Case Study Drivers of Industry Financial Structure
Case Study Drivers of Industry Financial Structure Executive Summary KR+H is a manufactory company in cabinet industry and it had devised a unique operating strategy of producing high quality custom cabinets at a low cost. Because the investments will reduce costs and increase the working efficiency in manufacturing process. And the analysis will show that adding investment is valuable and profitable. Based on KR+H’s past financial performance and the cost of investment, KR+H would need additional financing to fund the proposed capital investment.
The internal financing could be very difficult for KR+H based on it had a deficit in 1992. And internal financing may also slow down the investments because KR+H has to retain its profit. Also rising the price is not a very good option in a long-term perspective. Because it could retard their growth and therefore did not represent a viable path to a long-term profitability. So we suggest that KR+H should finance the proposed capital by relying on external financing from a bank or an outside investor. Context
KR+H is a manufactory company that designs,fabricates and installs high quality, uniquely designed cabinetry. Now it had devised a unique operating strategy of producing high quality custom cabinets at a low cost. KR+H believes that the use of computer-controlled equipment allowed the firm to significantly reduce their labor cost and other production cost while increasing the efficiency of the manufacturing process. In order to support the development if their innovative operating system, KR+H need to clearly define the scope and speed of growth for their business.
However, the partners do not have internal funds to finance the investment and their access to external capital markets is limited. Therefore KR+H needs a better operating and financial strategy to managing rapidly growth and its capital. I think the article “Seize advantage in a downturn” is very helpful. Many companies fail to see the opportunities hidden in economic downturns. In order to take advantage of opportunities, KR+H first need to do a thorough but rapid assessment of its own vulnerabilities and then move decisively to minimize them. David and Daniel, 2009) KR+H could approach their problem by using some of those steps introduced in this article such as Monitor and maximize its cash position 1. Evaluating the capital position: In the cash flow statement Exhibit 6, the net decrease in cash by $15,298 in 1991 and $46,955 in 1992. In order to meet cash requirement during 1992,KR+H gets a personal loan about $35,000 and the bank overdraft to cover its deficit about $14,000,which shows us that KR+H are short of cash during the past years and it gets worse. The total enhancement of the new investment will be: Category |Cost | |Require in Capital |$300,000 | | |$100,000(developing in 2 years) | |Software | | | |$25,000 – $30,000 (maintain & update per year) | |Marketing |$40,000 |
Based on KR+H’s past financial performance and the cost of investment, KR+H would need additional financing to fund the proposed capital investment for sure. 2. Adding investment is valuable and profitable: I think the proposed projects are profitable investments and it will add values. Because the investments will reduce costs and increase the working efficiency in manufacturing process: |Category |Number | |Increase production capacity |50% | |Labor cost saving per year |$170,000 |
Another fact is that on a pro forma basis, KR+H’s cost of goods sold in 1990, the year before merged is approximately 60% of sales. In 1991,the percentage is increased to 67% and in 1992 the year after the merger the percentage rose to almost 75%. It shows us that some unanticipated cost increasing rapidly while the revenue is rising. If KR+H could adopting the new investment it would make its production more efficiently and the technique may also save some cost of goods. In addition, the cabinet industry experienced a decline in efficiency in 1992. Firm size |Sales per work |Compare to 1991 | |Large |$120,000 |gain 9% | |Medium |$84,000 |decline 11% | |Small |$80,000 |off 2% | |
KR+H could gain a long-term rapid growth in sales by first adopting the new technique and the improvements in production efficiencies will give KR+H more advantages in sales. There is no doubt that the investment will increase the operating leverage and also increase risk. In Exhibit 9, with investments KR+H will yearly saving $207,900. Therefore, adding the investment is very profitable. And also rising the price is not a very good option in a long-term perspective. Because it could retard their growth and therefore did not represent a viable path to a long-term profitability. I think KR+H finance the proposed capital by relying on external financing.
Because the internal financing could be very difficult for KR+H based on it had a deficit that was covered with a personal loan to company about $35,000 by a partner and a bank overdraft $14,000 in 1992. And internal financing may also slow down the investments because KR+H has to retain its profit. The investors wouldn’t want a low return just because the firm wants to invest. Thus, external funding will be a better choice. Ratios In 1992 and 1993, exhibit 4 Year |Return on Sales |Return on Equity | |1992 |2. 1% |21% | |1993 |8. 3% |98% | | Besides this, KR+H also is profitable in 1992 and assume that it will have 10% growth rate. Meanwhile, with the investments could save KR+H about $209,900 each year.
Those profitable data in its financial performance will help KR+H to get a loan from a bank or other outside investors. Conclusion: KR+H has its new investments developed and they focus on reduction by continuing to increase the level of automation in the process. And this investment is valuable and profitable. Based on KR+H had performed not very well in their cash flow in the past 3 years. The company also troubled with limited access to the capital market. Therefore, it is necessary for KR+H to get external financing in order to maintain its revenue and get a rapid growth. References: Robert C. Higgins(2012), Analysis for financial management David Rhodes and Daniel Stelter(2009), Seize advantage in a downturn