The dynamic nature of business implies that a single successful idea cannot last for too long. The of the environment, the competitiveness of the market, and other determinants, once changed, new opportunities or threats might occur in the environment for which a suitable response is required. For Guillermo Furniture Store, a furniture company located in Sonora, Mexico, owned by Guillermo Navallez, the changes in the business environment revealed threats as well as than opportunities. The threats can be seen through the increased competitiveness of the business environment, in which competition utilized high tech approach were used which lowered the prices of furniture considerably, as opposed to the manual labor which costs increased over time.
There were also opportunities which can be seen through the chance to partner with a Norway company to work as their distributor in North America and/or selling flame retardant, which is created through the company’s patented coating process. Determining the way the company might avoid threats or utilize opportunities requires several considerations. In that regard, the present report will provide an analysis of the case of Guillermo Furniture Store, providing an explanation of the way understanding cost relationships and behaviors at the company can guide the decision making process. Additionally, the report will analyze various control system the company might implement to achieve its organizational goals. Finally, the report will provide an analysis of the current situation and the potential outcome of taking any of the opportunities presented in the case.
Cost Relationships and Behaviors
Managers are well aware that costs of different types behave in different manners. Managers, therefore identify cost drivers, or outputs of resources or activities requiring the use of resources thereby using funds. In management cost control the focus is on managing the actions used to make, sell and deliver a product not necessarily the product itself. Managers must also be aware of how administrative activities such as order processing affect costs. This cost outlook is from an activity based view which considers resources used by activities and the cost drivers for each resource(Horngren, Sundem, Stratton, Burgstahler, & Schatzberg, 2008).
The better the appropriate cost drivers are identified, the better the cost behavior can be understood by management and the more control management can have over cost. The relationship between cost drivers and activity level is measurable. As the activity level changes, there will be a change in the level of cost driver and the cost will subsequently change. Management can determine variable costs from fixed costs because costs that change in proportion to the cost driver level are variable. When the cost is stable regardless of the cost driver level the cost is a fixed cost (Horngren, et al 2008).
Cost behavior is measured by understanding and quantifying how the actions of a company affect its levels of costs. Cost drivers care used to measure the relationship between activity and cost drivers. Understanding this relationship allows managers to evaluate strategic plans and budget for future actions. Managers can use the knowledge of the cost behavior relationship to design effective management control systems and useful product costing systems.
Guillermo Furniture has firsthand experience with the effects of cost relationships and behaviors. When the opponent store entered the market offering lower priced products due to automated factory with a laser lathe Guillermo Furniture had great difficulty continuing to survive in the market (University of Phoenix, 2011). The cost relationships and behaviors became vital to the decision making for the owner of Guillermo Furniture. All managers need to have a good understanding of cost behavior and cost drivers when making decisions such as those facing the management at Guillermo Furniture.
Control System Use for Organizational Goals
Guillermo needs to research what control systems are about then look at the different ones available before implementing his own. A management control system is defined as “a logical integration of techniques for gathering and using information to make planning and control decisions, for motivating employee behavior, and for evaluating performance” (Horngren 2007, pg 386). Once a control system is designed and implemented it will cover some basic courses of action. The control system will… 1. Define the general goals of the company. 2. Make a plan to set up the information gathering system that will help in reaching the goals. 3. Define how to measure and report the results of the study. 4. Once the results and reports are ready, define how to use this information in performance evaluations, control decisions and motivational techniques.
Another part of setting up the control system is determining the key success factors. The key success factors are “characteristics or attributes that managers must achieve in order to drive the organization toward its goals” (Horngren 2007, pg. 388). Guillermo will have to decide just exactly what he considers to be the “key success factors”. As part of determining these key success factors Guillermo must determine and set up the responsibility centers as part in the control system: Some examples are the cost center, profit center, and investment centers. These centers of responsibility will report information straight into the control system but also use new data cycled back to them for action in driving the company forward.
If Guillermo is using a management control system properly, motivation will be evident. The employees and reasonability teams or centers will continually be driven by new motivation. Without motivation, the control system may seem like a hindrance instead of the tool is was intended to be.
Because Guillermo is in the manufacturing market, the control system will be easier to implement and use. The reason for this is because the data comes from solid numbers that are constantly flowing via the manufacturing process. If he chooses his techniques wisely and implements a control system that will best profit his company and employees, the system will be an invaluable integral part of boosting them into the future.
Break-Even Analysis for Flame-retardant
Cost volume analysis gives managers great power when they have a good understanding of the assumptions behind the method. Cost volume analysis can be used by management to not only predict the breakeven point for a product but to determine how much each addition product will contribute to the company’s net income after breakeven point. An understanding of the underlining assumptions allow management to predict costs and profit for the company and help managers to plan for future goals. Fixed costs are assumed to be given. Sales are assumed to be equal to 100% of sales. Sales minus variable costs are equal to contribution margin minus fixed costs which is net income. These are the assumptions to cost volume analysis which, when managers have a thorough understanding of these assumptions, can be used as a weapon for managerial and company success. Guillermo furniture has a flame retardant for which a cost volume analysis has been completed. See appendix B for this analysis.
Creation of this document required calculation of three financial performance indicators: return on investment, residual income, and economic value added. Return on investment is income divided by the investment required to obtain that income and is the product or return on sales and capital turnover. Residual income, also known as economic profit, is the after-tax operating income less a capital charge. The capital charge is the cost of capital multiplied by the investment. Economic Value Added (EVA) is a method of calculating economic profit and is the adjusted after-tax operating income less the product of the after-tax cost of invested capital and the average invested capital. Total assets less current liabilities is the definition used for invested capital. All calculations resulted from the Guillermo Furniture Store actual performance figures for the month of June and the average or the year-end figures from the assets, liabilities and equity information found the in Guillermo furniture budget spreadsheets available from University of Phoenix. The negative value of the three performance indicators reflects the company’s failure to achieve profit targets.
The present report provided an analysis of the case of Guillermo Furniture Store. Analyzing the cost relationships and behaviors, the managers of Guillermo Store are able to identify the cost drivers with the competitors entering the market, which in turn will enable the company to evaluate it budget and strategic plans. In terms of control systems to be used, it can be concluded that a management control system will benefit the company through timely report of information on the company’s operations. Considering the decisions and the opportunities before the company, it can be stated that a break-even analysis of selling flame retardant revealed that such decision will be infeasible for the company, where overhead costs are lower than other products the company manufactures. Thus, it can be recommended that the company consider increasing the production of its high-end goods. Finally, the analysis of the company’s financial indicators, return on investment, residual income, and economic value added all revealed negative values indicating the failure of the company to achieve profit targets. Thus, considering the latter it can be concluded that the company should seriously consider the option for partnering with the company in Norway.
Horngren, C. T., Sundem, G. L., Stratton, W. O., Burgstahler, D., & Schatzberg, J. (2008). Introduction to management accounting (14th ed.). New Jersey: Prentice Hall.
University of Phoenix. (2011). Guillermo Furniture Store Scenario [Week 1 reading]. Retrieved January 2, 2011, from University of Phoenix, Simulation, and ACC561-Accounting.
Appendix A: Economic Value Calculations
Table 1. Guillermo Furniture Store Calculations of Return on Investment, Residual Income, and Economic Value Added for the Current Situation. Note: From the Guillermo Furniture Store Scenario, University of Phoenix, 2010.
Appendix B Excel spread sheet for flame retardant break point analysis
Table 2. Break-Point Analysis for Flame Retardant Sale.
|Selling Price||Flame Retardant||Mid-Grade||High-Grade|
|$ 10.00||$ 509.00||$ 879.00|
|Variable Cost||$ 2.00||$ 440.00||$ 700.00|
|Contribution Margin||$ 8.00||$ 69.00||$ 179.00|
|Total fixed overhead cost||224,790||224,790||224,790|
|Break-Even in units||Flame Retardant||Mid-Grade||High-Grade|
|Break Even in Dollars||$ 280,987.50||$ 1,605,642.86||$ 1,123,950.00|