Guillermo_Store

The purpose of this paper is to discuss and explain if the flame retardant furniture should be added to the Guillermo Furniture Store’s product line to improve the company’s profit. Guillermo Furniture Store is a small centralized company that produces hand-crafted, High-end and Mid-grade furniture. As Guillermo’s business advisors, we will discuss the company’s cost structure, display and explain a breakeven analysis table, and calculate and define the use of the return on investment (ROI) and residual income (RI). Cost Structure Guillermo’s cost structure is the expenses that must be considered when manufacturing the furniture. A management control system will be established to measure and monitor Guillermo’s standards. The direct (variable) cost is based on these standards. The direct cost for the High-end furniture of $700.00 per unit compared to the Mid-grade cost of $440.00 per unit. The direct cost includes the foam, labor, materials and wood. The direct cost for the chemicals is $2.00 per unit for the flame retardant furniture. The fixed cost for Guillermo includes the equipment and buildings. For every unit sold at a price higher than the variable cost of its production, Guillermo gains a contribution margin. Sales which the total contribution margins from Guillermo’s operations equal its fixed cost, which is the breakeven point. Breakeven Analysis The Guillermo Furniture Store has to make some very sound decisions based on the company’s latest performance numbers. The first two quarters of the year ended with the company facing a net loss as a result of inaccurate forecasting. Correcting this problem is altering the product mix is an estimate that is achievable. Tweaking will capitalize on the surprisingly exuberant sales of the mid-grade product. Favoring the mid-grade product will first increase sales and profit while simultaneously decrease variable costs related to the manufacture of the high-grade product. This will result in a higher contribution margin for each product therefore becoming the definitive adjustment that will eventually improve the poor sales results. As briefly observed above, one of the most important aspects of the overall CVP or Cost Volume Profit relationship is the measure of the product contribution margin. The contribution margin is the difference between the product’s price and the variable cost (Homogren, 2008). It is the individual’s profit percentage that a product contributes to the overall profitability of the company. The variable cost involved with production and generates clear profits which will improve the bottom line. In the example of the Guillermo Furniture Store, we can view the contribution margin from the perspective of its individual products. The price for the high grade is $879.00 minus its associated variable cost of $700.00 results in a contribution margin of $179.00. The attached table will reveal the contribution margin in the same manner for the mid-grade with a CM of $69.00 finally the Flame Retardant product with a CM of $8.00. This is a seemingly minor alteration in the product mix but has a significant impact on overall sales. This will be welcome news for Guillermo and ultimately help him to accomplish some of the goals he’d originally established for both himself and his company. This estimation is achievable because it is both a tactic and a practical adjustment that both major and smaller companies make every day to improve their respective sales situations. This adjustment takes into account the importance of the overall cost, volume, and profit relationship because one cannot simply raise or lower prices to figuratively slow or stop financial hemorrhage. Each portion of the equation has independent significance, but ultimately they have more importance as a combined observation than they do as separate numbers. Let us now take a look at how these components of the CVP have impacted the overall sales mix and its total contribution margin per product. Breakeven Analysis Product High End Mid Grade Flame Retardant Total Price $ 879.00 $ 509.00 $ 10.00 Variable Cost/Direct Cost $ 700.00 $ 440.00 $ 2.00 Contribution Margin $ 179.00 $ 69.00 $ 8.00 Sales Mix 8.34 41.69 1 Total CM per product w/ Sales mix $ 1,492.63 $ 2,876.85 $ 8.00 $ 4,377.48 Breakeven # of units 428 2141 51 76649 147714 416 $ 224,778.92 Sales Mix In the current financial situation, Guillermo Furniture Store has a sales mix of two products. There is the choice to use the mid-grade or high grade products. Guillermo has to decide whether to use the flame retardant or disregard the product. The decision is based upon the results of the break even analysis and how contribution for profit or loss affects the budget. A sales mix refers to the product portions that are sold. The product combination should indicate the greatest amount of profits that can be achieved. The flex budget for Guillermo Furniture Store shows a sales mix of 8.34 for high-end product and 41.69 for mid-grade product. The sales mix numbers was derived from dividing the current budgeted sales mix of 2,585 mid-grade, 517 high-end each into 62 units. Based on the sales mix, Guillermo can improve the sales and increase profit with the mid-grade. The cost to produce the mid-grade product is more expensive, but less production time that could generate more sales. The High-end product cost less, but takes longer to process in production; which could indicate potential loss in Total Contribution Margin Guillermo’s total contribution margin is 1492.86 for high-end and 2876.61 for mid-grade, plus 8 for flame retardant. The total contribution margin was calculated by using the contribution margin of 179 for high-end, 69 for mid-grade and 8 for flame retardant. Each number is multiplied by the sales mix of 8.34 for high-end, 41.69 for mid-grade and 1 for flame retardant. The combined total contribution for sales mix is 4377.48. The direct cost of 51.35 per unit was calculated by taking the total fixed cost of $224,790 and dividing into total contribution margin of 4377.48. Break even Point Guillermo’s budget states a direct cost of 51.35 per unit. In order to calculate for total units at the break even point; multiply direct cost 51.35 by sales mix of 8.34 for high-end, 41.69 for mid-grade and add 52 for flame retardant. The units at break even point are 428 for high-end, 2141 for mid-grade and 52 for flame retardant. A break even point will not show a profit or loss, but show various levels of cost factor and current activity; according to sales and revenue. The units sold above the breakeven point indicate a profit. Units sold below the breakeven point indicate a profit loss. Guillermo Furniture Store’s contribution margin for high-end generated at break even point is $76,649. The contribution margin for mid-grade generated at break even point is $147,729. The contribution margin for flame retardant is $416. All three sales mix produced $224,794. After reviewing the break even point, Guillermo should consider adding the flame retardant to increase profitability. A small contribution margin can help generate more. Return on investment (ROI) and Residual Income (RI) As a part of Guillermo Furniture’s management control system, the measurement, return on investment (ROI), also known as the DuPont ratio and residual income will be discussed. Return of investment indicates the annualized income divided by annualized assets multiplied by annualized revenue divided by total assets. The financial data provided will help in analyzing Guillermo’s results which will indicate how much income is generated for each asset invested. Return on investment is comprised of the return on sales and capital turnover. Return on sales is derived from income divided by revenue. Income is generated over a period of time. For the same timeframe, Guillermo’s financial team analyzed the average investment that generated the income levels needed to meet established financial targets. Return on investment provides another important financial indicator. If Guillermo’s company had various business segments, the financial team would look at ROI in units. ROI in units would compare the financial performance of other segments within an organization. The ability to analyze data can reveal operating efficiencies or, conversely operating deficiencies. One of Guillermo’s top initiatives is to ensure the company is operating at an optimal level. Guillermo’s financial analysis revealed an annualized net income of $320,981 with annual total assets of $1,348,829. Net income, $320,981, divided by total assets, $1,348,829, yielded a ROI, also known as DuPont ratio, of 0.2379 or 24%. Manipulating the sales mix will decrease or increase the ROI metric, depending on the product contribution margins. Residual income for Guillermo’s worked out in the following manner. Annualized net income of $320,981 minus cost of capital of 8% multiplied by total assets of $1,348,829 produced a residual income of $213,075. The dollar amount of $213,075 should be interpreted as real profit, the remaining profit after debt servicing. For the company to remain viable, residual income must remain positive. Idealistically, every year, residual income should increase. Keep in mind, all financial data previously mentioned was derived from budgetary projections, therefore are estimates. Estimates that are achievable; in addition, revising product sales mix to improve profitability should be evaluated on a quarterly or annually basis. Conclusion As you can see from the breakeven point analysis that the flame retardant should be included in the flame retardant is $10.00 with a contribution margin of $ 8.00. As consumers after we have spent a lot of money in a store for a product, no one wants to pay extra for some flame retardant. The best solution for this would be for Guillermo to include the flame retardant in the customer’s purchase, where the customer would not see that it’s extra because it would be included in their purchase price, by increasing each product line by $8.00. I think that this would be a good way for them to increase their sales if they are trying to get rid of the flame retardant. References Homgren, Charles T. (2008). Introduction to Management Accounting Chap 9, Retrieved from University of Phoenix dated October 22, 2009. Homgren, Charles T. (2008). Introduction to Management Accounting Chap 10, Retrieved from University of Phoenix dated October 22, 2009.