original investment.
3.1.Quantitative Analysis
The market value of the mortgage backed securities has declined, as compared to the book value if the securities (See Appendix 4). The original price of the mortgage backed securities is 120,000 and the market value has reached to 60,000. The losses and gains related to an asset are recorded, when the security is sold. SO, if the mortgage backed securities are sold, suppose the sale is finalized at 60,000, it would lead to a loss of 60,000, which will be reported in the other comprehensive income of the company. On the other hand, the value of the shares have increased from 100,000 to 125,000, making a gain of 25%. The stocks are expected to increase in value, so the company should wait for the stock market to perform even better. The company is not in the state to report losses from the sale of its securities, so it should not sell the mortgage backed securities. Similarly, the gains are expected to increase from the stocks, so holding the securities is a good option for the company.
3.2.Qualitative Analysis
But unrealized gain and losses will affect the income statement only if investment is sold, selling the shares is not appropriate as it is expected that there are chances of further appreciation while selling of mortgage backed security will devalued the earnings for the year and similarly the valuation of the company. Therefore in order to maximize the value of the company both investments are as it is in the balance sheet of the company but are valued according to the quoted prices in active markets for fair representation of financial statements.........................
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