Evaluate how finance choices connect capital, investment, profit and cash flow in IB Business Management HL decisions.
Hums Athletics (HA)
Hums Athletics (HA) manufactures running shorts, sweat shirts, and sports bras. Operating only in the secondary sector, HA has a head office and three manufacturing facilities, one for each product. These are located in its home country in Europe. Labour costs are high. The quality of labour is excellent.
HA produces goods under its own HA brand, which it sells to wholesalers. HA also manufactures for other sportswear companies. HA puts the other sportswear companies' logos on the running shorts, sweat shirts, and sports bras. Sales to other sportswear companies are an important revenue stream for H A.
HA has many levels of hierarchy. Managers at each level have a narrow span of control, and the company is organized by product. HA's management believe that these features of organizational structure ensure product quality, which they view as essential for brand loyalty.
The sportswear manufacturing industry is becoming more competitive. Some foreign manufacturers have begun using penetration pricing to gain market share. For three years, none of HA's revenue streams have increased, despite increasing unit sales. HA's gross and net profit margins have declined. However, its sales have increased for the last three years. HA has had to raise additional external finance to increase production.
In response to the increasing competition, H A is considering two options:
- Option 1: Outsourcing some of its manufacturing overseas.
- Option 2: Entering the rapidly growing online business-to-consumer (B2C) retail market.
Market research has shown that consumers increasingly expect to buy online.
Explain:
why HA had to raise additional external finance to increase production.
Candidates may answer this question in one of three ways:
1. One way puts emphasis on the word external in the question. If a candidate chose this emphasis, they need to say something like "Because foreign competitors have used penetration pricing to gain market share, HA has had to lower its prices, which is why gross and net profit margins have declined. As a result, HA has not been able to generate sufficient internal finance to support increased production and has had to turn to external finance."
Both of the other ways candidates can answer this question emphasize the increase in production:
2. Candidates may believe that HA needs more working capital to support increased trading activity. HA has had increased unit sales volume, which means that it has been manufacturing and selling more product, even if at lower margins. For most companies, increased trading means increased inventory and accounts receivable. The asset accounts must be financed. Increased accounts payable will fund some of that increased trading activity, but probably not all of it. With margins declining, HA probably cannot fund this need internally and, thus, has had to turn to external sources of finance.
3. Candidates may believe that HA needs property, plant, and equipment to support increased production. However, because of contracting margins, in the past few years, HA probably has generated insufficient funds internally to finance long-term assets. Thus, they have obtained finance externally.
Award [1] for some understanding of one of the three issues above and an additional [1] for application to the stimulus. Up to a maximum of [2].
N.B. In all three cases, the key is for candidates to link contracting margins or lower prices (which is why HA's margins are lower) to external finance (rather than internal) or to increased production (increased working capital requirements or more property, plant, and equipment).
Office Supplies (OS)
Office Supplies (OS) is a family-owned private limited company that, for 40 years, has operated three retail office supply stores in a small city. OS offers a wide range of office products (such as computer paper and stationery) and office machinery (such as computers and printers). When each store opened, OS purchased the buildings using long-term loan capital. OS's objective is to have enough profit to finance the company's working capital and pay annual dividends.
OS has no clear marketing strategy. Traditionally, OS competed with several other office supply stores operating in the same city. The market was not competitive, however, and most customers went to the nearest office supply store. OS's prices were comparable to those of other retail office supply stores, and the company did little promotion.
Nationally, the retail office supply store industry is declining. Many retail office supply stores have had to close, and new competitors have entered the market, many of which benefit from some or all of the following:
- Specialization in particular office products
- Economies of scale leading to more competitive prices
- Greater convenience, including e-commerce with door-to-door delivery
Like other physical retail stores, OS has seen its sales decline. Gross and net profit margins have fallen. Last year, to ensure enough funds for capital expenditure and revenue expenditure, OS's board of directors chose not to pay dividends. OS also anticipates the need for additional finance next year. OS's board is considering changes to the company's marketing mix in response to new competitors.
With reference to OS , explain the difference between capital expenditure and revenue expenditure.
With reference to O S, explain the difference between capital expenditure and revenue expenditure.
Capital expenditure refers to any expenditure for assets with a life of more than one year. The stimulus refers to three instances of capital expenditure in the company's history: each time O S purchased a building location.
Revenue expenditure refers to those expenses that will be accounted for fully in the year in which the expense occurs. In the case of O S, revenue expenditures mention in the case are expenditures for inventory.
Mark as [2 + 2].
Award [1] for an explanation of capital expenditure and an additional [1] for an explanation with application to the stimulus.
Award [1] for an explanation of revenue expenditure and an additional [1] for an explanation with application to the stimulus.