Paul Vincelli was disturbed by a telephone call he had just received from an analyst with a major Bay Street investment firm. His company, Madison Avenue Fashions, had just released its third quarter results and finally the profit figures were beginning to look up. Profits had been languish- ing and Paul had tried everything to get costs down and profits up. Paul had been ill for several months and had left day-to-day operations to his trusted lieutenants.
He was pleased that his production people had seemed to have turned the corner on reducing costs of the various high-fashion items the company made. However, the analyst had just pointed out that, while gross margins had improved substantially, inventories seemed to have increased by about 40 percent. This observation had bothered Paul because he had been informed that any inventory increases were due to a shifting of orders from this quarter to the next quarter by customers and were not under the control of the production people. However, as he took a closer look at the financial statements, he realized that order levels were consistent with prior periods.
Now he was even more perplexed. With lower unit costs and increased profits, Bay Street should be praising management, but exactly the opposite was happening. The analyst suggested that the company had been managing the earnings of the company by increasing production well over the requirements for the quarter.
Required:
Paul has asked you to explain in detail how something like this could alter the operating results of the company.