Classic Fixtures and Hardware Company Case Solution

1. Why is Classic's seasonal loan balance of $37M greater than was forecasted for the end of July?

The root cause behind Classic Hardware's larger seasonal loan balance of $ 37 million than anticipated was the approved plan for 2008. The plan was based on high sales, which were much lower than the company had expected. The sales, at the start of the year 2008, fell short by 2 million, and later on in spring and summer, when Classic Hardware had a pattern of witnessing higher sales, sales fell short by nearly $13 million. Lower sales revenue had detrimental effects on the working capital of the company. Classic Hardware had increased its production and sales effort based on higher sales expectations, which, as a result of lower revenue, led to high inventory levels. The inventory levels at the start of the year exceeded the expectation by $0.79 million. Later in the summer, the company had to hold more than $12.7 million in inventory than expected. As a result, Classic Hardware could not release the cash stuck in the inventory levels, which led to a working capital shortage and hence more need for Southwest's loan facility. However, high inventory levels weren't the only culprit behind higher loan balances; the company needed to be more effective at collecting debts from its credit customers. The account receivables balance, on average, rose by nearly 9% throughout the six-month period, which lengthened the average number of days taken by Classic Hardware to receive payments from its credit customers to 60 days, five days more than what the company had anticipated and led to working capital shortage.

As a consequence of higher inventory levels and longer collection time, the company's cash operating cycle, i.e., the days required by the business to receive inventory and sell it for cash, increased by nearly 18 days than what the company had planned, requiring Classic Hardware to borrow more from the Southwest bank. In addition to operational inefficiencies, the high seasonal loan can also be attributed to the capital expenditures of Classic Hardware. The company planned plant expansion and modernizing programs and budgeted around $174 million for this capital project. However, the actual data shows the capex exceeded $180 million. Also, the long-term debt was $ 0.9 million, implying that the borrowings from Southwest Bank were being used to finance the expansion project, causing the loan facility to exceed the forecasted amount. 

2. Are the problems at Classic permanent or transitory?