Deutsche Brauerei brewing company was founded back in 1737 by Gustav Schweitzer and currently produces two varieties of beer, dark and light. Since the brewing company was originally family owned and family operated, the equity is all privately held stock which is distributed between 16 members of the Schweitzer family. Lukas Schweitzer asked his niece, Greta Schweitzer, to join the board of directors because of her financial expertise.
Lukas, the managing director of the firm, is seeking advice to prepare an agenda for the directors meeting in January. This case analysis addresses three main questions concerning the Deutsche Brauerei Company. The three questions that relate to approving the 2001 financial budget are declaring a quarterly dividend; and determining a reasonable compensation plan for Oleg Pinchuk, the company’s sales-and-marketing manager.
First let us look at the projections of the financial budget for 2001. Net sales have nearly doubled since 1997, for the most part on account of the expansion into the Ukraine market. Because of the new privatizations and market reforms made by the Ukrainian government, it made entry into this market more viable then ever before; which swayed the Schweitzers to expand. Since they were the first-movers in this sector, the beer-distribution pipeline in the Ukraine was nonexistent.
The entrepreneurs were eager to capitalize on the market but they had no capital. So Oleg basically turned the company into a bank for the Ukraines by extending credit to the distributors, allowing payment deadlines the extend to 90 days as opposed to the 40 day deadline in Germany (Bruner, Exhibit 4, #17 ; 18), not allowing distributors to pick up inventories until they were needed, and increased the amount of short term debt borrowing to finance this.
The later payment schedule helped sales in the Ukraine to grow tenfold, but the accounts receivable grew just as dramatically and Deutsche Brauerei has to cover its accounts payable obligations that are now for short-term debt. With such credit risk, the allowance for doubtful accounts was still kept at 2% by Oleg. The firm needs to either tighten its payment schedule or increase the allowance for doubtful accounts in order to keep the company from being so vulnerable to this credit risk.
The distribution network in the Ukraine was just getting started, so Oleg allowed distributors to pick up inventories when they needed them. This almost tripled the inventories; looking at the Table 1, you can see that inventory to total sales has leveled off while inventory to sales in Germany has slowly increased. Meaning that most of the increasing inventory is because to the Ukraine expansion.
The short-term debt is a main source of financing that Deutsche Brauerei has acquired to finance the expansion into Ukraine. This type of financing allows the firm to be a subject of the volatility in the market place. Long-term debt has been decreasing but would a better for a long term view in building up this new market. One indication of this fact is the company’s return-on-assets are decreasing (Bruner, Exhibit 4, #6). This reveals that more assets are being acquired to produce fewer returns because new plants and distribution centers are to be built in the Ukraine.
Looking at the degree of operating leverage (DOL) for 2000, which equals 5.0, means that the change in net operating income (NOI) is equivalent to five times the change in units produced. For the year 2000, Deutsche Brauerei operating risk structure shows that the firm is operating close to capacity. The breakeven analysis for the projected 2001 & 2002 are calculated in (Table 2) using the increases in volume as a percentage of increases in net sales. This shows that the DOL has decreased over these two years which is keeping the breakeven pretty close to the capacity, even though with the expensive new investments into the Ukraine market. If the firm is expected to make revenues that would cover its’ operating costs then it has to produce almost to full capacity which leaves little room for a bare market.
The increase in dividends that was proposed is not recommended for this budget. The company’s attempt to keep the older family members that receive these dividends as a primary source of income is not a reason to increase the dividends at this time. Because of recent and continued expansion, along with the increase in accounts receivable and inventories, the slower increase in net earnings doesn’t justify this. The decrease in gross margins shows that the company isn’t making the profits they should be with respect to the total sales projected (Table 3). It is better to keep the dividend payout to 75 percent of earnings or even lower the percentage. This would allow the company to reinvest more of its earnings into the new investment or, at best, pay off some of the increasing short-term debt that has been accumulating.
Making the company more financially sound and less risky for future family shareholders is a better long term focus. This would allow Deutsche Brauerei to gain a stiff advantage into the new market and have better opportunity to increase profits and shareholder wealth in the future. Oleg’s decision of how much could be paid out to the shareholders is dependent upon his estimates for the next two years. The sales growth can be misleading if many of the accounts receivable are not realized and if the growth of short-term debt hurts cash flow then, the eager increase in dividends paid will hurt the company that those family members helped to build.
The compensation package that Lukas Schweitzer proposes for Oleg is one where he increases his base salary 8,500 euros and an incentive payment increase from 0.5 to 0.6 percent of annual sales. Oleg has done well in quickly expanding into the uncharted market in the Ukraine with setting up distributors and good marketing techniques to get a huge increase in sales. He has done all this while changing the company’s financial budgeting to become more risky especially over a short term period, most likely because of his incentive payment by taking advantage of overextending credit. It is tied to the annual sales which he has significantly raised over the past years with the expansion.
He hasn’t developed an overall sound company during this expansionary period, which I’ve shown earlier. So in order for him to construct a firm that is an all around good company, his incentive payment should be tied into the areas where he has let the company become more risky. These could be by tying the incentives to reducing the accounts receivable or inventory numbers, or even somehow tie the payments that would subtract huge losses if allowance for doubtful accounts actually is above what he projects.
As for Oleg’s base salary increase, it should be approved as Lukas advises. He has brought the company a lot more exposure in both the German and Ukraine market. The new investments in equipment and inventory are much needed to stay ahead of the competition. This is greatly needed, especially in the Ukraine, because having the first-mover advantage will allow the company to have a good grip when other competitors try to enter the market.
In conclusion, there is a problem with all three questions that arise for the board members. In order to approve the budget, some of Oleg’s estimations need to be improved and become more reasonable to the economic factors that are more likely to arise then what he has anticipated for. Since it would be better to reinvest the euros back into the company to help alleviate some of the potential high risk factors that Oleg has produced through his earlier dealings in the new market, declaring an increase in dividends is not a financially sound approval. Finally, in order to help the company sustain an advantage over its competitors and force Oleg to build a more stable firm, his incentive payments should be tied into the financial areas where he has been inferior. These changes will help Deutsche Brauerei become a better company overall while still having great success in the expansion into the Ukraine.