Guillermo_Furniture_Store_Paper

Guillermo Furniture Store Paper_ACCT_561_Week 6 Several areas of financial study are important for companies to grow and succeed. The study of an organization’s cost relationship and behaviors, different control systems, and a break even analysis are some of those tools that aid in the planning and decision-making for managers. For the purpose of this paper it will use the Guillermo Furniture Scenario to manipulate data to determine cost relationships and behaviors, describe how those relationships and behaviors effect management decisions along with control systems that will aid Guillermo Furniture store. Furthermore, the paper will determine the financial results for implementing a product upgrade to the current product line. The paper will provide an accurate break-even analysis, compute return on investment, residual income, and economic value for the current scenario. Cost Relationships and Behaviors Management accounting contains a number of decision making tools that require change in all operating costs and expenses into fixed and variable components. The responsibility for providing this cost behavior information falls squarely upon the shoulders of the management accountant. The conversion of ordinary financial data as typically found in the general ledger accounts requires that the management accountants has a thorough understanding of cost behavior theory (Micro Business Publications). It is vital that Guillermo analyzes the way in which cost reacts or responds to changes in the level of the organizations business activity. Guillermo essentially needs to evaluate the series of output of sales over, which cost behavior patterns continue unchanged. By grasping the relationship between revenue, costs, and production or sales volumes, Guillermo will be able to make great decisions for the organization. According to Horngren, 2008 analyzing cost-volume-profit relationships is an important management responsibility. Managers are advised to gain a thorough understanding of the organization’s cost structure- the combination of variable-and fixed-cost factors. A smart tool to help Guillermo assess risk would be a cost volume profit analysis (CVP). This will support Guillermo in the decision process my providing a measure of the margin of safety. The margin of safety shows how far sales can fall below the planned level of sales before losses occur. It compares the level of planned sales with the break-even point (Horngren, 2008). Decision-making is an in-depth process that all managers’ face with difficult economic difficulties. However, it is a significant function of being a leader within any business. when decisions can affect the whole organization leaders must analyze all vital data that can hurt or improve the state of the organization and render a victorious decision. Control System A control system is applied in financial management as a tool to collect information from different modalities of technology to provide relevant feedback enabling managers to make business decisions, motivate success employee behavior, and provides more accurate forecasting and financial planning (Hornrung, p. 386). Control systems are prearranged around a company’s main goals and expectations. These goals and expectation are measurable and must identify a party responsible for those goals. For example, Guillermo Furniture Store may use the marketing department to maximize the spending budget by including less expensive yet more profitable ways to advertise their new furniture retardant. In the scenario it shows that Guillermo has compiled research showing a market for their patented flame retardant coating that is also stain resistant. From market research, Guillermo finds there is little market for the stain resistant factor of his patent; however, the flame retardant is unique and may add value to the product. Taking action on this scenario, Guillermo may use this factor to measure the increase in sales the store may see once the flame retardant is applied. Guillermo will need to set a standard to decide what factors will determine achieving their goals and what the break even point is for the marketing departments effort versus sales. Guillermo must then determine which customers purchased furniture with the retardant, and the number that did not. Some sales that would not contribute directly with the sales of these products but for the foot-traffic that those marketing efforts made upon the sales department should be considered when using a control system. Break-even Analysis A break-even analysis is used to determine the point at which revenue received equals the costs associated with receiving the revenue (Investopedia, 2011). The Break-even Analysis allows a company to determine what they need to sell, monthly or annually, to cover your costs of doing business (Berry, 2003). In the case of Guillermo the following break-even analysis has been formulated to help Guillermo deicide on whether it is beneficial for him to implement the flame retardant product. From looking at the current situation of Guillermo it shows that currently he has a sales mix of two products, this being the high-end and mid-grade. To decide whether to implement the flame retardant product, formulas need to be calculated to see if this is a wise decision. Therefore, to formulate the sales mix numbers this was calculated by using the current budgeted units divided by 62 flame retardant units. From the results of this, the cost of producing the mid-grade product is more than the high-grade, which results in more sales from less production time. Being the high-grade product takes a longer time to produce; it results in a decrease in sales volume. The total contribution margin was calculated from using the contribution for each of the three products and multiplying it by the sales mix. To get the direct cost of $62.71 per unit this was calculated by taking the fixed cost from the flexible budget and dividing it into the total contribution margin. The break-even point for Guillermo’s three products includes the high-grade of $93,603, mid-grade of $180,408 and flame retardant of $502. From reviewing the breakeven points of each product, Guillermo should consider implementing the flame retardant product to increase his profitability. Although the flame retardant does not show a great contribution margin the little that it does make does add value and profit to his business. Therefore in time these numbers could change as with new marketing of the flame retardant can further increase profit which in turn will help Guillermo become more successful in his industry. Return on Investment Residual Income and Economic Value Added In this scenario, the formula for determining the return on investment (ROI) is the following: ROI = net profits (before tax) / shareholders’ equity. In our given situation, we have three different scenarios: current, hi-tech, and broker. It is broken down as follows: Current scenario = $46,118.00 Hi-tech scenario = $213,175.00 Broker scenario = $65,041.00 In order to determine the ROI of each scenario, we need to first calculate the adjusted shareholders equity of each scenario. To facilitate with this we will use the following formula: Opening equity + Profit after tax Current scenario = ($213,984.00 + $26,748.00) = $240,732.00 Hi-tech scenario = ($213,984.00 + $123,642.00) = $337,625.00 Broker scenario = ($213,984.00 + $37,724.00) = $213,984.00 Accordingly, the ROI of each scenario will be as follows: Current scenario = $46,118.00 / $240,732.00; ROI = 19% Hi-tech scenario = $213,175.00 / $337,625.00; ROI = 63% Broker scenario = $65,041.00 / $213,984.00; ROI = 30% In this scenario, the formula for determining the residual value is the following: Last return of each scenario / discount rate. The building was financed at 7.5%, so the discount rate is assumed to be 7.5%: Current scenario = $46,118.00 / 7.5%; Residual value = $614,907.00 Hi-tech scenario = $213,175.00 / 7.5%; Residual value = $2,842,338.00 Broker scenario = $65,041.00 / 7.5%; Residual value = $867,219.00 In this scenario, the formula for determining the economic value added is the following: Return of each scenario - (shareholders’ equity x expected earning (%)) Current scenario = $46,118.00 - ($240,732.00 x 7.5%); Economic value added = $28,063.00 Hi-tech scenario = $213,175.00 - ($337,625.00 x 7.5%); Economic value added = $187,853.00 Broker scenario = $65,041.00 - ($213,984.00 x 7.5%); Economic value added = $48,993.00 Conclusion If companies like Guillermo Furniture want to grow and succeed the financial study becomes an essential part and process of the organization. Different control systems, cost relationships and behaviors as well as a break even analysis serve as a guide for managers in the planning and decision-making process. Using these tools Guillermo Furniture will be able to look at the financial results and based on that will be able to make a decision whether to implement upgraded products to the current product line. References Berry, T. (2003). Break-even analysis. Retrieved from http://www.businessknowhow.com/StartUp/break-even.htm Horngren, C. T., Sundem, G.L., Stratton, W.O., Burghstahler, D., and Schatzberg, J. (2008). Introduction to management accounting (14th ed.). Upper Saddle River, NJ: Pearson Prentice Hall. Investopedia. (2011). Break-even analysis. Retrieved from http://www.investopedia.com/terms/b/breakevenanalysis.asp Micro Business Publications. (2011). Management accounting theory of cost behavior. Retrieved June 19, 2011 from http://www.microbuspub.com/pdfs/chapter5.pdf