Advanced Medical Corporation is experiencing significant growth; however, large expenditures in R&D and poor inventory and accounts receivables management process have resulted in negative earnings. By reducing the company’s spending, employing lower cost developing techniques, and adjusting the inventory and accounts receivables management process, AMT will be able to generate enough positive cash flow to pay off its debt and eventually increase its R&D expenditures.
Mr. Haskins’ eagerness to maintain AMT’s market position is damaging to the company in the long-run. Extraordinary sales growth is resulting in major operating losses, and external funds are necessary to be able to continue with this rapid expansion. Even though the medical device manufacturing industry seems to be very promising, the banks are reluctant to provide additional funds to the company. Mr. Haskins’ inadequate cost management imposed a pessimistic view of AMT’s ability to generate profits. Acquiring a new loan of $8M may be very unlikely.
There is an option for a merger with Biological Labs Corporation, however, it is not recommended at this time. There are few aspects of the current operations AMT employs which are undeniably the key factors to its unprofitability. Concentrating on market share by spending tremendous amounts of capital on R&D and SG&A does not prove to be beneficial at this time.
To understand how AMT’s increasing growth is continuing to result in negative net earnings a chart has been created to examine the company’s current expenditures. As seen in Figure 1, the analysis reveals that in 1984 AMT’s sales increased by 64%. The rapid growth is the result of significant increase in SG&A and R&D expenses. However, inadequate inventory management resulted in a decreasing inventory turnover ratio. Mr. Haskins’ policy of maintaining inventory for ten to twelve weeks is ineffective since inventory has high storage cost and zero rate of return.
In 1985, the company decreased its SG&A and R&D expenses substantially. However, not only did the sales drop, but the absence of control over accounts receivables resulted in a low turnover ratio and increased collection period. AMT needs to re-evaluate its credit policies in order to guarantee the timely collection of credit. One of the ways to improve this problem is to complete background checks on all new customers. Customers with poor credit history must pay for the products before they are shipped to reduce the risk of default. Also, collection of unpaid accounts needs to be pursued more aggressively.
Sensitivity analysis reveals that the growth rate and EFN are positively correlated. As the growth rate increases through the years, external financing needed to fund operations also increases significantly. Although growth is a concern for the company, no matter how low or even zero growth, CATO remains negative given existing costs the company incurs. Current v-factor is extremely high at 1.039 and is a key factor contributing to the negative earnings. It implies that the cost to produce each product is higher than the actual sale proceeds from that product.
In 1986, Pharmaceutical Manufacturers Association conducted a survey of sixteen medical equipment companies. The study showed that research and development to sales ratio averaged 5.5 percent in 1986. Even though the survey concluded that smaller companies are spending almost double the industry average, AMT’s current R&D expense as a percentage of sales is almost triple the...