Investment Proposal of the All-Natural Extreme Energiser - Assignment Example

 Investment Proposal of the All-Natural Extreme Energiser This report aims to present the financial background to an investment proposal in a new energy drink – Extreme Energy. The proposal will be supported through use of marginal costing and breakeven analysis and projected income statement, balance sheet and cash flow budget. It will conclude with a summary of why this investment is a good opportunity for the discerning investor, generating high returns without the risks associated with stock market crashes. Introducing the Extreme Energiser Sports drinks are being refocused to target serious athletes due to the competition from alternatives such as functional juices (Rouan 2010). This leaves a gap in the market for those who wish to target the more casual exerciser and the impulse purchaser. With manufacturers of sports drinks also looking to expand their existing offerings to create “systems” of workout drinks (ibid), a gap exists for a simple solution to the need for energy, with an emphasis on natural ingredients. Extreme Energiser is formulated to fit into these gaps. It is an all-natural smoothie with kiwi fruit, bananas and pears in an organic yoghurt base. The nearest competitor, with 77.5% of the market (www.innocentdrinks.co.uk), is the Innocent Smoothie, which has grown from nothing to this level in just over ten years. To clearly differentiate the new product, it will be supplied in 300ml plastic bottles (compared to Innocent’s 250ml bottles) and will retail at the same price, currently £1.95 (Tesco price as at 12th December 2010 – see http://www.tesco.com/groceries/ product/search/default.aspx?searchBox=innocent%20smoothies). This offering is better value for money for the consumer, as well as providing a natural source of energy that will appeal not only to those who exercise regularly, but also to those who purchase their own lunches and purchase drinks on impulse during the day. This ties into the trend for a combination of “sports drinks and functional beverages” (Spano 2010 p.75) and takes account of the continued fragmentation of the sports beverage market (ibid). One market not currently specifically targeted by sports beverages is women. Extreme Energiser will appeal to this currently underexploited segment, increasing sales. The consumer desire for ingredients with “a higher ‘natural and healthy’ score” with carriers with “better health credentials, such as dairy and fruit juices” (Wright, 2010, p.36) is met on all fronts with Extreme Energiser, providing a source of energy that can be used by anyone in need of an energy boost. This market is expanding and this product is poised to take advantage of that. The Basic Cost Structure £ Single product 1.95 Cost of sales @ 50% (industry standard) 0.98 Gross profit 0.97 A single bottle of Extreme Energiser will yield a 50% gross profit margin, after allowing for costs of packaging materials and ingredients. It is assumed the cost of ingredients is consistent with those charged to Innocent (a small company so reasonable comparator) and the costs of manufacture and packaging remain consistent with industry norms. The manufacturing facility is already in place and fully fitted out, but is, at present, rented. It is anticipated that further investment in the brand will allow the outright purchase of buildings and equipment to manufacture the drink, allowing a higher net profit margin to be achieved following the removal of rent payments. In addition, for local deliveries, a small van will be purchased, reducing reliance on external carriers to deliver our product to wholesalers and retailers. It will also improve the working capital position of the business to allow more equal negotiations with debtors and creditors (McLaney 2009). Marginal Costing Analysis and Breakeven Income 130,000 @ £1.95 £ 253,500 Less Variable costs 130,000 @ £0.98 £ 127,400 Contribution £ 126,100 Less Fixed costs £ 96,800 Surplus/Profit £ 29,300 Breakeven in units = fixed costs/contribution per unit = 96,800/0.97 = 99,794 units = £194,600 turnover Based on first year sales of 130,000 units (see later for justification of figures), and with all other things being equal, the business will generate a profit of £29,300 on turnover of £253,500 – a return of 11.56%. This is slightly below industry norms of between 12% and 18%, but is acceptable for a first year return on a new business. As the business expands, it will be able to take advantage of economies of scale, as well as expanding the product range. New facilities that are fully owned by the business will mean a substantial drop in fixed costs, increasing net profit margin. The net profit margin also provides a reasonable margin of safety should sales fail to meet predicted levels: Margin of Safety = Expected Sales – Breakeven Sales/Expected Sales = 253,500 – 194,600/253,500 = 23% This means sales can fall up to one fifth below predicted levels before there is any cause for concern. When considering breakeven analysis, however, there are several assumptions made by the analysis that should be made clear. Some have already been mentioned. Drury (2004) identifies eight: all other variables remain constant (already stated above); a single product or constant sales mix (assumption met by proposal); total costs and total revenues are linear functions of output (assumes no steps within the costs – semi-fixed or semi-variable costs that change with output); profits are calculated on a variable costing basis (assumption met by proposal); the analysis applies to the relevant range only (assumption met by proposal – no extrapolation beyond the expected sales level); costs can be accurately divided into fixed and variable elements (unclear at this time as to whether proposal meets this assumption); the analysis applies only to a short-term horizon (assumption met by proposal – period is a single year); and complexity-related fixed costs do not change (assumption met by proposal – no complex issues at this time). No predictions should be made outside the parameters of this report based on its contents. Sales Predictions Sales predictions are based on Innocent’s start up sales of 20 units on first day of trading (www.innocentdrinks.co.uk) and assume initial sales of around 30 units per day with 5 retailers taking stock sufficient for one month’s sales. It is also assumed there will be a seasonal sales pattern in the initial phase of product launch and any sales beyond the initial 5,000 units will be made on credit (30 day terms) with no bad debts and prompt payment. Predicted number of units sold January 2011 5,000 February 2011 5,000 March 2011 7,500 April 2011 7,500 May 2011 10,000 June 2011 15,000 July 2011 15,000 August 2011 20,000 September 2011 15,000 October 2011 10,000 November 2011 10,000 December 2011 10,000 Total Sales 130,000 Expenses £ Rent (2 units @ £7,250 p.a.) 15,500 (Source: Box Pod web site) Delivery (@ £50 per day) 1,250 (Source: ParcelLink web site) Administrative assistant (per month) 525 (Source: Reed web site) General expenses (per month) 5,000 Estimate Total monthly expenses 6,775 Total annual fixed costs 96,800 Business expenses are expected to be £6,775 per month, with the exception of month one, which requires payment in full of the rent of the two units used to manufacture and store the product. The units are based in Sittingbourne in the Medway area, with close proximity to London and based in the South East providing access to the more affluent areas of the country to establish the brand. The City and Canary Wharf especially, represent good opportunities to establish the brand, and the upcoming Olympic Games provide a further opportunity to publicise the brand as the energy drink of choice for professionals everywhere. Financial Projections There now follow the projected income statement and balance sheet for the first year’s trading. It is assumed there are no stocks and, due to the nature of the product, all stocks are purchased as needed (a just-in-time approach) to ensure freshness of the ingredients and quality of the final product. The sum of £29,000 is available to assist with setting up the business and enables the first three months’ outgoings to be covered, including the rent, which prevents any issues regarding tenancy occurring during the first months over non-payment of rent. An administrative assistant will be hired on a part-time basis, for two days per week at a rate of £7.50 per hour (an average figure for such a post) to keep paperwork and bookkeeping up to date. The business will not own any fixed assets, so the income statement does not show any depreciation and the cash flow budget does not show any capital outflows. There are also no predicted capital inflows, despite this proposal, as the business model stands without such investment. On the basis that there is no capital investment, the business will be reliant on organic growth based on a slower-growing capacity for production. Products will be delivered initially using a delivery service, the cost of which has been allowed for in expenses. This ensures the business is able to sustain itself before any capital expenditure is undertaken (purchase of a small van for local deliveries to retailers and wholesalers who agree to carry the line). The overall business strategy is considered conservative and fully achievable within the stipulated timescale. Extreme Energiser Income Statement for Year Ending 31st December 2011 £ £ Sales 253,500 Less Cost of Goods Sold: Opening Stock 0 Purchases 127,400 Closing Stock (0) (127,400) Gross Profit 126,100 Less Expenses: Rent 15,500 Delivery Service 15,000 Administrative Assistant 6,300 General Expenses 60,000 (96,800) Net Profit 29,300 Extreme Energiser Balance Sheet as at 31st December 2011 £ £ Current Assets: Stock 0 Debtors 9,750 Cash at Bank and in Hand * 19,550 29,300 29,300 Net Assets as at 31st December 2011 29,300 Capital Account Opening Balance 0 Net Profit 29,300 (0) Closing Balance 29,300 Closing cash balance less cash held before start of year = 48,550 – 29,000 = £19,550 Initially, all transactions will be for cash, with the exception of sales on credit for a period of 30 days. As the business settles down and sales forecasts are met, consideration will be given to setting up credit accounts with suppliers after establishing a history of prompt payment of invoices and a good credit track record. The proposed investment would allow the business to take earlier advantage of credit facilities and provide greater bargaining power when providing credit to wholesalers and retailers (McLaney, 2009), maximising resources and returns. Extreme Energiser Cash Budget for Year Ending 31st December 2011 Jan 11 Feb 11 Mar 11 Apr 11 May 11 Jun 11 Jul 11 Aug 11 Sep 11 Oct 11 Nov 11 Dec 11 Cash held 29,000 11,575 9,650 5,275 5,775 3,825 1,840 9,625 12,500 30,025 42,700 45,625 Income:           Cash sales 9,750 9,750 9,750 9,750 9,750 9,750 9,750 9,750 9,750 9,750 9,750 9,750 Credit sales 4,875 4,875 9,750 19,500 19,500 29,250 19,500 9,750 9,750 Cash injections           Total cash receipts 9,750 9,750 9,750 14,625 14,625 19,500 29,250 29,250 39,000 29,250 19,500 19,500 Total cash held 38,750 21,325 19,400 19,900 20,400 23,325 31,090 38,875 51,500 59,275 62,200 65,125 Outgoings:           Purchases 4,900 4,900 7,350 7,350 9,800 14,700 14,700 19,600 14,700 9,800 9,800 9,800 Other expenses 22,275 6,775 6,775 6,775 6,775 6,775 6,775 6,775 6,775 6,775 6,775 6,775 Capital changes           Total outgoings 27,175 11,675 14,125 14,125 16,575 21,475 21,475 26,375 21,475 16,575 16,575 16,575 Cash balance 11,575 9,650 5,275 5,775 3,825 1,840 9,625 12,500 30,025 42,700 45,625 48,550 It is assumed the increase in sales from March onwards will be on 30 days credit terms. Conclusion The opportunity to invest in Extreme Energiser at this time is not to be missed and is fully supported by the financial analysis. The predictions for sales and growth are moderate with a single main competitor and a favourable market situation providing the opportunity to establish a new brand of natural energy drink that can be enjoyed by anyone in any setting for a price that provides better value for the customer than the nearest rival. Setting up purpose-built manufacturing facilities with delivery capability will allow full advantage to be taken of the opportunity in the market at a much faster rate than at present, generating high returns on invested funds. (1,596 words, excluding tables and financial statements) References Drury, C. (2004) Management and Cost Accounting (6th edn.) Thomson, London McLaney, E. (2009) Business Finance: Theory and Practice (8th edn.) FT Prentice Hall, Harlow Rouan, R. (2010) ‘Working out a new strategy’ in Beverage Industry, May, pp.18-21 Spano, M. (2010) ‘Trends in Sports Drink Formulations’ in Prepared Foods, June, pp.75-85 Wright, R. (2010) ‘A New Era for Functional Beverages’ in Nutraceuticals World July/August, pp.34-45 Web Sites: BoxProd: http://www.boxpodcommercialproperty.co.uk/business-property/778/sittingbourne-industrial-unit [accessed 12th December 2010] Innocent: http://www.innocentdrinks.co.uk/press/cheatsheet/ [accessed 12th December 2010] ParcelLink: http://www.parcel-link.co.uk/ [accessed 12th December 2010] Reed: http://www.reed.co.uk/job/searchresults.aspx?k=administrative+assistant&jto=false&s=3&l=&lp=&ms=From&mxs=To&st=5&jt=3&ns=true&ps=20&da=8630 [accessed 12th December 2010] Tesco plc http://www.tesco.com/groceries/product/search/default.aspx?searchBox=innocent%20smoothies [accessed 12th December 2010] Read More