Guillermo’s Furniture is small size furniture store with a low capital income and a simple business structure located in Sonora, Mexico (“Guillermo Store Scenario,” 2012). The furniture store was the only manufacturer in the area before the ninety’s, when a new competitor from overseas entered in the furniture market with a hi-tech approach, and woke up the community of Sonora, increasing the cost of labor substantially, and causing prices to bottom out. As a result Guillermo watched his profit margin deflate as the price fell and the cost rose. Team B will analyze Guillermo’s alternatives to overcome this situation. The alternatives that will be covered in the analysis will be the current, high-tech, and broker alternatives. After the analysis Team B will select the best alternative for Guillermo’s store, and present a Pro Forma Cash flow budget for the next five years, along with a recommendation based on the results of the analysis. Current Alternative
The current alternative is for Guillermo to continue his operation as he has been for years. This has worked for the store in the past and will continue in the future. Guillermo’s business was going very well until competition moved in. Guillermo needs to think about what he needs to do for his business to succeed. First he will need to analyze his current situation, second he needs to create a budget, and a sales forecast for his business, including his current operations, and the effects of economic trends within and out of the furniture industry. Benefits of the Current Situation
Guillermo currently has a patented process for creating a coating for his furniture that will make the handmade piece unique, and luxurious. The process creates a common flame-retardant coat for the furniture, and upon further processing, the coating is complete and long lasting stain resistant, improving the product quality, and differentiating its product from the competition. This process will give Guillermo an edge against the competition. Another benefit is that Guillermo has hired a new accountant, who will help him to organize his finances, create a budget, and control costs. The accountant will also help him to understand his current position, and create a forecast of costs and sales for the store success. Guillermo is well known in the area, his reputation, and excellent customer service leads the new companies. Sharing the market however will be his chance to demonstrate his quality over the competition, without expending large sums of money in marketing promotions. Sensitivity Analysis
The current alternative calculation of NVP with the use of 0.12 or 12% over a payback time of 11 years for the capital rate was done because of the negative NPV of a ten year payback time. The eleven year period had a positive NPV, which means that Guillermo could choose to go with the current alternative. If he chooses to do so, his actual net income before taxes will be $42,577 (Guillermo Furniture Store Data 2012). By inspecting the company’s financials, Guillermo can make a financial decision to increase his sales and production levels. For this choice overhead costs vaguely changes, and the difference between net margins and overhead costs will provide a positive net income. If Guillermo can supply the needs of the consumer faster, and keep up with the competitors, he will increase sales for the business and give him the edge he requires. High-tech alternative
The High-tech alternative will require Guillermo to ask for additional financing, such as borrowing to cover the required changes on the production level. Although the high-tech alternative should generate an increase in revenue from $272,549 to $916,038 (“Guillermo Furniture Store Data,” 2012); it will also require more capital to change the production type and level. The salary costs will increase $45,000 and that is a fixed cost (from $50,000- $95,000). Because of this and other reasons the high-tech alternative will result in a negative NPV for Guillermo’s store, which negates this alternative as a viable means due to the high amount of financial risk involved in the conversion.
Based on the investments required for the High-Tech alternative (“Guillermo Furniture Store Data,” 2012), Team B decided the risks outweighed the potential gains by an exponential difference. Since the Brokerage Alternative is not be a viable model, the High-Tech alternative is definitely too risky for Guillermo to consider. Broker Alternative
The Broker alternative operates the furniture outlets, which means one of the competitors relies on the chain distributors. Guillermo could move from primarily manufacturing to primarily distributing, however, this will require him to contract with numerous outlets. Making such a decision will require Guillermo to contract with numerous outlets, and places his hard earned reputation at risk. Based on the analysis shown in Table 1, the broker option can bring an increase in production of 50% with no material costs. The price will decrease by 10% because of the increase in supply; however, the labor rate will increase due to the technical skill level of operators. Thus the broker alternative will also be a risky proposition with the potential for negative returns until Guillermo can build a solid customer base for the new products. This is not a guarantee as he has been in business for himself for many years, and while he shows a profit should he make a drastic change to his business model he could very well lose his customer base due to the change in production. Below is a summary of the cash flow projections from 2012 to 2017 (Table 1). Table 1:
While the Broker alternative may look attractive at first, a closer look shows the increased labor costs, increased production times, and the risk of finding quality outlets for his products make this alternative much more of a risk that it first appears. Alternative recommendation
Based on the results of the analysis conducted for each alternative, Team B agrees the best alternative for Guillermo is the current alternative. The current alternative does not need additional financing or any major changes in the production line, like the High-tech or Broker alternative. Nor does the current model change the company’s structure from manufacturer to distributor, such as, the broker alternative. Guillermo needs to focus on his current alternative, and create an action plan with his new accountant to overcome this market sharing situation. Product differentiation and quality will be his strength and focus to gain a market share, especially with the use of his patented coating finished. Team B will analyze Guillermo’s cash budget situation, and a suggested Pro forma cash flow for the current alternative. While the temptation to generate larger cash flows will be great, Guillermo is a seasoned veteran at this business and understands the risks, rewards, and the potential for failure, should anything provide a negative impact on either of the two riskier alternatives.
Cash Budget for Guillermo
The cash budget is an important part of the overall financial planning process for Guillermo’s store. Pro forma financial statements such as the income statement, balance sheet and statement of cash flows, combined with specialized budgets such as the cash budget, and sales budget comprise the financial planning process for the store. The cash budget contains cash inflows, outflows, and beginning and ending cash balances. The cash budget is important because it helps determine how cash is available for other potential opportunities such as investments, expansions, or product differentiation. By formulating a cash budget Guillermo will have a solid idea of his financial situation. Revenue Assumption for Guillermo
Revenue for Guillermo was derived from the income data within the set-up data. The initial revenue figure used was $272,549 for the current alternative. To complete the cash budget, revenue must be projected for the next five years. Revenue for the next five years was projected using a five percent increase from the previous year’s revenue. The five percent increase incorporates a three percent inflation rate which will drive sales prices up slightly. In addition the five percent increase in price will accommodate the cost of living, also increasing overhead and salaries. Please see schedule of revenue below (Table 2). Table 2:
Pro Forma Cash Flow Budget for Guillermo
After the revenues were projected, the actual cash inflows and outflows were projected based on the revenues for the current scenario. A majority of the Guillermo’s sales and revenue is from credit sales. As a result yearly account receivables will be the main source of cash for Guillermo, representing 98 percent of the revenue. Guillermo assumes a two percent bed debt, in which Guillermo will not receive two percent of sales. In other words Guillermo’s yearly cash inflows will represent 98 percent of the sales value. Please see the entire cash budget for Guillermo’s furniture store below (Table 3): Table 2:
In addition to cash inflows, assumptions regarding the cash outflows need to be made. Non-cash expenses such as depreciation were not included in the cash budget. Payables increased three percent a year. Salaries increased 5.26% per year based on $50,000 salaries expense, and taxes paid were 42% percent of the revenue taken from income information in the set up sheet (“Guillermo Furniture Store Data,” 2012). Starting cash for the initial year was based on 75% percent of current year’s projected payables, and 75% percent of next year’s salaries. Finally, ending cash was calculated by taking the starting cash, adding the cash inflows and subtracting the cash outflows. The previous year’s ending cash will be used as the starting cash point for the next year. Recommendation and Justification
Guillermo can assess the effectiveness of changes by comparing an increase in revenue and a decrease in costs to those changes using performance reports. Guillermo can make corrections and revisions of his plan if needed. Performance reports compare results to the budgets, which will give Guillermo a real-world analysis. By staying with the current business model, Guillermo can significantly reduce production of high-end furniture and increase production of middle-end furniture with a slight adjustment to price-setting. The sales history shows that middle-end furniture sells the best. It does not require any additional investments, just change of the product mix and price. By making a slight change to his business model even as he stays with his current methods, Guillermo will be able to maximize his profits while minimizing is risk.
For Guillermo this is a win-win scenario. Either of the other two methods is too risky with the potential for negative returns and the ultimate loss of his business, either to defaulting on loans, or losing to his competition. The essence of any business operation is to maximize profits. In conclusion, Guillermo’s will need to change his business organization to be more competitive through reduction of costs, improving efficiency, or modifying the core business. Team B feels that the current method is the best business model for Guillermo’s business. Guillermo has an advantage with the patent pending coating process. However the market for this will take time to develop. Guillermo must recognize the need to make significant changes to continue his operations. The financial picture of the current method is most advantageous for Guillermo, and the current situation will be the most profitable to allow for future growth in to the near and long term. Guillermo will be able to continue as a manufacturer of fine furniture products for the market. Guillermo can also continue to do what he loves. Business must be flexible, adaptation is essential.
Emery, D. R., Finnerty, J. D., & Stowe, J. D. (2007). Corporate Financial Management (3rd ed.). Morristown, NJ: Wohl Publishing Inc. Guillermo Furniture Store Data. (2012). University of Phoenix. Guillermo Store Scenario (2012). University of Phoenix.