Guillermo\'s Furniture Store Scenario

Finance Concepts

There are a number of finance concepts that Guillermo should consider regarding the decisions that need to be made to maintain the company's financial viability. The first concept that leaps to mind is the supply and demand concept. This supply and demand of a product will, for the most part, determine how much profitability (if any) a company can project on certain products. Guillermo has been pricing his products at a 'slight premium' knowing that the quality product manufactured by the company would sell at a certain volume. However, when a competitor was able to supply the same quality product at a lower price, demand for Guillermo's product dropped to a lower level. Guillermo's response would likely have to be a lower price (with less profitability) or an answer to the drop in demand.

While the demand for Guillermo's product dropped due to the pricing and quality, Guillermo's labor costs remained at the same level. Guillermo still had the same workers, working at the same rate, producing the same product, so the labor costs remained the same. Guillermo was being introduced to the concept of revenues less expenses equal profits. If revenues drop due to lack of demand, yet expenses remain the same, then profitability will suffer.

Guillermo is also learning that a going-concern concept could apply in this situation.

The going-concern concept is when an assumption can be made that a business or business unit will be in business for a long time. The key in making this assumption is that the company will be viable at least long enough to use all its existing resources. Since Guillermo's demand has fallen due to lower prices for the same quality from a competitor, his first thought should be to determine whether the company would be viable enough to last that long.

GAAP definitions state that an 'entity is an organization or economic unit that operates as an independent of anyone else" which is a concept that Guillermo needs also to consider in this particular situation. Guillermo is deciding whether to offer his distribution services to a competitor. The situation for Guillermo is that he "could coordinate his existing distributor network and essentially become a representative for this other manufacturer." This avenue of response is fraught with danger and pitfalls for Guillermo. Would he then be an entity that operates as an independent, or would he then have to depend on a competing entity to fulfill his obligations? It is a concept that would have to be heavily considered in this situation.