Sparkling Financials

EL SEGUNDO, CAOne afternoon 23-year-old Melody Kulp was playing outside with the young cousin of a friend when she placed yard-picked flowers in the girls hair and thought how much prettier they looked than headbands or hair clips. The next day, with some silk flowers and Velcro she purchased, Kulp made similar hair accessories, called then sparkles, and began wearing them.

When a friend wore one to work at Fred Segals, the shops buyer asked to meet with Kulp about putting together a product line. Kulp quickly organized a businessdubbed Mellies (Mellies.com)and then converted a 10 X 10 room in her house into a minifactory. The rest is the stuff of Hollywood movies.

After only three years, Mellies is a $40 million accessories company. With her 25-year-old partner David Reinstein, Melody Kulp now manages 15 employees and plans to launch a cosmetic line.

The young entrepreneurs learned a lot in a hurry. She had to meet creditors and bankers, set up a reliable accounting system, draw up financial statements, and analyze and interpret financial data. It was at times overwhelming, says Kulp, but the key to stay focused and keep doing what you believe in.

Kulp knows how important a timely and reliable accounting system is for Mellies continued success. Historical and projected financial statements have enabled her company to obtain the necessary financing to propel it to new heights.

This chapter focuses on the accounting system underlying financial statements. Says Kulp, Weve got the system set up where we can look ahead, rather than live day to day. That look ahead reveals sparkling financials.

Melody Kulp of Mellies is aware of Robin Drucker, who operates a collection agency. For a 50% commission, Drucker collects on accounts receivables for her clients customers who are delinquent in their payments. For example, assume that a company turns over a $100 accounts receivable to drucker. If she can collect the $100 from the customer, Drucker keeps $50 and remits the other $50 to her client. Kulp is negotiating with Drucker to offer her a discount from the normal 50% commission that Drucker charges. Kulp has proposed a fee of 40% on amounts collected by Drucker, and leaving 60% of the receivable for Mellies. Currently, Mellies uses a different collection agency that charges a 50% commission.

Required

1. Why would a company hire a collection agency to purse its accounts receivable?
2. Assume that Mellies profit margin is 8%. What is mellies net income on sales of $40 million?
3. Assume that Mellies currently pays 2% of its $40 million sales to collection agencies. What is the current amount of commission expenses Mellies pays to collect delinquent accounts?
4. If Mellies is able to successfully negotiate with the Drucker agency for the reduced collection fee, how will its commission expenses for collecting account change?
5. How would Mellies profit margin change if it hires the Drucker collection agency at a 40% commission?