Executive summary
The additional $10,000 is the main issue that Robert and Teresa need to resolve in order to start the enterprise. The root cause of the issue is that they made a budget without visiting shops to get the actual costs of the items they were to use in the business. Another root cause of the problem is that they allocated 45 percent of the capital on purchasing inventory. The inventory is more than what is needed to start the business.
They should have prioritized the order in which they made an expenditure of individual items. Rent, legal fees, and equipment should have been covered first. There are four alternatives to solving the problem. The best alternative is for them to hire an agent to find willing buyers to purchase part of their inventory. They can sell inventory worth$17,000 at a 10 percent discount and 5 percent commission. They will generate $14,450, which they can use to cover the additional expenses. They can set aside some amount for unforeseen expenses. The main advantage of the alternative is that it does not change the initial plan of the business in allowing them strategic control of the business.
Short cycle
Decision maker
The Norman family is the decision-maker in the Framemakers’ business. The new family consists of Robert and Teresa. The Framemakers is a family business. The Norman family is the sole proprietor of the business.
Main issue/ problem/ opportunity
The main issue is that there are inadequate funds to start up the business after Robert and Teresa have made some of the planned expenditure. The actual expenditure exceeds the budget by $10,000. They are unable to find an additional source of capital, apart from the bank that offered them $75,000.
An opportunity may arise from their decision to register their business as a corporation. It gives them the freedom to seek additional capital from the public.
Why the issue has risen
The business incurred additional overhead costs and miscellaneous expenses that were not expected. Robert and Teresa bought more supplies on some items, which were not necessary for starting the business.
Making a decision
A decision must be made in a few days because they had already set the date for launching the business. The earlier they make the decision, the easier it will be to meet the opening schedule.
Long cycle
Immediate issue
The immediate issue is to find a way of raising an additional $10,000. The family can decide to go back to the bank and ask for additional capital. They will need to show that they have used the other amount in the most efficient manner. They can seek a third person to contribute $10,000 to be a shareholder in the business.
Strategically, the decision is very important because rent may still be incurred when the business delays opening. When the business is delayed, salaries will be lost. The urgency is short-term because it only affects the starting of the business.
The basic issues
One of the basic issues is raising capital to open the business. The business has a plan, but it is facing problems in funding and budgeting.
Another issue is the business structure. The business owners have decided to incorporate the business, different from a sole proprietorship. A sole proprietorship requires less documentation than a corporation. There are legal fees associated with starting a corporation.
The business would need less marketing when it uses a franchisor’s brand. However, the costs are higher in the long run for a franchise.
The budgeted expenditure for marketing is $3,600 for the three-month advertising. It appears inadequate for effective advertising. Television and radio advertisements are more expensive. Advertising in a popular newspaper may also be more expensive.
Robert and Teresa have the skills needed for running the business. However, their experience has not been gained specifically in frame making. They need someone with experience in making frames to assist them at the beginning.
They need to decide how to solve disagreements when they occur in the future. They have to decide the person who will be the final decision maker in case they have divergent views.
Analysis
Cause and effect
The funding problem starts from a less detailed budget. Robert and Teresa should have carried out a more detailed report about budget items. For example, they should have sought a carpenter’s opinion on the cost of fixing shelves.
Inventory
They purchased more inventory than they needed in the short run. The budget allocation for inventory is very large. It covers 45% of the budget.
Equipment
They should have visited shops that sell equipment before making the budget. It would have enabled them to have an accurate price for the equipment. Another root cause of the problem is that they started buying supplies without completing payment for more important items. They did not prioritize needs. They should have started with rent, equipment, and legal issues, before purchasing supplies.
Rent
The root cause of the rent problem is that the business is delayed in having the bank loan processed. It took two weeks to process the bank loan, resulting in a need to pay rent for two months.
Legal fees
Legal fees emerge from a change of plan. They changed from registering a sole proprietorship to a corporation. Only a license is needed for a sole proprietorship.
Constraints and opportunities
The bank may decide not to give additional capital, but that may put the loan they have already issued at risk. If the business does not start, they will not be able to pay the loan. A higher level of debt means higher interest expense. Less cash will remain for expansion and improvement of products.
The family can seek a partner to contribute the additional capital. If a new member joins the business, the family may lose the decision-making advantage. It may take longer to make decisions because they have to consult a third person.
One of the opportunities is that the projected profit indicates the ability to repay the loan. The business expects $38,400 annually as net income.
Qualitative and quantitative analysis
There is a population of 35,000 people in Brandon. The business expects about 4,800 customers annually (20 customers each day for 240 days). It shows that 13.71% of the population will become their customers. If they share the market concentration equally with the other framing store, it would mean that 27.42% of the population would purchase frames. It appears a higher percentage of the population, which may be difficult to maintain. However, a single customer can make repeat purchases.
Inventory covered 45% of the budget. The budgeted inventory covers $45,000 when the total budget was $100,000. One would expect equipment, rent, miscellaneous expenses, and legal fees to take a larger part of the start-up capital. When evaluating the inventory cost, one realizes that it is able to cover 3,000 units of material. Materials cost $15 per unit sold, considering that overheads are budgeted separately.
It results in 3,000 units of material when $45,000 is divided by $15. The business intends to sell 20 units in a day. The 3000 units are able to cover 150 days, which is 62.5% of the 240-day year. It shows that they have inventory to cover more than half the year when they lack the cash to cover other expenses. The business should have reduced inventory by a half to cover three months. Inventory can be replenished in quarterly periods.
Teresa and Robert have basic bookkeeping skills because they studied business management. It is a small business and does not need a highly specialized accountant.
The budgeted cost of advertising is low, considering that it has to cover three months in the chosen media channels. Advertising has been allocated $3,600 and the business intends to advertise through television and radio. The cost is able to cover advertising costs in media channels that cover a small area.
Miscellaneous expenses were also allocated an inadequate amount ($400). Considering that it is a new business, unexpected costs may vary by a wide margin. It requires the business to allocate a considerable amount to cover unforeseen expenses. The allocation may be reduced once all operations of the business are known accurately.
Alternatives
- Robert and Teresa can resell part of the inventory to recover part of the capital. It may be difficult to get a refund from the suppliers. However, they can bargain for a deal with the suppliers to get a refund and promise to make more purchases in the near future. Suppliers will want to retain their profit margin. They may also seek to sell to businesses that use the same type of material. They can sell inventory worth $15,000.
- The business can look for a partner, who can raise $10,000, to be given a proportionate share in the business.
- The business can seek to purchase the equipment on hire purchase if there is a hire purchase offer. They can also seek an agreement with the landlord to make payment for the additional month, two weeks after opening a business.
- The business can seek additional capital from the bank that issued $75,000. The bank may be reluctant because Robert and Teresa did not use the initial cash properly. They did not have a detailed budget with verified costs.
Decision criteria
- A 25-percent profit margin is adequate to repay the loan. The business can seek additional capital from the bank. Additional debt will result in higher interest expense, reducing cash flow and the rate of expansion. (Weight 80%)
- A new business partner may come up with new ideas that may help the business to make more profits. However, a new business partner may have a different vision from what Teresa and Robert have, which may create disagreements in running the business. It may be more costly to buy out a partner’s share when the business starts to flourish than repaying a loan. The partner may charge a higher premium to allow the family to have full control of the business. A partner shares profits. However, his contribution does not incur a compulsory interest expense. (Weight 70%)
- The hire purchase option distributes the cost into installments. Sometimes, the rate of the additional cost is higher than that of a bank loan. In addition, they can negotiate with the landlord to cover the additional payment later within the month. (Weight 50%)
- Robert and Teresa can also seek out their parents as partners in the new business. They can buy out their parent’s share when the business becomes more profitable. The business can maximize utilization of capacity. They can shelve their parents’ paintings in the shop. Their parents can also operate from the background and they can share the rent expense. The painting business may generate more income because Robert and Teresa have sought a busier street. The main weakness of the alternative is that their parents may not have the cash, or they may be unwilling to become partners. Robert and Teresa may still have the advantages they had when they planned for the business. They will retain full control of the business, which gives them ease in making strategic decisions. (Weight 85%)
- Reselling part of the inventory will not recover the whole amount of the cost used to buy supplies. The dealer may want to retain his profit margin when the goods are returned. The business may need an agent to find a person willing to buy the goods if it seeks new customers. It will need to offer a discount to find a willing buyer urgently. Its advantage is that there will be no need to seek a partner in the business or an additional bank loan. (Weight 90%)
Assessing alternatives and recommended action
The ranking of alternatives should follow the weights assigned to them. Higher ranking alternatives may fail to generate additional capital because they have some form of uncertainty. However, they provide better alternatives in terms of cost of capital and retaining full control of the business. It would have been easier to amend the budget when they had not spent any money on inventory. All options have some form of uncertainty because they may fail to raise the required additional capital.
Robert and Teresa should first seek to resell inventory worth $17,000. They can only seek a partner when they fail to get willing buyers for their material. The next option is that they can seek capital from their parents. They can offer them a partnership with the option of buying their shares when the business grows. If their parents are unwilling, or they lack the amount, Robert and Teresa can seek partners from the public. A hire purchase option and negotiating with the landlord should be the last alternative.
Robert and Teresa should first try options that allow them to retain full control of the business. Their college training and work experience put them in a better position to run the business without interference from another partner. Teresa and Robert grew up in the area, so they know the people’s culture. It can help them serve customers better than newcomers. Ability to understand customer preferences and expectations may increase customer satisfaction.
Action and implementation plan
Robert and Teresa have to raise at least $10,000 using the best alternative. They should set $17,000 worth of inventory for resale. They can offer a 10% discount to any business that will purchase promptly. They can offer a 5% commission to the broker, who finds willing buyers. The agent will look for businesses that use similar materials. The agent should be able to find willing buyers within a few days. The business will incur $2,550 through the commission and discount. It will remain with $14,450 from the resale. It can use $10,000 to cover the immediate needs of the business. The remaining $4,450 can be set aside to cover unforeseen expenses.
The business will remain with inventory worth $28,000, enough to cover 93 days of business. The business can purchase more inventories after the second month of operation. The alternative allows Robert and Teresa to open the business without seeking additional capital from external sources. It allows them full control of the business, which enables them to make strategic decisions in a timely manner.