Magnet beauty products Harvard Case Solution & Analysis

Leasing Decision at Magnet Beauty Products Inc

Introduction:

Janette Clark is the owner of Magnet Beauty Products Inc. In late August 2010, she was evaluating the different leasing options that she had for her stores. For this purpose of evaluation Clark asked David Cameron, a newly recruited accountant, to analyze the impact that the new accounting standard for leases would have on her business. Clark asked Cameron to analyze how the different leasing proposals she had received from her landlord would affect Magnet’s financial statements. The analysis of Cameron showed that as a result of the forthcoming accounting changes the different leasing options would have very different impact on the company’s financial statements for years to come. She doubted how she should take these differences into account in making her final leasing decision.

Problem Statement:

The owner of the Magnet Beauty Inc. is facing a challenge to analyze two options of the lease arrangements of the properties acquired by the company. Clarke wants to know the impact of each option incorporated according to the new proposed accounting policies on the financial statements of the company. The new proposed accounting policy has directed to recognize the assets acquires on the operating lease from landlords in the non current side of balance sheet as an right of use assets heading.

Background of company:
Magnet Beauty is a fast growing business, which operates by selling premium hair, body and face care products. Magnet started its business operation witha limited product line, however the company grew and started offering complete skin and hair care product range, make-up and sun care products and herbal supplements. In the year 2010, Magnet offered around 100 innovative and creative herbal products. The company has 300 employees in the same year and maintaining production and manufacturing facilities of 140 thousand square feet.

Magnet established competitive advantage for itself from the competition by selling only products made only from natural extracts and ingredients. Hair and body products of the company equaled 21% and 19% of total sales respectively. Pharmaceutical and other products of the company represented remaining15% of the sales.

Current financial position of the company:

For the fiscal year 2009, the company reported the sales revenue of $52.4 million, the sales revenue was 12% higher than the revenue of last year. On the other hand,the net income of the company stood at $1.4 million after tax, the net income was also 10% higher than the net income of previous year. However, due to the growth in sales the account receivable of the company also increased significantly, the figure of the account receivables reached at $30 million. This has resulted in the cash flow problems at the Magnet Company, as the total net cash flow for the year 2009 was negative $1 million and the cash flow before financing activities stood at $2 million of negative balance. This also made the company to finance its short term needs with its current liabilities or account payables; this has increased the account payable balance of $20 million. On the other hand,the debt ratio of the company is increasing constantly and has become highly leveraged company. The outstanding debt of the company has reached at $52 million. This has showed the reason why the net profit margin of the company is low, as it is 2.6% because of the high interest expenses of the company. The interest expense in 2009 was$3,640,000, which evaporated the operating earnings of the company significantly.......................

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