research paper

Darlarna Furniture

Fredrik Blix immigrated to Canada six years ago after meeting his wife Cathy, a Canadian, on a Mediterranean holiday. Mr. Blix was born in Darlarna province in Sweden, but moved to Stockholm after completing the Canadian equivalent of high school called gymnasium. While in Stockholm, Fredrik earned a diploma in commercial design and apprenticed with Arlanda, a furniture manufacturer that supplies the IKEA chain with innovative new products.

After working for Arlanda for eight years and acquiring a reputation as a very inventive young designer, Mr. Blix moved to Winnipeg, Manitoba, his new wife’s home town, and secured a design job with Palliser, Canada’s largest furniture manufacturer. Initially, Mr. Blix enjoyed his job at Palliser and became involved as a hockey coach in the local community and was an avid curler, but after a few years he became frustrated at work. Although he had a very friendly relationship with his colleagues and received a number of raises and promotions, he longed to return to designing furniture with more of a Swedish influence as he had at Arlanda back in Sweden.

A New Venture

In early 2015, Mr. Blix approached the Crocus Fund, a labour-sponsored venture capital firm located in Winnipeg about financing a new “boutique” furniture manufacturer. His new company, Darlarna, would design and manufacture high-end, Swedish-styled furniture for distribution in Canadian initially but he hoped eventually to “crack” the U.S. market. Instead of distributing his product through the large chains such as The Brick, Dufresne, or Leon’s or department stores such as The Bay, Mr. Blix hoped to sell his products through high-end, independently-owned furniture retailers who provide interior design services along with an extensive selection of home furnishings.

After preparing a detailed business plan and raising $180,000 in financing from friends and family in the Mennonite community in Winnipeg and Steinbach, the Crocus Fund agreed to make a matching investment for a 40 percent share in Darlarna Furniture. By October, 2015, Mr. Blix had purchased a small factory and the necessary manufacturing equipment and had recruited skilled furniture makers who he knew from working at Palliser. Darlarna began shipping product in January, 2016 and quickly built up sales in its target market with its unique designs.

Expansion

After a very successful 2016, Mr. Blix found that his current factory couldn’t keep up with demand so he began purchasing additional manufacturing equipment. Instead of buying used equipment for which there was an active market in Winnipeg with Palliser’s large manufacturing operations, Fredrik felt new equipment might help impress customers when they came for factory visits. By late 2008, the factory was becoming too small due to growing sales and large inventories of raw materials and work in process, so a search was begun for new facilities in Winnipeg.

In 2018, the Winnipeg economy was “booming” and it was very difficult to find skilled furniture makers given opportunities in the building trades and the Tar Sands oil developments in northern Alberta. As a result, Darlarna was forced to give its workers a significant increase in wages and benefits to retain them. Also, key production inputs such as fine leathers and foam cushioning materials rose dramatically in price due to a rapid expansion of the Chinese furniture industry.

By 2018, Mr. Blix felt that Darlarna was ready to expand into the U.S. market so he began taking out ads in a number of American design magazines to test the market and prepared an expensive new catalogue displaying its many products. With the prospect of increased orders from the U.S., the company expanded its order processing, shipping/receiving and accounting functions despite industry reports of a possible deep recession in the U.S. in the coming year due to excesses in the mortgage, consumer, and corporate lending markets.

Financial Statements

The financial statements for Darlarna’s first three years of operation are:

Income Statement
	2016	2017	2018
Net sales	1,304,000	1,507,000	1,791,000
Cost of sales	781,000	952,000	1,210,000
Gross profit	523,000	555,000	581,000
Marketing	135,400	149,670	220,245
General administration	151,000	151,200	219,560
Depreciation	35,695	49,805	60,345
EBIT	200,905	204,325	80,850
Interest	45,000	57,000	70,000
EBT	155,905	147,325	10,850
Income tax	48,331	45,671	3,364
Net income	107,574	101,654	7,487
Balance Sheet
	2016	2017	2018
Cash	55,000	43,500	11,000
Accounts receivable	220,000	261,000	376,337
Inventories	388,124	437,139	545,000
Prepaid insurance	25,000	28,000	28,500
Total current assets	688,124	769,639	960,837
Fixed assets, net	356,950	498,050	603,450
Total assets	1,045,074	1,267,689	1,564,287
Accounts payable	127,500	196,500	301,523
Other payables	51,000	69,860	79,499
Line of credit	61,500	51,300	130,200
Current portion of long-term debt	32,500	42,800	57,850
Total current liabilities	272,500	360,460	569,072
Long-term debt	325,000	428,000	578,500
Shareholders' equity
Common shares	360,000	360,000	360,000
Retained earnings	87,574	119,229	56,715
Total liabilities and equities	1,045,074	1,267,689	1,564,287

Mr. Blix was also able to attain average ratios from the Bank of Montreal, which they considered typical of operations in the high-end furniture manufacturing industry.

Ratio	Industry Average
Current ratio	2.5
Cash ratio	.5
Inventory turnover in days	90 days
Accounts receivable turnover in days	60 days
Accounts payable turnover in days	15 days
Cash conversion cycle	135 days
Fixed asset turnover ratio	4.01
Total asset turnover ratio	2.21
Long-term debt to total capitalization ratio	30%
Cash flow coverage	3.21
Effective interest rate	8%
Gross profit margin	45%
Operating profit margin	25%
Net profit margin	10%
ROA	22%
ROE	31%

Financing

Darlarna was able to secure both line of credit and term loan financing with the Bank of Montreal. The line of credit had a limit of $300,000 and was secured by both inventory and accounts receivable. Since Darlarna’s customers were small retailers with more limited access to financing compared to the large chains or department stores, the Bank of Montreal was only prepared to lend 40 percent of the value of the accounts receivables that were not yet past due. Also, because the inventory was composed mostly of raw materials and partially completed furniture and as a result difficult to sell, it agreed to lend only 20 percent of its value. The line of credit is non-committed, which means the bank is not obligated to lend to the company under the loan agreement if it feels the company is in financial difficulties or if the bank has a shortage of loanable funds.

All loans require that the company maintain a current ratio of 2.0, a cash flow coverage ratio of 4.0, and a long-term debt to total capitalization ratio of 55 percent. The loan agreements also specify that Mr. Blix could withdraw no more than $70,000 a year for living expenses and that he had to receive the bank’s permission to make capital purchases. Financial statements were to be provided when Frederic Blix met with his loans officer in July and January each year.

Darlarna sells all products net 60 and purchases most of its inputs 2/15, net 60. These terms are typical of the high-end furniture manufacturing industry.

Company Analysis

When Mr. Blix got his 2018 financial statements back from the accountant in mid-January, 2019, he became quite concerned about the dramatic drop in profits as he knew the venture capitalists were looking to sell their investment soon. He was also alarmed by reports in the media that a number of investment firms in the U.S. had failed and required government bailouts to continue operating. Could a severe recession be soon to follow? How would this influence demand for his products? Would the Bank of Montreal still be prepared to provide needed financing?

In response to these concerns, Mr. Blix retained Sally Delaney, CPA to conduct an analysis of Darlarna’s operations and to make recommendations for future action within the week.