Located in downtown Cologne Haefren Baum is a high end retailer, which recently expanded its operations by opening three retail outlet stores in nearby Rhineland suburban areas. The company carries Wiegandt’s high-end furniture whose furniture is heavily advertised and carries a much recognized name. Due to the economic conditions and new competitors entering the market Haefren Baum had to decrease its prices in order to maintain sales volume.
The new competition and economic conditions caused sales to decline by -19% and -5% between 1993 and 1995 which portrays cyclical demand, rather than seasonal since different seasons have insignificant sales on furniture sales. The German recession has recently been improving, however this has not helped the German furniture market, and the outlook for the near future does not look very promising as the company will need to adapt to the growing competition. Operations analysis:
Although the sales of the company have declined significantly their cost of goods sold has remained high, especially between 1994 and 1995 the company had a decline in sales and an increase in cost of goods sold. This is evidence the company is having problems passing costs to its consumers. The company is not very asset intensive and its decrease in total asset turnover can be due to their decrease in sales, however their rather low total asset turnover which is also decreasing from 2. 1 to 1. 5 shows their assets are not being used very efficiently.
As a result of their sales decrease their Fixed Asset turnover also decreased from 7. 0 to 5. 4. The decrease in sales and increase in competition also means more shelf time for their inventory which has increased from 103 to 129, which makes Haefren Baum’s price cutting strategy questionable. The company is already experiencing a loss of revenue due to their lower prices; however this is not stimulating the number of different sales because the inventory is sitting in the shelves by an extra 26 days.
Meanwhile in 1993 two partners sold their shares in the company to the other two partners. Significant insider selling is typically a sign of potential trouble ahead. Financial analysis: The company’s cash has been decreasing over the 2 years however its current and quick ratio has gone up, from 2. 26 to 2. 53 and 1. 06 to 1. 26 respectively, due to its increase in accounts receivable and inventory, the company may need to minimize amount of sales based on credit or require however down payment on its installment sales.
Haefren must also be offering more lenient credit terms to its customers since its average collection period has also gone up significantly, this could be correlated to the lax credit terms Wiegandt currently offers Haefren. Haefren’s return on equity is also declining, using the DuPont method, as a result of our low net profit margin and our decreasing asset turnover (as a result of lower sales and higher assets). The company currently finances itself with bank loans which have decreased while cash is decreasing, the increase in debt may be growing to an unsustainable rate as our debt to equity ratio has almost doubled from 5. 4 to 9. 37 between 1993 and 1994.
This poses a major a problem for the corporation as cash and sales are decreasing and loans are increasing, the company may need to liquidate the warehouses. The warehouses could be a major factor in another problem: low profitability. Low operating profit margins of 1. 6% suggests high operating expenses. The company may need to cut operating expenses by reducing by cutting its work force, liquidating one or more of its workforce would provide cash necessary and reduce operating expenses.
If the company continues to with its poor performance its ability to take more loans for cash to continue operations may not be possible. The company’s ability to service its debt as the times interest earned continues to decrease from 2. 5 to 1. 5. As previously mentioned the two of the four shareholders were bought out using the company’s equity. The problem with this transaction is the lack of control for the loan terms, in other words, the money may never be paid back yet it still affects the financial statements the company provides.
The company has taken measures decreasing cash outflow such as suspending dividend payment, however with such poor economic conditions the company currently faces it may be necessary for the company to sell a part of these shares that were bought back. Summary: As Wiegandt keeps close tabs on its customers in order to oversee Haefren Baum’s ability to pay its debt, the line of credit and its terms should be reevaluated by Wiegandt due to Haefren Baum’s extremely poor and continuously deteriorating economic condition. Wiegandt may have to take a hit by providing tighter and stricter credit terms even if it results in lower sales.
As of now Wiegandt has relaxed its credit terms to maintain its own sales volume but this could eventually mean disaster for Wiegandt if Haefren Baum’s condition doesn’t improve and the company fails. Regardless of its critical condition it is also important to acknowledge Haefren Baum’s long time and experience in the industry has so far been successful. Wiegandt must be careful renegotiating credit terms and covenants however it’s important to note that the companies have a long standing relationship for over 20 years, and Haefren Baum’s success is in Wiegandt’s best interest.