CYCLONE FURNITURE COMPANY

The Cyclone Furniture Company is a well established family business. It consists of an ‘exclusive furniture retail show room in the downtown business centre of a large New Zealand city, and a manufacturing plant in a neighbouring satellite town. The plant manufactures furniture for their own retail showroom (25% of the output) and for export to Australia. The plant also makes top quality office furniture all of which is exported to Australia. Overall 75% of all output is exported to Australia.

Three weeks ago you were recruited as general Manager for the company. Until you were appointed, Winston Prebble had managed the business. Winston was the son of the founder of the business. Winston, although only forty, has decided to retire from running the business so as to pursue other interests. Yesterday, 31st May, he left with his new wife for an extended world trip. His parting words to you were ‘you have full authority, treat the business as your own, keep in touch, phone or e-mail me once a month’.

You have a tangible incentive for the business to perform well as your remuneration package includes a bonus calculated at 2.5% of the pretax profit of the company (if the budget is achieved your bonus will be $16,500). Today, 1st June, is the first day Winston has not been breathing down your neck and you get to the office early, keen to get started. (The ‘Head Office’ is on the mezzanine floor of the retail showrooms). You are particularly anxious to visit the factory, for although you have met Rangi MacDonald the factory manager, you have not as yet visited the factory. Winston had shown little enthusiasm for the manufacturing side of the business. In fact he had said to you ‘I sometimes wonder if we would be better to close the factory and just concentrate on the show room and export side of the business’. You have to admit that Winston certainly seems to know the retail side of the business. The décor and presentation of the store, for which Winston takes personal credit, exudes just the right atmosphere of sophisticated elegance which has given Cyclone their reputation as ‘the’ place for finely crafted furniture.

On arriving at the office you are pleased to see that Rachel Huntress the accountant is already at work. Your sense of pleasure however does not last long! Rachel shows you the trading results for the first three months (up to 31st March), which she has just finalised. You are shocked to see that the results show profit to be below the budget by over $100,000! On being pressed Rachel says that she won’t be able to produce the detailed May/ June results for at least another 3 weeks.

Extracts from Rachel’s financial statements are shown at Appendix A. You do some quick calculations and come to the conclusion that the debtors are far too high and that the organisation as a whole is carrying too much stock. The sales figures also look low for the first six months when compared to budget. Rachel blames the recession brought on by the economic downturn in Australia. She says ‘If Sales don’t improve, and I don’t see why they will, the loss for the year will be about $200,000. I

suggest that we cut back heavily on staff numbers’. You ask Rachel what she knows about the factory. She replies she has only been with the company nine months and hasn’t had time to visit the factory. You suggest that Rachel visit the factory that afternoon with you.

While you and Rachel are talking Ransom the Bank Manager phones. Her concern is the high level of the overdraft. She asks you to visit her office in two days time. Ms Ransom says that one of the terms of the overdraft is that a balance sheet and key trading figures be supplied to the bank at the end of each quarter; she says she has yet to see the results for the March quarter. Ms Ransom adds that in view of the high level of overdraft a cash flow and profit forecast up to 31 December is required. Once Ransom hangs up, (you had turned the speaker on so that Rachel could hear), Rachel says, ‘Well I can’t visit the factory now, I’m going to have to put all my efforts into getting the forecasts together’. You reply that without information from the factory, you don’t believe a forecast can be made.

You call for Silver Fern the Marketing Manager and ask her for sales figures for the last few years, and also for an updated forecast of sales through to December.

Silver returns in five minutes with the following information.

$’000

Actual Sales by Quarter

1997 1998 1999 2000 2001

Jan – Mar 800 660 945 930 940

Apr – Jun 1050 900 1080 1055 1080*

Jly – Sept 975 865 1040 1005 --?--

Oct – Dec 1085 1075 1135 1115 --?--

Full Year 3900 3500 4200 4105 --?--

Budget 4200 4000 4200 4400 4600

Net profit (actual)

Before Tax $390 315 360 310 ?

* April – June figures are based on sales invoiced, and goods on order for delivery in June. Silver is comfortable with the figure of $1,080,000.

Silver says ‘by the way don’t worry about being behind budget, in the ten years I have been here Winston has always set an impossible budget, he seemed to think this would make us try harder’.

Before you can consider the figures in detail you realise that you are due at the factory and that Rangi will be waiting for you. You invite Silver to come with you. Silver agrees, she says she hasn’t seen the factory since the new extension. You don’t comment but you know that the extension is at least two years old!

When you get to the factory (ninety minute drive), you explain to Rangi and Silver that ‘we’ have a temporary cash flow problem and that we are going to have to cut back on expenses. Rangi looks concerned and says that in his opinion head office is over staffed and that the factory is very efficient, ‘so there is no point expecting me to cut back’.

On a tour through the factory Silver comments on how clean and tidy it is. You also note how cheerful the workers are and that there is an overall sense of people taking pride in their work. You then inspect some of the finished products in the large warehouse and there is no doubt that the quality is first rate. You and Silver congratulate Rangi on the high standard of workmanship. Some what mollified Rangi begins to relax.

You are surprised to find that Rangi has an office staff of five people including an accountant. You have also noted that a large number of machines are idle, you know that most of the plant is leased and wonder if some can be retuned to the lessors. You are also surprised to see just how long the stock of raw material and finished stock is and how much space it takes up (you think ‘no wonder they had to build an extension’).

While Silver has a cup of coffee with the factory accountant you ask Rangi how work is scheduled. Rangi explains he has 22 factory workers, and that they are all kept fully employed. He schedules work up to 12 months in advance and has standard times for each element of every job. For

simplification he aggregates the standards times up to 20 hours, and each 20 hours of standard time equals a unit of work. For example a Queen Anne Bed takes 1.2 units of work, (24 hours of labour).

His schedule for the next six months shows

(Using June as an example for calculations; June has 22 work days x 8 hours per day x 22 people = 3872 hours. Divided by 20 gives 193.6 available units of work).

Total available Units In Month Units of Work Scheduled Demand (Required for Delivery at end of month)

June 193.6 192 140

July 184.8 184 165

Aug 193.6 192 165

Sep 184.6 184 160

Oct 184.6 184 150

Nov 193.6 192 200

Dec 150 150 160

Jan 125 125 70

Feb 176.0 175 200

1578 1410

June, July and August are definite orders, the balance is based on past experience. February (and March) are always big months for exports.

Your quick calculation is that for the next six months Rangi is planning to make enough stock to cater for about seven months demand. This suggests to you that the factory staff could be reduced and that there would still be adequate capacity. You also recall that Rachel’s figures show that the factory has finished goods on hand at the end of March. Rangi partly explains this by saying a big order was sent to Australia in April, but he does admit that as demand has been a little slower than expected he does have about three months of uncommitted stock of finished goods on hand at present. He adds that most of this is office furniture which traditionally sells well in February and March. He says part of their good reputation is that they always deliver on time and that this is

company policy. He agrees that customers usually order some weeks in advance, and he agrees that perhaps it could be possible to make to order.

You then ask Rangi how he calculates the amount of raw materials to order. Referring to Rachel’s figures he says that at the end of March there appeared to be at least three months of raw materials on hand. Rangi explains that 25% of the timber used comes from South America and there are three shipments a year. Shipments arrive December/ January, April/May, and August/September. Orders are placed in October (for December/January), February and June. Thus an order placed in October has to cover requirements up to the end of May, and therefore Rangi has to make generous estimates to avoid stock outs. Rangi advises that 12 months ago a computer package was installed which has made ordering easier. Rangi says that the computer specialists had explained that by using an economic order quantity (EOQ) and a recorder point for each item of stock holding calculated on lead times that a reduction in stock holding of about 30% could be expected. However, Rangi thinks that actually more stock is being held than before.

He explains that the formula used by the system is

EOQ which equals the square root of (2 DA/IC) where:

A = $ cost of placing an order

D = Annual demand in units

I * = Carrying cost for holding inventory for a year

C = Unit cost of item

*

(The carrying cost interest rate is 30% pa, being 20% cost of funds 5% for obsolescence, 5% for storage and an ordering cost of $10 per order).

Rangi is not sure of how the EOQ works. ‘It is based on the last four years’ usage. The computer people said it would work very smoothly because the system would self adjust’. Before the new system was installed Rangi said he didn’t rely on past usage but calculated orders on known future demand. He believes that all stock should turn over at least three times a year ‘but now I think about 25% of the stock is just taking up space and gathering dust and apart from the imported stuff (about 25% of the materials needed) you can usually get the rest locally more or less when needed.’

Winston notes that the factory is arranged into three sections, each with it’s own dedicated plant.

The first section (Domestic) makes furniture only for the retail shop

The second section (Exports) makes export orders and the

Third section (Commercial) makes office furniture.

Work from each of the three sections then moves to a single finishing department (staining and french polishing), and where appropriate to an upholstery department.

/-- Domestic Furniture \

V – Export Furniture --- Finishing Upholstery V C

\ --Office Furniture /

Rangi explains workers for the three manufacturing sections are interchangeable but that the finishers and upholsterers are specialists.

Silver, who has rejoined you, asks ‘why are three sets of machines required, and wouldn’t it be more efficient to have just one manufacturing section?’

Rangi says rather brusquely that office furniture is different from domestic furniture. ‘For example this month Domestic is making beds, Export is making coffee tables, and Commercial is making desks. We prefer to work in small batches and to keep each type separate. We have always done it this way, and no one has queried our quality.’

You and Silver have much to discuss as you drive back to head office.