Koala Fun BILLION‐DOLLAR COMPUTER GAME companies such as Activision, Blizzard, and Zynga are unusual in the electronic arts industry, which consists primarily of small developers. One such firm is Koala Fun (KF), located in Baltimore, MD. KF was started seven years ago by Owen Charles and Tessa Benjamin, who between them had over 15 years of experience with various computer systems design companies. The partnership initially blended very well. Owen, reserved and introspective, is creative with a flair for designing games and spotting trends. Mainly as a result of his genius, the KF brand is synonymous with intriguing electronics with high graphic appeal. Tessa, more outgoing with a strong marketing focus, has assumed the role of the firm’s chief operating officer. THE PARTNERS’ FIRST SUCCESS The first successful product the two partners developed was a game called Koala Fun, which they used as the company name. The game uses a cute image of a koala bear cub chasing treasure and villains around coastal Australia—the koala homeland—while helping “rescue” heroes and animals. The game was so successful that various spinoff products were licensed, including stuffed toys and a movie. The Chinese even picked up on the idea and joint‐ventured games with KF using a giant panda as the theme. Tessa was particularly good at marketing opportunities like the panda deal and working with resellers like the retailers GameStop and Target, the online merchandiser Amazon, and other large companies. She also sold to smaller resellers who provided national and some global distribution. However, the Great Recession and the resulting reduction in consumer discretionary spending affected KF. In addition, competition from free or low‐cost Internet games made it more difficult to sell the tens of thousands of games and other products required for an assured, constant revenue flow. A problem with this industry is that it experiences cyclicality, as players (usually children and teens) move on to other activities. The company enjoyed initial success, showing profits by its second year. Owen and Tessa preferred to work on designing new games and the development of marketing strategies over the administrative aspects of the business. As the result, new games and products were in development and production costs escalated, but sales were somewhat slow to be realized. FINANCIAL CONCERNS Owen and Tessa loved their company but were inexperienced in business matters. Owen asked his mother, Amy, an accountant, for assistance. After studying the ledgers and other records, she reported that there was a signifi- cant working capital problem with declining cash, unsold inventory (mostly old Koala Fun games), and vendors who had not been paid. Tessa had been handling this side of the company, but that had mostly involved writing checks to employees and for payables while waiting around airports. Files were misplaced, documents were missing, and some money was unaccounted for. The problems appeared to be more related to failing to priori- tize financial matters rather than any deliberate mistakes. Owen’s first reaction was to consider the sale of his half interest in KF. Though he has enjoyed the creative side of the business, he was upset by his mother’s report and by Tessa’s apparent failure to take care of that responsibil- ity. Periodically, some of the resellers KF deals with have encountered finan- cial problems and have strung out their payments, which often caused a mad scramble for cash at KF. And if Owen decides to sell, he knows that he is likely to be involved in some stressful negotiations surrounding the company’s value. Though he would hire a consultant to aid him in any negotiations, he decides it is a good idea to educate himself about KF’s financials. Another reason that Owen is interested in the firm’s financials is so he can better judge Tessa’s managerial competence. When KF was first starting, Owen thought Tessa did a fine job, but now he wonders whether she is capable of operating the firm. Actually, if Owen were convinced that Tessa is a competent manager, he would not consider selling out since he genuinely enjoys being an owner of a creative software developer. But he thinks the industry will face even tougher times in the next few years, and wonders whether Tessa is talented enough to successfully meet these challenges. BORROWING ISSUES Tessa’s personality compels her to make virtually all major operating decisions. Owen is concerned that firms the size of KF have had difficulty maintaining a stable bank relationship. Due to increasingly strict federal regulations, some lenders have called in loans, and most are scrutinizing new business loans very carefully. Consequently, Tessa views bank debt financing as unreliable, a potential problem should business become slow, and thinks that loan officers are capable of wasting her time. Owen isn’t sure what to make of these arguments, but he is concerned that avoiding debt has significantly reduced KF’s financial flexibility because it means that all projects will have to be equity financed. In fact, over the past five years there have been no dividends because all earnings have been reinvested. And three years ago each of the partners had to contribute $20,000 of capital in order to meet the company’s needs. Another infusion of capital may be necessary since the firm’s present cash position is low by historical standards. More important, however, Owen feels that the company is not benefiting from the leverage effect of debt financing, and that this hurts the profitability of the firm to the two owners. WORKING CAPITAL Owen suspects that KF’s inventory is excessive. He stated, “Capital is unneces- sarily tied up in inventory.” Tessa’s position is that a large inventory is necessary to provide speedy delivery to customers. She replied, “Our customers expect quick service when a game is in demand, and a large inventory helps us to provide it.” Owen is skeptical of this argument and wonders if there isn’t a more efficient way of providing good service. He also questions Tessa’s credit standards and collection procedures, and believes that Tessa has been quite generous in granting payment extensions to customers. At one point, nearly 45 percent of the company’s receivables were more than 90 days overdue. Furthermore, Tessa would continue to accept and ship orders to these resellers even when it was clear that their ability to pay was marginal. Tessa’s position is that she doesn’t want to lose sales and that the difficult times are only temporary. Owen wonders about the wisdom of passing up trade discounts. Vendors frequently offer KF terms of 1.5/10, net 30. That is, KF receives a 1.5 percent discount if a bill is paid in 10 days and in any event full payment is expected within 30 days. Tessa rarely takes these discounts because she “wants to hold onto our cash as long as possible.” She also notes that “the discount isn’t espe- cially generous and 98.5 percent of the bill must still be paid.” FINAL THOUGHTS Despite all of Owen’s concerns, however, the relationship between the two partners has been relatively smooth over the years. And he admits that he may be unduly critical of Tessa’s management decisions. “After all,” he concedes, “she seems to have reasons for what she does, and we have never lost money since we started, which is an impressive record, really, for a firm in our business.” Owen has discussed with two advisors the possibility of selling his half of the firm. Since KF is not publicly traded, the market value of the company’s stock must be estimated. The consultants believe that KF is worth between $35 and $40 per share, figures that appear reasonable to Owen. QUESTIONS 1.Using the data in Exhibits C2.1andC2.2, calculate and analyze the firm’s 2012 and 2013 ratios. 2.Part of Owen’s evaluation will consist of comparing the firm’s ratios to the industry as shown in Exhibit C3.3. Discuss the limitations of such a comparative financial analysis. In view of these limitations, why are such industry comparisons so frequently made? (Note: Sales are forecast to be $8.25 million in 2014.) 3.Owen thinks that the profitability of the firm has been hurt by Tessa’s reluctance to use much interest‐bearing debt. Is this a reasonable position? Explain. 4.ThecasementionsthatTessararelytakestradediscounts,which are typically 1.5/10, net 30. Does this seem like a wise financial move? Explain. 5.Is the estimate of $35 to $40 for Owen’s shares a fair evaluation? 6. WhatdoyourecommendthatOwenandTessadotoimprovetheircompany? Module Three Case Study Review: Koala Fun To respond to the following questions, you will need to review the Koala Fun case study on pp. 226–228 of your textbook, Working Capital Management: Applications and Case Studies; the questions were adapted from the same section of the textbook. Respond in complete sentences as appropriate. 1.Using the data in exhibits C2.1 and C3.3, calculate and analyze the firm’s 2012 and 2013 ratios. Enter the ratios in the table below in the 2012 and 2013 columns, respectively: Ratio Type 2012 2013 Current (times) 3.2778 3.4284 Quick (times) 2.3925 1.8288 Debt (%) 100 100 Times interest earned (times) 8.5066 11.6171 Inventory turnover (times) 6.3975 5.9025 Total asset turnover (times) 2.7838 2.9811 Average collections period No credit sales No credit sales indicated (days) indicated Return on equity (%) 18.0063 17.6951 CALCULATIONS AND ANALYSIS Current ratio= current assets/ current liabilities 2012: 2136800/573200=3.2778 2013: 2619700/764100=3.4284 Current ratio measures the ability of the company to meet its short and long terms obligations. Positive current ratio demonstrates the company’s ability to meet these obligations and therefore over the two years KF has been able to achieve this payments of obligations impressively and progressively. Quick ratio= (total current assets-inventory-prepaid expenses)/current liabilities 2012: (2136800-765400)/573200=2.3925 2013 :( 2619700-1222300)/764100=1.8288 Quick ratio evaluates whether the company is able to meet its current obligations when they are due with its quick assets. A positive ratio indicates this ability and therefore KF signifies this ability. However, its ability declined in 2013 as compared to the previous year. Debt ratio=total liabilities/ total assets 2012: (2361200/2361100)*100=100% 2013: (2879500/2879500)*100=100% Debt ratio examines total liabilities as a percentage of total assets of a company.in other words the ratio indicates the ability of the company to pay its liabilities with its assets. As such, KF has indicated 100percent ability to meet its total obligations with its assets within the two years. 2012 was however stronger then 2013. Times interest earned=income before interest and tax/ interest expense 2012: 322400/37900= 8.5066 2013: 367100/31600= 11.6171 The ratio measures the amount of income proportionate to meet future interest expense. KF has signified growth of this ability over the two years as the ratios indicate. Inventory turnover=cost of goods sold/ average inventory 2012: 4896700/ (0+765400)/2 =6.3975 2013: 5866200/ (7654000+1222300)/2=5.9025 This ratio examines the effectiveness in inventory management by providing comparison between cost of goods sold and average inventory for a particular period of time. In this case, KF was able to make more sales times in the previous year than in 2013. Total asset turnover=net sales/average total assets 2012: 6572800/((0+2361100)/2)= 2.7838 2013:7811500/((2361100+2879500)/2)= 2.9811 This ratio evaluates the firm’s ability to make sales from the assets by providing comparison between net sales and average total assets. This indicates that KF was able to improve its efficiency in asset utilization to generate more sales in 2013 than in 2012. Average collections period= (Average Debtors / Credit Sales) x 365 This ratio examines the average time taken in collection of trade debts. Return on equity=net income/shareholder’s equity 2012:170700/948000=18.0063 2013:201300/1137600=17.6951 ROE shows the amount of dollar profit generated by common stockholder’s equity. The ratios indicate that KF was able to generate more dollar profit from the shareholders’ equity in 2012 than in 2013 which is drop. 2. Part of Owen’s evaluation will consist of comparing the firm’s ratios to the industry as shown in Exhibit C3.3 of the text. Discuss the limitations of such a comparative financial analysis. In view of these limitations, why are such industry comparisons so frequently made? (Note: Sales are forecast to be $8.25 million in 2014). Type a three- to four-sentence response below. Some of the major limitations of comparative financial analysis are based on interpretation and history (Brigham et al 321). On the interpretation, sometimes it could be quite challenging to ascertain the major reasons behind a certain ratio, for example, the current ratio which although it might appear so excellent, the company could have just made high stock amounts to boost its cash position which might be a temporary case in the business. Likewise, the comparative financial analysis is entirely based on historical data which does not guarantee the consistency of the same results in future. Nevertheless, the comparative financial analysis is important in the evaluation of the performance of the business and the information is also critical when seeking further business financing whether from creditors or investors. 3. Owen thinks that the profitability of the firm has been hurt by Tessa’s reluctance to use much interest-bearing debt. Is this a reasonable position? Explain. Type a three- to the four-sentence response below. Whereas debt financing could have increased the flexibility of the business which could have expanded the revenue generation of the business, it could not be the actual cause behind the decline of Koala Games Company (Ramcharran 2). Poor cash flow management and poor accounting procedures are the major factors behind the challenge. As stated in the case, some of the company records are missing, there is also the case of misplaced files and unaccounted finances. 4.The case mentions that Tessa rarely takes trade discounts, which are typically 1½/10, net 30. Does this seem like a wise financial move? Explain. Type a three- to the four-sentence response below. This is not a wise move as trade discounts are very important to the business. Trade discounts play an important role in improving business cash flows as well as boosting the business working capital (McGuinness, Gerard, and Teresa 430). When a motivation to pay dues is created customers tend to settle their debts faster and that’s why Tessa should reconsider her approach to trade discounts. 5.Is the estimate of $35 to $40 for Owen’s shares a fair evaluation? Explain. Type a three- to the four-sentence response below. No, it is not a fair evaluation. This is because the estimates are based on mere estimations without empirical consideration from the company’s financial statements. Furthermore, its financial statements fail to provide adequate data for fair evaluation. Works cited Brigham, Eugene F., et al. Financial Managment: Theory And Practice, Canadian Edition. Nelson Education, 2016: 302-350 McGuinness, Gerard, and Teresa Hogan. "Bank credit and trade credit: Evidence from SMEs over the financial crisis." International Small Business Journal 34.4 (2016): 412-445. Ramcharran, Harri. "Financing Small and Medium-Sized Enterprises in Thailand: The Importance of Bank Loans and Financing Diversification." The Journal of Entrepreneurial Finance 19.2 (2017): 2. Module Eight Journal Guidelines and Rubric In this course, the journal will be used for reflection. Journal activities in this course are private between you and the instructor. Overview: For this journal task, you will revisit the Koala Fun case from your textbook, including the answers to the case study review you completed in Module Three, and consider management decisions made in response to working capital problems, including risk. Prompt: First, review the Koala Fun case (Case 2) in your textbook, as well as your responses to the case study review in Module Three, and then explain your answers in the review. In addition, address the following in a two- to three-paragraph journal assignment: • • • • Risks: Describe the risks that Koala Fun faced as a company. Management: In what ways was Koala Fun not being managed to obtain optimum performance from its assets? Explain. Decisions: How does this case demonstrate the importance of analyzing financial data when making financial decisions? Recommendations: What recommendations regarding risk and profitability would you make to Koala Fun’s owners to improve their company? Briefly describe your recommendations. Support your answers by referencing the case and providing information, including the financial ratios you calculated when you first worked on this case in Module Three. Rubric Guidelines for Submission: Submit assignment as a Word document with double spacing, 12-point Times New Roman font, and one-inch margins. Your journal assignment should be two to three paragraphs in length. Critical Elements Risks Proficient (100%) Describes the risks that Koala Fun faced as a company Management Describes the ways Koala Fun was not being managed to obtain optimum performance from its assets Needs Improvement (75%) Describes the risks that Koala Fun faced as a company, but description is cursory or lacking in detail Describes the ways Koala Fun was not being managed to obtain optimum performance from its assets, but description is cursory or lacking in detail Not Evident (0%) Does not describe the risks that Koala Fun faced as a company Does not describe the ways Koala Fun was not being managed to obtain optimum performance from its assets Value 22 22 Decisions Describes how the case demonstrates the importance of analyzing financial data when making financial decisions Recommendations Identifies and describes recommendations regarding risk and profitability that would be made to Koala Fun’s owners to improve their company Journal is free of errors in organization and grammar Articulation of Response Describes how the case demonstrates the importance of analyzing financial data when making financial decisions, but description is cursory or lacking in detail Identifies, but does not sufficiently describe, recommendations regarding risk and profitability that would be made to Koala Fun’s owners to improve their company Journal contains errors of organization and grammar, but they are limited enough that submission can be understood Does not describe how the case demonstrates the importance of analyzing financial data when making financial decisions 22 Does not identify or describe recommendations regarding risk and profitability that would be made to Koala Fun’s owners to improve their company 22 Journal contains errors of organization and grammar that make the journal difficult to understand Total 12 100% 
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