Economic starting conditions in capstone business simulation games

¶ … Business Simulation 2005 Game

In order to be able to draw the most relevant conclusions, we will be discussing and evaluating the company's overall and per segment market share, the company's financial situation and the production vs. capacity matrix, with a closer look at the latter, where several weaknesses may be causes for concern in the future.

Market share

There are two different segments we should have a look at, the size segment and the performance segment. Digby is currently a market leader with two of its products, Dot for the performance segment and Dune for the size segment. Because this is a starting situation and not an evolving one, it is hard to compare and see what the 17% and 15% respectively figures actually mean. In my opinion, the company has a problem with Dot, a product with low contribution margins (see below) which is currently one of the main products in the performance segment. Even if it would best fit the size/performance matrix in the upper left quadrant, the company needs to be able to produce it more cheaply in order to remain competitive.

Financial Analysis

In order to properly describe the financial status for the business, we need to calculate a few financial ratios, the best measure in this sense. The current ratio, calculated by dividing the current assets value by the current liabilities value is 3.1. In general, the current ratio should be higher than 1 and, in this case, it is more than enough. I have calculated the current ratio for the company in order to be able to evaluate the short-term solvability for the company, whether it is able to cover its short-term liabilities (accounts payable) with its short-term earnings.

The return on investment (ROA or ROI) is 4.4%, as the ratio between Met Profit after Taxes and the total asset value. This number is meant to show the return on the entire capital invested in the business. Although a term of comparison would have been useful, in my opinion, at this point, 4.4% shows a moderately high return, with prospects for improvement in the future.

The contribution margin is another important financial clue that represents the total revenue minus the total variable costs for a product, divided by total variable costs. In Digby's case, this is 28.2%, more than a quarter. In general, there are no fixed values or intervals for this indicator, although it is generally accepted that it ranges from 25% to 40%.

It is interesting to differentiate between the five products in the portfolio here. If we look at the 2005 Income Statement, the difference between the highest contribution margin (Dell) and the lowest one (Dot) is 72.7%. This lets us know that for Dot, for example, the variable costs cover a large amount of the revenues.

One of the most important financial ratios that can be calculated is the profit margin on sales. This indicator will show us what the profit is for every dollar sold. This is the best indicator of the company's profitability.

In this case, calculated as net profit after taxes divided by net sales, the profit margin on sales is 4.2%. This means that for every dollar that Digby sells, it makes a 4.2 cents profit. The figure is encouraging and somewhat expected given the contribution margin I have already discussed.

The fact that the company has a stable short-term financial situation, with high current ratio values, and that its contribution margin and profit margin on sales indicators have performed well are positive aspects we should not when referring to the company's financial situation. One of the more worrying aspects is related to the company's inventory.

We can use the inventory value in order to calculate the inventory turnover, as the ratio between net sales and inventory value. This is 11.7, a figure that is much higher than it should actually be. In my opinion, this shows that the inventory value is too small and could be a clue that the company will not be able to handle any raise in sales, simply because it will not be able to cover them.

It would have been interesting to have an analysis of the stock evolution for Digby. However, given the fact that this is an evaluation at a certain given moment, it is impossible to have a tracking view over what has happened on the stock exchange.

Production vs. Capacity

The issue related to the inventory, detailed in the previous paragraph, is best noticed if we look and analyze the inventory figures for each product in the portfolio. This will give a clear measure of the company's production facilities for each product in part and its capacities.

The plants producing three of the products, Daze, Dot and Dune, work at an averagely high number, 68%, 73% and 63%, respectively. We would expect this kind of numbers because they show a moderate pace of production.

On the other hand, Dixie is somewhat working below capacity and thus us clearly shown if we look at the units sold and unit inventory figures. Indeed, the ratio (inventory turnover per product) is 7.8, which may show a buildup in stock.

However, this is nothing compared to Dell. Dell has a plant utilization of 129% and an inventory turnover of almost 35 times. This enormous value comes to show two things. First of all, Dell is selling way faster than it is making stocks. Naturally, from the point-of-view of economic theory, it will not be able to keep up with its level of selling.

The second thing, perhaps even more worrying than the previous, is that the workers in these plants are already working overtime and 2nd shifts in order to meet production deadlines. This will probably show in the quality of the work produced and will, ironically, probably lead to a decrease in the level of customer satisfaction and customer retention.

I would suggest here a moderate decrease in the production figures, especially given the fact that this product is the cheapest and at the lowest quality levels. In my opinion, the company should rather turn to more profitable products in its portfolio and use the extra workforce in other areas.

Conclusions and Final Remarks