Reference no: EM131596

Background Information

Chris White was a forestry technician who had been searching for several years for a business opportunity to combine with his forestry career. While he had no business experience, he always believed that he had what it took to be an entrepreneur. His friend, John Noel, was also very interested in supplementing his salary as a sales representative for a national shoe company. Both Chris and John considered themselves to be hard workers and comfortable with taking on calculated risks.

Twin Peaks Building Supplies was a family-owned business that had existed in the same location, in a declining business area of downtown Lewisporte, for many years. In its 25 years of operation, it had built up a considerable amount of goodwill. The owners wanted to sell in order to convert their holdings to cash and retire. An examination of the records of the business showed a small drop in net profit in each of the last two years. When questioned about this drop, the owners replied, "we can attribute this to our lack of commitment to the business during these years."

The new owners hired Peter Jones as the new manager and retrained the five other existing employees. Jones had been an assistant manager at Pioneer Building Supplies in Catalina. Since both partners had full-time employment, all aspects of management and day-to-day operations were delegated to Jones. Several times a month, Chris and John would run into the store and ask him how things were going. Every two months they would review monthly sales statements prepared by the part-time bookkeeper, Elsie White.

The pricing objective of Twin Peaks Building Supplies was to obtain satisfactory profits. This was to be achieved by setting prices to cover costs plus a "reasonable" profit. However, on numerous occasions, profit margins had to be reduced to keep prices at the same level as the competition's. The company's pricing policies allowed quantity discounts to buyers who purchased large volumes and cash discounts to customers who paid their invoices within fifteen days of billing.

The first six months of operation were profitable, despite the fact that there was a large drop in housing starts, a downturn in the construction industry, and a large increase in interest rates, resulting in increased borrowing costs. With the goal of increasing these profits, Chris and John decided to expand their business. The company borrowed additional funds and added a 20,000 square meter extension to the existing building. With this new extension, the company added a new line of furniture and appliances. As a result of this expansion, sales increased a little, but costs also rose because of the need to hire extra employees, both full time and part time.

However, the next three months were a different story. The introduction of the GST appeared to turn buyers away. The so-called "recession" began and consumers were hesitant to spend in hard times. Believing that lower prices and major sales would entice the public to spend, Twin Peaks Building Supplies held several "blow-out" sales. These sales were unsuccessful in generating any additional revenues. The downturn in the fishing industry, public sector lay offs and the general increase in unemployment added to the already unhealthy economic situation. And as John exclaimed "the last thing we needed was more competition with the opening of a new Mr. Build-All Center."

The steady decline in sales during the winter months began to worry Chris and John. Cash outlays were greater than expected and a cash shortage in the near future was looming. The company's operating line of credit that was originally established at $150,000 to assist in the purchasing of inventory was rapidly dwindling.

The Problem

On April 29, 2009, Chris received a telephone call from the company's bank manager, Marie Smith, "Twin Peaks' account is overdrawn and your manager Peter Jones has informed me that he has written checks totaling $8,000 to be placed in the mail today." Smith added, "it's paramount that I meet with you and John Noel as soon as possible to discuss your solutions to this problem."

Realizing that the bank would need to know how much revenue the business was generating and what expenses were being incurred, Chris and John immediately requested their accountant to prepare an income statement for the nine months ended April 30, 2009.

After receiving the income statement from their accountant, Chris and John quickly realized that something had to be done. "We must take a day off and assess where we are going," said Chris. "We've got to devise several alternative solutions before we meet with the bank next Monday."