ready a business report for Burnaby Butter, providing specific, detailed recommendations. Discuss all relevant issues, including pros and cons of each course of action. Outline any questions/inquiries which should be directed to Fred and why the information is important to certain decisions.
Fred McLaurin, the founder and CEO of Burnaby Butter, finds it difficult to believe that something that started as a tiny dairy farm with two cows fifty years ago is now a massive multi-country business with hundreds of products. It's true, and yet the firm's struggles are very real.
Only a few years ago, the business was humming along with no real obstacles in sight. However, that rosy picture has clouded quickly, and Burnaby Butter faces some specific challenges relating to its new cheese department. And so, Fred has sought some help from a talented group of MBA students.
Perhaps the first complications with Burnaby Butter began after a major acquisition two years ago. The firm held a large sum of cash and was looking for ways to invest it. DeliCheesious, a local producer of high-end cheeses, had run into some short-term financing challenges and Burnaby Butter was quick to step in.
While Burnaby Butter didn't have the cash to purchase DeliCheesious fully, it was still able to put up almost half of the $2.2 million dollars easily by liquidating short-term investments in marketable securities. The other $1.3 million was raised through a $400,000 common share issue and $900,000 bond sale. The bonds, which sold at par, pay annual coupons of 6.10%.
Fred notes that DeliCheesious held $1 million plus of debt prior to the takeover and Burnaby Butter now has about $2.3 million (it held no long-term debt prior to the DeliCheesious takeover). For reference, the firm's assets total $7.8 million. Fred believes he has a good understanding of debt and equity, but he still wants some insight on the differences. He is specifically interested in the risks a firm with a lot of debt may face.
After the takeover, aligning existing systems and people had been a significant challenge. Out of frustration, some key employees had left the organization (from both the Burnaby Butter and DeliCheesious sides). Things have gotten a bit better as processes and roles became clearer over time, but there are still conflicts and frustrations. Fred believes the company has not been proactive enough with human resource management functions and is looking for some advice on how to improve in this area.
Due to a downturn in the American economy, Burnaby Butter's US cheese sales have dipped 30% from its peak average of $34,000 monthly (achieved over a 4-month stretch last year). The company typically earns a gross margin of 41% on American sales.
Local grocers have also felt an economic pinch recently and have pushed for lower prices (sales volume has only dropped 5% to date). At peak volume, sales are $102,000 monthly. Typically, the gross margin on sales to large local grocers is 37%.
The fixed costs of the cheese department currently total $570,000 annually. Fred notes that one of the major factories also produces whipped butter. Based on square footage (used for allocating fixed costs), 37% of the factory is used for whipped butter manufacturing. As the shared fixed costs for the factory total $19,000 per month and whipped butter generated an average monthly gross margin of $6,400 over the past three months, Fred is wondering if closing the whipped butter department is a good idea. In addition to insight and recommendations on the overall financial performance of the cheese department, Fred wants a recommendation on closing the whipped butter department, with all relevant factors discussed in detail.
Fred is aware that there is a risk with selling primarily to large grocery store chains, but he wants more insight on the matter. He is looking for new local grocers who will be willing to pay more for the cheese products. The ideal customer might be a smaller mom and pop shops who sell premium cheeses at higher prices. Fred believes it may be possible to establish partnerships with five small stores, with $25,000 in annual sales on average. He believes it is possible to make a 55% margin on specialty cheeses sold in this manner.
Fred isn't sure how the company would maintain records for orders of specific cheeses from specific stores. For example, if a customer requests twenty pounds of aged white cheddar with infused jalapeno and bacon, what would be the process of tracking costs and maintaining records for the order as it is manufactured? Fred wants specific examples of journal entries in addition to a detailed description of the cost-tracking process.
One final change Fred is considering is adding wines to the product mix. Since cheese and wine go hand-in-hand, there may be an opportunity to package things together for liquor stores, perhaps even American grocers who are permitted to sell alcoholic products. Fred is looking for a second opinion on this strategy.
If Burnaby Butter were to close its whipped butter department, the freed factory space could be a natural fit for wine production. Fred has heard of incremental analysis and opportunity costs, but he wants specific insight on this situation.
Fred has started budgeting out a potential wine department. He believes that, with $15,000 of fixed marketing supplemented with $2,000 a month in variable marketing expenditures, $6,000 worth of wines can be sold each month in the first year (this number will grow at a 20% rate for five years, then remain consistent). Making the wines wouldn't be too pricey- it would cost about $1,500 per month in ingredients, bottles, and labels.
However, the major cost would be $30,000 in new equipment. Fred isn't too concerned as he feels that the machinery will last fourteen years and can be sold for parts/scrap metal at that point for $2,000. He is wondering about proper accounting for the purchase and use of this equipment.
Additionally, Fred wants to know how he would go about evaluating performance of a new wines department. As he has an idea of revenues and costs, he can obviously compare actual results to what is budgeted. However, he wants to do more detailed analyses, as a cost accountant would. He is asking for your guidance and recommendations in evaluating financial results and implementing the right changes.
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