Guillermo Finance a Practical Application of Basic

Guillermo Finance

A Practical Application of Basic Concepts in Finance: The Guillermo Furniture Case Study

In any situation that a business might face, there are many different perspectives that can be brought to bear on the issue in order to help develop an effective and well-reasoned decisions. Analysis of internal strengths and weaknesses as well as external opportunities and threats -- a standard SWOT analysis -- is one largely qualitative way of developing an understanding of a business's current position and its potentials for success in any number of alternative choices. Other methods include industry analyses such as Porter's Five Forces, focusing on the overall changes occurring in the market and the industry rather than specifically scrutinizing the organization at hand, and direct and actionable examinations of strategy based on competitors current reactions to changing situations.

At times, however, an examination of financial data is the most effective way to develop a successful and responsible decision following major changes to internal capabilities and/or external environments. Financial considerations are always important, of course, but they are not always the central feature of analysis when selecting a response to changes in industry and company potential. An understanding of some basic concepts in finance are a necessary for any business owner, and for a more complete financial analysis -- which is definitely necessary in a time of extreme change for a business -- a more solid grounding in these concepts is needed. Such is the case with Guillermo Furniture.

Though Guillermo's furniture factory has been successful for many years, automation by a foreign competitor and the rising cost of labor in his (and his factory's) native region of Sonora, Mexico has begun to seriously threaten his ability to continue competing. Several different options have been identified for the future of Guillermo's Furniture, and while it is unclear precisely which way forward is best for this company it is quite clear that the company cannot continue operating as it does now. One option is for Guillermo to invest significant amounts of capital achieving the same level of automation as his new competitor; though the upfront cost would be enormous, his factory could again produce furniture at competitive quantities and prices. He could also transition the business into one that focuses on distribution, as another foreign manufacturer is looking for a North American distributor and Guillermo already has a distribution network in place.

Financial Issues

Certain financial issues can be seen on the surface of this issue, even before examining Guillermo's specific financial figures. For instance, the cost of labor that is referenced in the case description is an example of overhead -- the costs that are inescapable parts of running a business (Besley & Brigham 2007). At the same time, labor costs as the factory operates now are not fixed, but rather are variable -- the more that is produced, the more expensive labor becomes, and the less produced the less has to be spent on labor (Besley & Brigham 2007). Costs of automated manufacturing would be far more fixed, however,

An examination of fixed vs. variable costs is certainly important for Guillermo Furniture as its owner ponders what direction to take the company in its future, as this will affect the marginal costs of increasing production -- the cost that is incurred for producing each individual unit (Helfert 2001). This can be compared to the marginal revenue, which is defined as the increased revenue the company would generate with each individual unit (Helfert 2001). With more fixed costs, marginal costs would be much lower and marginal revenues much higher at higher levels of production. This in turn relates to other key financial concepts such as revenue -- the cash that the company can count oncoming in based on sales -- and profits, which is the actual amount of money the factory makes after taking care of expenses (Banks 2010). Guillermo is not having problems with his revenue stream right now -- his furniture is still selling -- but his profits are so low that his business is being threatened.

An examination of Guillermo Furniture's actual financial data can of course reveal more basic concepts in finance that have a direct bearing on the case at hand -- both in understanding the situation that Guillermo Furniture is facing and in analyzing and possibly selecting a future strategy and position for the company. By understanding how money flows through, into, and out of the company, an understanding of how these different alternatives will affect cash flow and the company's financial position can be developed. Once this is understood, an analysis of how the greatest amount of positive cash flow can be achieved while still maintaining Guillermo's other values and non-financial goals.

For instance, looking at the real numbers for specific issues in the financial management of Guillermo Furniture provides a more complex and slightly different picture than a simple analysis of the face values of the case. Guillermo's direct labor costs -- the cost of one unit of labor -- in this case, the cost of one hour of one employee's labor -- actually increases if he adopts the automated machinery or becomes a distributor, as the expertise required is higher. There is a significant reduction in needed labor hours with each option, however, which creates costs savings on the production or brokering of both mid-grade and high-grade products. This will enable Guillermo to drop the prices he charges for items while maintaining profits even at current sales levels, and of course according to a standard supply-demand curve a drop in price should lead to an increase in sales, thus actually increasing the profitability of the company following a drop in the prices charged (Banks 2010).

There are also other complexities that must be considered when deciding how Guillermo should move forward. The concept of overhead has already been briefly explored above in terms of labor; in this case, because labor is so variable, it is less accurate to view this as an essential part of running the business (Besley & Brigham 2007). Labor costs drop significantly by changing options, it can be seen, but overhead costs actually rise dramatically -- running at full capacity (producing as much as the factory is physically able, running constantly) with automated machinery, utilities alone are expected to triple. There are also increased salary, benefits, and insurance needs going with the automated option.