Question

I own a hardware store. Sales this quarter are 50 percent higher than the same quarter a year ago because I allow customers to defer payment for one year without paying interest when they purchase a home electric generation or a fancy barbecue grill. As the hardware store owner, I think this is a good thing because higher sales mean higher profits. Please indicate if the increased sales is necessarily a good thing. Assume you have access to the company’s financials. Explain how you would use the company’s financial evaluate the company’s situation.

Answer 1

Higher sales may not necessarily mean higher profits. The operating costs associated with the higher sales need to be taken into account. It is possible that the operating costs are much higher and hence the profit will decline. Moreover allowing the customers to defer the payment for one year without any interest implies a very high opportunity cost of the funds. If the payment has been received the same could have been used as working capital in the business or invested for some amount of Return which is lost due to the deferral

Also due to the different payment there is a risk of bad debts which again lowers the profits rather than increasing them. Therefore higher sales may not necessarily mean a higher profit and the entire cost structure and impact of the different payments have to be taken into account before coming to a conclusion.