?INTRODUCTION Carmen Diaz, with a ten thousand dollar loan from two of her cousins, and one thousand dollars that she invested in equity, was able to open a specialty store called Ribbons an’ Bows, Inc, which was located in Coconut Grove, Miami, Florida. Four months after opening the business, Carmen’s relatives requested a financial report, which was part of the original business arrangement. Within a short time, Carmen had expanded the business, purchased small equipment, paid wages to a part-time employee, and by all outward indicators, had been running a flourishing business.
As Carmen gathered the necessary information to prepare financial statements, she started to scrutinize the transactions and was somewhat perplexed. Carmen realized that numbers were not adding up as she had anticipated. Additionally, it became questionable whether the business was operating successfully, at least when accounting principles were appropriately applied. Statement of the Problem It was fortuitous for Carmen Diaz to have family who were supportive of her small business endeavor, thereby providing start-up funds and legal advice.
Carmen’s endeavor can be recognized as a “microbusiness” operation; “microcredit”, microenterprise” and “microfinance” are terms that have been associated with microbusinesses (Datar, 2009). Clearly, Carmen would have benefitted from some professional entrepreneurial guidance that is widely available at no cost in the United States. Indeed, her uncle practiced law, but it was not clear if business law (finance/ accounting) was within his forte.
It was noticeable that Carmen was unskilled in accounting principles; she had apparently prepared a business plan but was not adept in all accounting proficiencies, for example, budgeting and long term planning. There was no evidence to indicate that Carmen had planned for the replacement of essential equipment, such as the computer and essential accounting management software, beyond the basic business tracking tools. She was not in tuned with important details of running a business.
Altogether, Carmen was operating under a misapprehension about managing a business; one significant issue was that she was not paying herself a salary, and she had obviously not planned for such necessary compensation. In addition, Carmen had not make provisions for repayment of the loan from her family members. The major issue however, was that Carmen had spent more cash on the sewing machine, rent, employee wages and inventory, when compared with starting cash and the revenue that the business had generated (Appendix I: Income Statement).
Carmen Diaz had encountered what has been described as “one of the most severe problems in microenterprise cost management” and that is the management of inventory (Datar, 2009). DESCRIPTION OF ALTERNATIVE SOLUTIONS According to Datar (2009), “access to financial capital isn’t enough for many of the most vulnerable clients. Microbusiness owners often lack the knowledge and skills necessary to make effective use of financial capital. While it was necessary for Carmen to pay rent, wages and purchase small equipment to develop her business, she needed to monitor cash flow data (Appendix II: Cash Flow), thereby paying better attention to details about inventory. Inventory sitting on shelves or stored in boxes is essential capital that was not performing for the business. 1Carmen should seek out an accounting or business class at a local small business center, perhaps a community college, or engage the help of someone who could provide assistance with basic accounting skills.
Having access to capital was promising but Carmen, by evidence, was somewhat vulnerable, lacking basic knowledge, skills and abilities to adequately utilize and “make effective use of financial capital” (Datar, 2009). As noted in the literature, “Five management accounting tools have the greatest potential for microbusinesses: cost management, throughput enhancement, budgeting, risk management, and identifying opportunities” (Datar, 2009). 2An alternative to the operating procedure Ms. Diaz has used is to order lesser inventory, more frequently. This would keep more cash in the business, which would allow Ms.
Diaz to take some salary for herself and to set up a payment schedule for the business loan from her cousins. As noted by Sergeant (2009), it is best to keep minimal inventory on hand. Excessive inventory, whether materials needed to perform services or office supplies, ties up cash. More frequent orders would allow Ms. Diaz to order more accurately based on actual consumption rather than estimating needs over the longer term, using the principles of Just- In- Time (JIT) ordering. This alternative is dependent on shipping costs and order turn-around times as well as customer order lead times. 3Another alternative is for Ms.
Diaz to keep only samples in her store. Customers pay a 50 % deposit when they order the product and Ms. Diaz then orders the materials for that specific order. When the materials arrive, Ms. Diaz fabricates the product and subsequently, delivery and final payment take place. Again, she will use JIT principles to order only the materials for work that has been ordered. In the situation where particular products are standard or quick turnover items, an exception may be made to the no inventory rule. Again, the concept is that less cash is tied up in inventory and is available for a salary for Ms. Diaz and her loan repayment.
SELECTION OF THE BEST SOLUTION The best solution is dependent on the mix of Ms. Diaz’s business. If the store experiences most of its sales in ready-made items or off the shelf ribbon products, the solution of minimal inventory purchased frequently to support those sales is appropriate. If, on the other hand, most of the sales are comprised of custom orders for wedding decorations and other similar products, the procedure of requiring a 50% deposit at the time of order, ordering materials for the specific job and collecting the outstanding balance at the time the customer picks up the finished product would be appropriate.
If the store does both types of business in fairly equal proportions, there is no reason why a hybrid of both methods could not be used. At such an early stage in business, it is important for Carmen to balance cash flow and inventory with sales/ income figures and synchronize with the turnover (ultimate decision to purchase) of inventory. Four months after opening for business, Carmen must monitor walk-in-business versus special-orders, scrutinize accounts for profitability, and manage inventory accordingly.
The incorporation of standard/ routine management accounting principles and techniques would significantly enhance the day-to-day business decisions. Having access to business software is an excellent start but is not an adequate replacement for the expertise of education and knowledge that could be found at a small business center, or obtained in a class at a community center or local college. Conclusion and Summary Carmen Diaz’s new business appears to be profitable as of June 30, 2006. The financial statements are included as Appendices I, II, and III.
Cash was depleted by the purchase of materials, explaining the difference in the bank account on June 30th. The business could not be considered successful in that there has been no movement toward repaying the $10,000 loan, and no salary was paid to Ms. Diaz. However, if the on-hand materials inventory is reduced and the suggested steps are taken, it is likely that the business can be successful and provide Ms. Diaz with a salary and the ability to repay the loan. Carmen started on her venture with $11,000; within four months, the balance sheet (Appendix III: Balance Sheet) shows that assets totaled $12,770.
It might appear that the business had earned $1,770. On the other hand, Carmen had earned $1300 dollars per month as a cashier. According to the numbers, had Carmen kept her job, she would have earned $5,200 over four months. When compared with $1,770 that the business earned, Carmen would have been more profitable than the business entity by $3,430. Appendix I Ribbons and Bows Income Statement Q1, 2006 INCOME STATEMENT Sales Revenue $ 7,720. 00 COGS $ 2,100. 00 GROSS MARGIN $ 5,620. 00 Supplies $ (80. 00) Rent $ (1,800. 00) Advertising (150. 00) Wages $ (1,600. 00) Depreciation on Sewing Machine and Computer $ (310. 00) Interest on Cousin’s loan $ (200. 00) NIBT $ 1,480. 00 TAXES $ – REVENUE AFTER TAXES $ 1,480. 00 Appendix II CASH FLOWS 3,390. 00 Starting Cash $ 4,000. 00 Sales (Q1) $ 7,400. 00 Sewing Machine (bought after April 1st) $ (1,800. 00) Rent (April-June) $ (1,800. 00) Inventory (replenishment after April 1st) $ (2,900. 00) Employee Wages $ (1,510. 00) Appendix III Ribbons and Bows Balance Sheet June 30th, 2006
ASSETS 12,770. 00 LIABILITIES 12,770. 00 Current Assets 9,030. 00 Current Liabilities 10,290. 00 Cash in Bank $ 3,390. 00 A/P $ 90. 00 A/R $ 320. 00 Cousin’s Loan $ 10,000. 00 Inventory $ 4,100. 00 interest payable $ 200. 00 Prepaid Rent $ 1,200. 00 Supplies $ 20. 00 Fixed Assets 3,740. 00 Long-term Liabilities 0. 00 Cash Register $ 250. 00 Sewing Machine $ 1,740. 00 Computer $ 1,750. 00 Shareholder’s Equity 2,480. 00 Earnings $ 1,480. 00 Carmen’s Personal Investment 1,000. 00 References Anthony, R. N. , Hawkins, D. F. , , K. A. Accounting: Text & Cases 12th Edition, New York, NY; McGraw-Hill Irwin Publishing Company Datar, S. , Epstein, M. , , K.. (2009). MANAGEMENT ACCOUNTING AND CONTROL: Lessons for and from the World’s Tiniest Businesses. Strategic Finance, 91(5), 27-34. Retrieved August 15, 2010, from ABI/INFORM Global. Sergeant, D. J. , (2009, October). Painless Cost Cutting. Alaska Business Monthly, 25(10), 42. Retrieved August 15, 2010, from ABI/INFORM Dateline.