Business Finance Series

The setting

WELDON FABRICATION needs a cutting machine. Buying costs $78,000 outright; leasing costs $1,750 a month for five years with an option to buy at the end. The technology is typically replaced every six years.

Your role

You are to assume the role of a finance associate at WELDON FABRICATION.

Your task

WELDON FABRICATION makes custom metal parts and needs a new laser cutting machine to keep up with orders. It can buy the machine outright for $78,000, which would use most of its cash reserves, or lease it for $1,750 per month over five years with the option to buy it at the end for $8,000.

Machines of this kind are usually replaced after about six years as the technology improves. WELDON also expects to need cash next year to hire two additional fabricators, and the owner wants to understand which option leaves the business in a stronger position.

The owner (judge) wants you to recommend which route WELDON takes. Describe the nature of the cash flows each option produces, discuss the nature of depreciation and how it differs between them, demonstrate the financial analysis that compares the two properly, demonstrate the budgeting applications that show what each does month to month, and calculate the cost of the credit the purchase would require.

Performance indicators

• Describe the nature of cash flows.
• Discuss the nature of depreciation.
• Demonstrate financial analysis applications.
• Demonstrate budgeting applications.
• Calculate the cost of credit.

The judge will ask

1. 1.Which option would you recommend, and what is the deciding factor?
2. 2.What would change your answer if borrowing became more expensive?

The setting

LARKFIELD JOINERY shows a $94,000 profit for the year and cannot make payroll next week. Customers pay in 60 to 90 days; suppliers and staff are paid immediately. The owner does not understand how both things can be true.

Your role

You are to assume the role of a finance associate at LARKFIELD JOINERY.

Your task

LARKFIELD JOINERY builds custom kitchens and cabinetry. Its accountant has just reported a profit of $94,000 for the year, the best in the company's history. Next Friday, however, payroll of $38,000 is due, and the business bank account holds only $11,000.

Most of LARKFIELD's clients are contractors who pay 60 to 90 days after a job is finished, while timber suppliers and staff must be paid straight away. Two large jobs worth a combined $85,000 were completed last month and have not yet been paid. The owner cannot understand how a profitable business can run out of money.

The owner (judge) wants you to explain the position and say what happens next. Describe the nature of cash flows and how a profitable company runs out of money, demonstrate the budgeting applications that would have shown this coming, demonstrate the financial analysis that sizes the gap, describe the techniques used to analyze which customers could pay sooner, and describe the need for financial information the owner does not currently have.

Performance indicators

• Describe the nature of cash flows.
• Demonstrate budgeting applications.
• Demonstrate financial analysis applications.
• Describe techniques used to analyze customer financial information.
• Describe the need for financial information.

The judge will ask

1. 1.How can a business be profitable and unable to pay wages?
2. 2.What would you do in the next seven days?

The setting

PENFIELD LOGISTICS' bank loan requires a current ratio above 1.5. After a slow quarter it has fallen to 1.31, which entitles the bank to demand repayment in full. Nobody was tracking the ratio between reporting dates.

Your role

You are to assume the role of a finance associate at PENFIELD LOGISTICS.

Your task

PENFIELD LOGISTICS has a $2.4 million bank loan used to buy its fleet of delivery trucks. The loan agreement requires PENFIELD to keep its current ratio above 1.5 at all times, and allows the bank to demand immediate repayment of the full balance if it falls below that level.

After a slow quarter, PENFIELD's current assets are $1.18 million and its current liabilities are $900,000, giving a current ratio of 1.31. Nobody had been tracking the ratio between the quarterly reports the bank receives, and the next report is due in three weeks.

The chief financial officer (judge) wants you to recommend the approach. Calculate the cost of the credit the covenant sits on, explain how contract compliance documentation should be maintained, demonstrate the financial analysis showing what would move the ratio back above 1.5, explain how a breach of a contractual requirement should be monitored for, and explain how a process for timely reporting of required information would have caught it a quarter earlier.

Performance indicators

• Calculate the cost of credit.
• Maintain contract compliance documentation.
• Demonstrate financial analysis applications.
• Monitor for breach of contract of non-performance related terms and conditions.
• Establish processes for timely reporting of required information.

The judge will ask

1. 1.Do you tell the bank before they notice? Explain.
2. 2.What is the fastest legitimate way to improve the ratio?

The setting

ROWANTREE CONTRACTING quoted $41,000 for a refit last year and finished it at a $3,600 loss. The same client has asked for a quote on an almost identical job, and nobody has established where the money actually went.

Your role

You are to assume the role of a finance associate at ROWANTREE CONTRACTING.

Your task

ROWANTREE CONTRACTING renovates commercial interiors. Last year it quoted $41,000 to refit the offices of a local law firm and completed the job at a total cost of $44,600, a loss of $3,600. Labour ran well over the estimate, and materials cost more than expected because some had to be reordered.

The same law firm has now asked for a quote to refit a second floor that is almost identical to the first. The client was delighted with the work and is likely to become a long-term customer, but the operations director does not want to lose money twice.

The operations director (judge) wants you to recommend the quote. Demonstrate the financial analysis that establishes where the loss came from, demonstrate the budgeting applications the new quote should rest on, describe the types of cost used in managerial accounting and which ones the last quote missed, describe the marginal analysis techniques that bear on taking the job at all, and explain how you would evaluate alternative revenue arrangements for work like this.

Performance indicators

• Demonstrate financial analysis applications.
• Demonstrate budgeting applications.
• Describe types of costs used in managerial accounting (e.g., direct cost, indirect cost, sunk cost, differential cost, etc.).
• Describe marginal analysis techniques and applications.
• Evaluate alternative revenue arrangements (e.g., cost-plus pricing, contingent fees).

The judge will ask

1. 1.What would you quote, and how would you justify the increase?
2. 2.Are there jobs you should decline? How would you decide?