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Chapter 18 - Financial Management
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critical thinking exercise 18-1 (continued)
1. Which of the budget items should be investigated?
2. What could be causing the difference?
3. What are some suggestions for improvement?
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notes on critical thinking exercise 18-1
Weinsten Manufacturing Company
Monthly Budgetary Control Worksheet
____________________________________________________________________________
Expense Budgeted Actual Difference
Category Amount Expenditure from Budget
____________________________________________________________________________
Labor $162,500 $195,000 +$32,500 +20.0%
Raw materials 172,500 151,500 −21,000 −12.2
Utilities 6,500 6,300 −200 −3.1
Maintenance 9,750 8,950 −800 −8.2
Other variable expenses 16,750 18,000 +1,250 +7.5
Fixed overhead expenses 25,000 25,000 0 0.0
Total Expenses $393,000 $404,750 +$11,750 +3.0%
___________________________________________________________________________________
1. Which of the budget items should be investigated?
If management looked only at the bottom line, this budget report would appear very positive. The
total expenditures are overbudget by only 3%. However, closer inspection of the individual budget items
shows that the actual labor cost is exceeding budgeted amount by 20%, a significant overage. This item
company needs to make certain that everyone in the organization is using the improved method.
2. What could be causing the difference?
The increased labor costs may be due to an increase in the number of workers or an increase in
the amount paid each worker. In other words, has the workforce increased or have individual worker earn-
3. What are some suggestions for improvement?
How can workers be used more efficiently? Are there ways to increase productivity? Is automa-
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Name: ___________________________
Date: ___________________________
critical thinking exercise 18-2
EXTENDING CREDIT
You are a partner in Creative Crafts, a small shop in your town’s historic district. The district at-
tracts many tourists from nearby states as well as regular customers from town. During your first year,
your monthly sales average was about $25,000.
You and your partners invested all your personal savings in the shop. Business has been better
than you forecasted, but you believe that sales and profits could have been even better. You sell on a
cash-only basis. Your motto has been, “In God we trust; all others pay cash.” You are wondering about
continuing this policy since one in four people who comes into the store leaves without buying when told
you don’t accept credit cards.
You and your partners are trying to decide how to go about offering credit to your customers, if
you should at all. None of you has experience in dealing with credit, but you each have your own ideas on
the matter.
1. Why would you not sell on credit in the first place?
2. Why do you think the lack of credit caused some shoppers not to buy from you?
3. What alternatives for offering credit can you and your partners suggest? Which alternative do you
recommend? Justify your answer.
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notes on critical thinking exercise 18-2
1. Why would you not sell on credit in the first place?
also the risk of credit card fraud, which could really cut into profits.
2. Why do you think the lack of credit caused some shoppers not to buy from you?
Buyers are used to buying things on credit. It is the American way. Some people don’t carry
3. What alternatives for offering credit can you and your partners suggest? Which alternative do
you recommend? Justify your answer.
You can accept any of the many credit cards available. It is probably best to accept several of the
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Name: ___________________________
Date: ___________________________
critical thinking exercise 18-3
FINDING THE COST OF BANK LOANS
The Bankrate.com website is devoted to tracking interest rates for bank loans and investment ve-
hicles such as CDs. Currently, the site does not specifically give rates and monthly payments for business
loans. The questions below refer to either mortgage rates or personal loan rates as a representative sample
of other types of loans. Go to www.bankrate.comvi and answer the following questions:
1. Follow the website links to the “interest rate roundup.” For each of the following types of loans,
record the average interest rate.
a. Mortgage loan (30-year fixed)
b. Auto loans
c. Credit cards
2. Use the “compare rates” tab to compare interest rates in your local area. The site does not specifi-
cally give rates for business loans. Use “personal loans” to see similar interest rates. List three
bank quotes by lender, rate, rate, and fees and conditions:
a.
b.
c.
3. Follow the website links to find the subpage giving the prime rate.
a. What is the prime rate this week?
b. What was the prime rate a month ago?
c. What was the prime rate a year ago?
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4. Use the rate calculator to calculate the monthly payment for 30- and 25-year loans. Again, busi-
ness loans are not specifically listed. Use the “mortgage payment calculator” to view sample loan
payments.
a. If your company wanted to get a 30-year loan for $165,000 at 7% interest, what would the
monthly payments be?
b. For a $165,000 loan at 7% interest over 15 years?
c. For a 15-year loan for $165,000 at 10% interest?
d. For a 15-year loan for $500,000 at 7% interest?
e. For a 30-year loan for $500,000 at 7% interest?
f. For a 30-year loan for $500,000 at 10% interest?
5. If your company was considering taking out a $165,000 bank loan:
a. Would you advise that it borrow the money this week or wait two months? Why?
b. Would you advise using a 15-year loan or a 30-year loan? Why?
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Name: ___________________________
Date: ___________________________
critical thinking exercise 18-4
FINANCING OPTIONS
You’ve owned a tool and die company for the last five years. Even during the recession, you have
been earning a net profit of 30% on your investment and have been able to pay yourself a reasonable sala-
ry. You are feeling so confident that you are considering expanding. You believe that your profit potential
can improve greatly if you could expand your product line with newer high-tech equipment. You estimate
that you will need $1 million for the expansion.
1. What are your financing alternatives?
2. Would you consider selling bonds if you had to pay 12% interest? Why or why not?
3. What are the major advantages of issuing bonds?
4. A venture capital firm has agreed to invest the money you need. In return, the firm will own 75%
of the business. You will be replaced as board chair and CEO, though you’ll retain the title of
company founder and president. The VC firm will hire a new CEO. Would you be willing to take
the money but lose control of your business? Why or why not?
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Name: ___________________________
Date: ___________________________
critical thinking exercise 18-5
OBTAINING FINANCING
Many factors influence how businesses are funded. Think about the factors involved in each of
the situations below. Solve the problems by applying the concepts in the text. Where can your firm find
financing?
1. Your company needs a new copy machine quickly. The high-volume, multifeatured model you
2. Your firm has a large payment that needs to be made by next week. The company doesn’t have
the cash available at this time. You already have large outstanding loans, so you don’t want to go
3. You own a dry cleaning store near an apartment complex. The store attracts a growing number of
young patrons who find it convenient to drop off their garments on the way back and forth to
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notes on critical thinking exercise 18-5
1. Your company needs a new copy machine quickly. The high-volume, multifeatured model you
want costs $3,000, but your small business doesn’t have that much cash on hand right now and
doesn’t want to borrow at this time.
You would finance the machine through the seller and pay for it over time. You and I face this
2. Your firm has a large payment that needs to be made by next week. The company doesn’t have the
cash available at this time. You already have large outstanding loans, so you don’t want to go to
the bank. Your stockholders don’t want you to sell more stock because it would dilute their con-
trol. You can’t sell bonds by next week. Your inventory is small but your accounts receivable are
large. Your firm sells everything on a 30-day open account, and most of your customers pay on
time.
You could sell the appropriate amount of accounts receivable to a factor. You would receive cash
3. You own a dry cleaning store near an apartment complex. The store attracts a growing number of
young patrons who find it convenient to drop off their garments on the way back and forth to
work. In fact, business is doing so well, your tiny store is starting to feel cramped. Your next-door
neighbor, a donut shop, has just offered to sell you his business and real estate for $100,000. You
believe that the location and expansion potential are great, but you don’t have the cash at the
moment.
This is the time to go to the bank and arrange a loan. Your business has had a steady income, and
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bonus
case
bonus case 18-1
THE REBUILDING DECISION
After Rob and Janet Colton finished veterinary school in the early 1990s, they spent several years
working for other veterinary clinics. By 1997, they felt it was time for them to start their own practice.
They considered several towns in the south-central United States, visiting local chambers of commerce
and studying each town’s demographics. They finally settled in Wardston, a small city in Arkansas.
Wardston is a regional center for the surrounding counties, located at the intersection of a two major
cross-state highways. The industry rule of thumb is that it takes a population of 1,500 pet owners to sup-
port one veterinarian. Wardston appeared to be an underserved area, and no other veterinarian in the area
was treating large animals. A big factor in their decision also was the fact that Janet’s parents and three
brothers lived in Wardston. “If we failed, at least we knew we could get a good homemade meal,” said
Rob.
They bought an abandoned veterinary clinic with a three-quarter-acre plot of land on the major
thoroughfare. The clinic, a sturdy 2,000-square-foot cinderblock structure, had been constructed in 1950
and needed major renovations. Rob and Janet were still paying off $45,000 in student loans and had no
savings to draw on. However, Janet’s parents agreed to deed them a house and tract of land to get started.
Now a property owner, Rob was able to borrow $165,000 from a local bank. Rob’s family took out a
home equity loan to help them complete the renovations. When the clinic opened in May of 1998, the
small concrete building had been transformed into the Wardston Animal Hospital, a 4,000-square-foot
veterinary clinic, complete with treatment room, surgery, kennels, and offices.
As they had anticipated, the area badly needed another vet clinic, and business began to boom.
They were able to pay off the loan from Rob’s parents and make improvements to the clinic’s parking
area. By 2000, the Wardston Animal Hospital had grown large enough to need another vet, and Dr.
Wayne Harper joined the practice. He soon became an equal partner with Rob and Janet.
The clinic building, while adequate for a small practice, was still half a century old with an in-
convenient traffic flow. The building was designed around a single center hallway going from north to
south. Clients going to exam rooms, animals being weighed, vets heading to treatment rooms, staff going
to the break room all had to go down same central hallway. The partners always knew that they eventual-
ly wanted to build a new “ideal” clinic. Janet kept a notebook full of ideas and possible floor plans that
they dubbed their “five-year plan.”
Then in April 2005 a line of severe thunderstorms passed through the city. It was a Wednesday
afternoon, the clinic’s early closure day, and the staff—with the exception of the office manager—had left
the building. At 3:00 p.m., a tornado dropped out of the squall line and plowed through the northern part
of the city, tearing the roof off the Wardston clinic and wrapping it around several nearby pine trees. For
three hours, a steady downpour flooded the damaged building, leaving six inches of water on the treat-
ment room floor. Worse still, the rainwater soaked into the insulation in the walls, the sheetrock on the
walls, and the ceiling tiles. Volunteers, staff, even other veterinarians flocked to the clinic to help ferry
the boarded animals to temporary homes and clean up the shredded interior. None of the animals were
hurt, and no one was injured, although the clinic office manager was in shock for a few days.
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Within two weeks, the partners were back in business, operating out of a doublewide trailer set up
on the north side of the parking lot. They hired a cleanup service to start the long process of recovery. The
cleaning crew soon realized the extent of the damage and told the partners that the cleanup would be very
costly. They also warned that the soggy walls and ceiling would probably have mildew problems in the
future no matter how thoroughly the building was cleaned.
Rob, Janet, and Wayne had to make a decision about how to proceed. As Rob saw it, there were
four options to consider:
Plan A: Restore the building to its existing condition before the tornado. The $150,000 insurance
settlement would just cover the renovation costs. This option would be the least costly,
but they would still have the same 55-year-old building with the same bad traffic flow.
Plan B: Gut the old building and create the “ideal” building within the old shell, total cost ap-
proximately $400,000.
Plan C: Level the old building and rebuild on the site. This option was almost immediately elim-
inated for several reasons. First, the cost just to demolish the building would be $50,000.
Also, the clinic staff was using undamaged parts of the old building for kennel space and
storage. The doublewide trailer alone would be inadequate to support the practice if the
old building were immediately demolished.
Plan D: Build the clinic of their dreams on land the partners owned adjacent to the clinic. The
clinic would take almost a year to complete at a cost of $650,000.
discussion questions for bonus case 18-1
1. Are there other options that have not been considered? Explain.
2. How should the renovations or rebuilding be financed—debt or equity financing? Why?
3. What would you advise the veterinary partners to do? Why?
4. If the Wardston area suffered a major economic blow, what risks would the partnership face?
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notes on discussion questions for bonus case 18-1
1. Are there other options that have not been considered? Explain.
2. How should the renovations or rebuilding be financed—debt or equity financing? Why?
Debt financing involves borrowing money, creating a legal obligation. If the revenue created does
3. What would you advise the veterinary partners to do? Why?
This case is based on an actual incident. The partners decided to go with plan D, financing the
new clinic entirely with a bank loan. According to an industry study, building a new veterinary facility
4. If the Wardston area suffered a major economic blow, what risks would the partnership face?
Borrowing funds to build the new clinic creates a legal obligation to repay the loan. If a major
economic blow occurred, the partners would run the risk that revenues generated will not cover the
monthly loan payment.
The outcome: The partners moved into the new clinic in 2006.
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endnotes
i Source: Dan Macsai, “A Source of Their Own,” Fast Company, October 2010.
ii Source: Michael McDonald, “Paying the Price for Following Yale,” Bloomberg Businessweek, September 30,
2010.
iii Lecture enhancer written by Michael McHugh, 2013.
iv Lecture enhancer written by Michael McHugh, 2012.
v Source: Elizabeth Hester and Linda Shen, “A Long Shadow over Small Banks,” Bloomberg Businessweek, De-
cember 21, 2009.
vi The Internet is a dynamic, changing information source. Web links noted of this manual were checked at the time
of publication, but content may change over time. Please review the website before recommending it to your stu-
dents.
