POLAR SPORTS, INC.

Year-Round Level Production Analysis

Financial Statement Analysis

1. What are the total savings from adopting level production?

The company will eliminate $480,000 in overtime costs during the busy
season and
eliminate $600,000 as a result of decreased hiring and training costs as a
result of this change, and therefore reduces COGs by a total of $1,080,000,
reducing COGs from 66% of revenue to 60%.
However, Polar Sports will also incur a $300,000 increase in storage costs for
inventory needed during the non-busy season, and is distributed throughout
the year in increased operating expenses of $25,000 per month.
With the reduction of COGs less the increase in operating expenses, Polar
Sports will save $780,000 net each year as a result of switching from
seasonal to level production, before accounting for interest expenses, which
are $148,000 and interest income of $16,000, resulting in total after-tax net
savings of $406,560.
COGS (Labor)

$1,080,000

Operating Expenses (Inventory)

$300,000

Interest Expense

$148,000

Interest Income

$16,000

Savings before taxes

$616,000

Increase in Taxes

$209,560

TOTAL NET SAVINGS

$406,560

2. Which factors should Mr. Weir consider in deciding whether to

adopt level production?
Mr. Weir should consider the following factors when deciding whether to
adopt level production:
a)
Capacity Cost: Under seasonal production, machinery that is idle
for half a year is then put to extensive use, leading to high
maintenance costs. Polar Sports, under level production, could see a
potential decrease in these maintenance costs.

b)
Personnel Costs: Under seasonal production, it is costly to hire
and train new contract-based employees. Wage premiums due to
overtime also increase these operating costs. Under level production,
Polar Sports could save $480,000 by eliminating this overtime cost,
while also realizing $600,000 as a result of decreased hiring and
training costs.
c)
Product Obsolescence: A risk of adopting level production would
be that a product has the potential to become obsolete in this
competitive space, as predicting which products/styles would sell best
is difficult. The company could be burdened with housing this excess
merchandise, which would ultimately need to be deeply discounted at
the end of the peak season. Any remaining obsolete inventory would
need to be written off.
d)
Interest Expense: Under level production, Mr. Weir will need to
borrow more money to be able to buy the material necessary to
maintain inventory levels. The more money that is borrowed, the
higher the interest rate could potentially be that will need to be paid on
those borrowed funds.
e)
Reduction of COGs: Under level production, COGs accounts for
60% of total sales, whereas under seasonal production, COGS is 66%.
f)
Net Savings: Adoption of level production would save Polar
Sports $406,560.
g)
More Predictable Work Schedules: Under level production, worker
schedules will follow production schedules and not see a high degree
of variability from required output levels, allowing for a greater degree
of predictability.
h)
Seasonal Demand: A small benefit to adopting level production
may be Polar Sports not needing to ramp up production in times of
increased demandas during periods where demand for products
decrease, there will be a surplus, which can be sold during periods of
higher demand.
3. Think about the concerns of Polar's bank. As the banker, would
you be willing to extend the line of credit to more than $4 million to
finance level production? Why or why not?
Under Level Production, Polar Sports requires a credit line which exceeds $4
million in August, September, and October. The credit line limit was recently
increased to $4 million, and in the event that Polar Sports needed to exceed
that amount further negotiations must be made.

While Polar sports does generate losses for two-thirds of the year, as well as
generates negative cash flows from operations for two-thirds of the year, the
company manages to cover its interest expense on time, and stays well
within the parameters of the loan covenant. We do not feel that the overall
leverage brought on by increased debt without an offsetting increase in
equity is too much of an issue, and should not keep the company from
obtaining its required level of credit.
The loan covenant specified that Polar sports outstanding balance on the
credit line was not to exceed two-thirds of accounts receivable and inventory
combined. The table below shows that the company is operating well within
the covenant.

As the Banker of Polar Sports, Inc., we would be willing to extend the line of
credit to more than $4 million to finance level production.
4. Suggest another strategy that Polar Sports could employ to
optimize profitability and risk?
Another strategy that Polar Sports could employ is a hybrid of their previous
production model and the proposed level production model. Throughout the
year, instead of only producing to meet orders as in the prior model, Polar
could continue to produce at a lower level production rate. Instead of taking
total production and spreading it evenly over 12 months, Polar could take a
percentage (between 60 - 80%) of total production and spread that portion
over the 12 months evenly. This would help mitigate some of the risk
associated with completely level production. They could focus the level
production on best sellers (ex. black gloves/jackets) and then save the
remaining percentage (20 - 40%) for the more risky patterns/styles.
Additionally, this strategy would help Polar decrease the seasonal labor
costs. By creating a hybrid of level production and produce to order, this
strategy should optimize profitability and mitigate more of the risk than
either strategy individually. More research would need to be done to
determine the optimal percentage of level production vs. seasonal.