Introduction to Accounting and Finance - Essay Example

?INTRODUCTION “ABC Energy” is a business project that has been designed keeping the idea of success of Dragon’s Den success of Levi Root’s Reggae Reggae Sauce. It has been suggested with believe that any single idea can gain market acceptance and does not require to be an extra ordinary product or extremely different in order to gain the market share. The quality of the product and well managed business operations are always prone to capture the taste buds acceptability. Moreover, if the product is marketed properly, then it can help the product to be successful. The given report, hence, provides the financial feasibility of the project which is about introducing a new drink based providing potential investor an attractive opportunity to enter the growing market and earn attractive returns. Based on the forecasted data assessed with ratios and capital budgeting techniques, the project has been found highly feasible with attractive returns. For details view of the financials; forecasting sheets have also been provided. Moreover, there are some assumptions made while forecasting the financials of the project and these assumptions have also been discussed. ASSUMPTIONS ABC DRINK Following set of assumptions have been followed to prepare the following financials for the data: 1. External environment has been analysed and the market has been found conducive of conducting the energy drink business. 2. ABC drink has been evaluated for the offering size of 250 ml. 3. Costing of the material has been used the cost of item listed. 4. All the expenses are based in fictional figures. 5. Price of the product has been set according to competitive prices available on the Amazon grocery offering 6. It is assumed the changing season would not affect the demand. 7. Production and will follow the given pattern. 8. The closing stock of each month is utilised in next month. 9. Frequent receipts do not affect the payments as even in the months when the cash position is running negative. 10. For business valuation, the forecasting for the net income has been done for 5 years with NI increasing with 2.5% with first two years, 5% in third-year, 8% in fourth-year and 10% in fifth-year. 11. Required rate of return for business valuation has been taken as 15%. It has been selected so high to incorporate any effect of unlikely event that negatively affects business operations mainly cost and revenues. MARGINAL COSTING COST STATEMENT   TOTAL EXP. CATEGORY FIXED AMT VAR AMT   (Monthly) (PROD OR SELLING) (%) In (%)   LABOR           Factory Manager ? 7,083 Production 100% ? 7,083 0% ? - Accountant ? 4,500 Selling 100% ? 4,500 0% ? - supervisor ? 2,500 Production 50% ? 1,250 50% ? 1,250 Marketing team of 3 people ? 3,600 Selling 35% ? 1,260 65% ? 2,340 SCM team ? 5,000 Selling 25% ? 1,250 75% ? 3,750 Sales Force (10 people) ? 8,000 Selling 20% ? 1,600 80% ? 6,400 Technician (2) ? 6,400 Production 50% ? 3,200 50% ? 3,200 On Floor Labor ? 14,000 Production 10% ? 1,400 90% ? 12,600 watchman (Prod dept) ? 980 Production 100% ? 980 0% ? - watchman warehouse ? 980 Selling 100% ? 980 0% ? - Transporter ? 1,300 Production 65% ? 845 35% ? 455 Transporter   ? 1,800 Selling 40% ? 720 60% ? 1,080 BREAK-EVEN ANALYSIS Break even analysis is the point where the total cost of the company is equal to the total revenues (Levy, & Brooks, 1986) and at this point the profit of the company is 0 (Anand, 2004). Breakeven analysis is used to determine the minimum quantity that should be produced in order to achieve no loss (Arnold, 2008; Besley, & Brigham, 2007). Breakeven point for the discussed project has been identified and it is 42,304 units. This means that the company needs to sell 42,034 units of drink in order to achieve zero profitability. BREAK EVEN ANALYSIS T. FIXED COST ? 38,954.33 VC ? 1.18 SALES PRICE ? 2.10 CONTRIBUTION MARGIN ? 0.92 BREAK EVEN ANALYSIS 42,304.70 Break even has also been calculated using graph. The following graph shows break even and it is almost the same point as calculated above. Cash budget Cash budget shows the cash inflows and cash outflows of the company throughout the period (Brimson, 1991). Cash budget for the company is prepared and it is presented below:       CASH BUDGET                   For Month on Month Activity       RECEIVING JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC OPENING CASH 0 6,256.31 1,488.04 3,969.88 4,038.25 6,109.13 13,355.89 24,053.24 31,300.00 37,684.12 44,068.23 50,452.35 INVESTMENT ? 40,000.00 ? - ? - ? - ? - ? - ? - ? - ? - ? - ? - ? - REVENUE ? 63,000.00 ? 79,800.00 ? 94,500.00 ? 94,500.00 ? 98,700.00 ? 105,000.00 ? 109,200.00 ? 105,000.00 ? 103,950.00 ? 103,950.00 ? 103,950.00 ? 103,950.00 TOTAL CASH AV. ? 103,000.00 ? 86,056.31 ? 95,988.04 ? 98,469.88 ? 102,738.25 ? 111,109.13 ? 122,555.89 ? 129,053.24 ? 135,250.00 ? 141,634.12 ? 148,018.23 ? 154,402.35     LESS: PAYMENTS AND EXPENSES   Plant and machinery ? 20,000.00   EXPENSES   FIXED COST   production ? 26,384.33 ? 26,384.33 ? 26,384.33 ? 26,384.33 ? 26,384.33 ? 26,384.33 ? 26,384.33 ? 26,384.33 ? 26,384.33 ? 26,384.33 ? 26,384.33 ? 26,384.33 selling ? 12,570.00 ? 12,570.00 ? 12,570.00 ? 12,570.00 ? 12,570.00 ? 12,570.00 ? 12,570.00 ? 12,570.00 ? 12,570.00 ? 12,570.00 ? 12,570.00 ? 12,570.00 VARIABLE COST   Production ? 26,548.18 ? 31,375.12 ? 36,202.06 ? 38,615.53 ? 40,063.61 ? 40,063.61 ? 40,063.61 ? 40,063.61 ? 40,063.61 ? 40,063.61 ? 40,063.61 ? 40,063.61 selling ? 11,241.18 ? 14,238.82 ? 16,861.76 ? 16,861.76 ? 17,611.18 ? 18,735.29 ? 19,484.71 ? 18,735.29 ? 18,547.94 ? 18,547.94 ? 18,547.94 ? 18,547.94 Tax ? 11,570.06 profit To Project Mgr. ? - ? 9,448.89 Total Payments ? 96,743.69 ? 84,568.27 ? 92,018.16 ? 94,431.63 ? 96,629.12 ? 97,753.24 ? 98,502.65 ? 97,753.24 ? 97,565.89 ? 97,565.89 ? 97,565.89 ? 118,584.84     Cash Balance ? 6,256.31 ? 1,488.04 ? 3,969.88 ? 4,038.25 ? 6,109.13 ? 13,355.89 ? 24,053.24 ? 31,300.00 ? 37,684.12 ? 44,068.23 ? 50,452.35 ? 35,817.51 Forecasted Income Statement Income statement of the company shows the revenues that the company has generated along with the cost of the revenue and expenses that have been incurred throughout the period (Gitman, 2003; Khan, 1993) INCOME STATEMENT SALES           ? 1,165,500.00     LESS: Contribution   Variable Cost (Production) ? 453,249.78   (Including Direct material @ 0.45 p & labor and OH 0.38 p)   Variable Cost (Selling) ? 207,961.76   Cost of Goods Produced ? 661,211.54       Add Opening Stock ? -       less closing stock ? 2,730.42       Variable Cost of Goods Sold ? 658,481.12     Contribution ? 507,018.88     LESS: TOTAL FIXED COST     Production ? 316,612.00     selling ? 150,840.00     Depreciation Expense ? 1,000.00   Total fixed Cost ? 468,452.00 EBT ? 38,566.88 Tax @ 30% ? 11,570.06 Net profit ? 26,996.82 profit paid to Project Manager ? 9,448.89 Net Profit Available to Entrepreneur     ? 17,547.93 Project balance sheet Balance sheet As On 30 Dec 2013 CURRENT ASSETS         CURRENT LIABILITIES Cash ? 35,817.51 -   Inventory ? 2,730.42       -             FIXED ASSETS   CAPITAL   Plant and Machinery ? 20,000.00   Investment ? 40,000.00 Depreciation Exp. (5%) ? 1,000.00 ? 19,000.00 Add: Profit ? 17,547.93         Total Assets     ? 57,547.93 Total Equities ? 57,547.93 PROJECT EVALUATION The ABC Energy drink business project has been suggested based on the suitable market conditions to launch a healthy energy drink. Energy drinks are gaining popularity among large number of people especially youth (Jensen, 2001). For this purpose, it has been proposed to enter the market with offering energy drink with the name of ABC Energy and packaging of 250 ml bottle. This report discusses the forecasted financial statements and the feasibility of the business operations for the 12 months for each component of investment in project has been discussed herein INITIAL INVESTMENT REQUIRED The initial investment required by the business amounts to ? 40, 000.00. This initial investment is mainly required to finance investment in fixed asset i.e. plant and machinery of amount of UK ? 20, 000.00 while rest of the amount is required to meet the initial capital to meet the financing needs and manage the operations of the business so that it is able to generate revenues. Successful business operations will be able to generate 44% of return on this investment for the investor (Appendix: VI). FEASIBILITY Based on the evaluation, the project has been found highly feasible for investment. The feasibility has been developed with forecasted data. Detailed forecasting for Cost has been attached in the Appendix: 1. Production and revenue schedules with Break-even analysis have been presented in the Appendix: II. Cash Budget has been presented in the Appendix: III, Income Statement is attached in the Appendix: IV and Balance Sheet can be found in the Appendix: V. The financials have been developed using the marginal costing methodology. The stated method has been adopted mainly for its suitability to support business in production decision and the pricing policy. Moreover, it provides clearer picture of the expenses incurred that has ample impact on the profitability. Therefore, with time, the profitability can be increased with increasing efficiency by controlling expenses. The limitation of the marginal costing methodology related to difficulty in allocating expenses to particular category has been addressed by allocating percentage of few expenses in both fixed and variable costs head. This also addresses the adopted methodology limitation of unpredictable nature of expenses as fixed or variable (appendix I). Finally with forecasting has been tested for suitability of investment using various evaluation techniques such as breakeven analysis (Appendix: II), ratio analysis and capital budgeting technique (Appendix: VI) for evaluation. To mention, forecasting of the business has been prepared under consideration with certain assumptions. Appendix VII provides detailed set of assumption for the project. PROFITABILITY Profitability is the main objective of every investment and different profitability ratios are used to analyse the profitability of the company (Kaplan, and Atkinson, 1998). Net profit margin and operating profit margin have been used in this report to analyse the profitability. Net profit margin is the ratio of net profit to sales (Hilton, 2010). However operating profit margin is the ratio of operating profit to sales (Johnson, Scholes, and Whittington, 2008). With this general rule, ABC Energy is the most attractive opportunity for business to invest. The profitability of investment in this project has been viewed with Profitability ratios and Turnover Ratios. Profitability   Year 2013 Operating Profit Margin 3.309% Net Income Margin 2.32% Businesses often fail to achieve profitable in the initial year of operations (Cravens, and Piercy, 2008) whereas the ABC ENERGY has managed to fetch positive profitable in its first year of operations. Low profitability is mainly for the reason of market having competitive position. Low margins are expected to improve with passage of time as the business develops efficiency with economies of scales and experience and learning curve in its operations. Moreover, as the business will expand and more people will know about the ABC drink then this will help the company in increasing its sales and attracting not only new customers but at the same time retaining old customers as well. Refer to Appendix VI for details. TURNOVER ABC ENERGY, despite of the fact is able to generate low profitability in the first year, but still the company has highly attractive returns to offer for the investors. Turnover ratios provide the most important picture of this project to investor as presented below: Turnover   Year 2013 Total Asset Turnover 20.253 Fixed Asset turnover 61.342 ROI   44% Business being highly maintained on cash basis maintains two main assets, cash and asset with minimal closing inventory; hence, the business has highly an attractive position with total asset generating sales 20x of its worth which is found by calculating the total assets turnover. Total assets turnover is the ratio of total sales to total assets (McLaney, 2009). Moreover, the fixed asset utilisation is also highly efficient with 61x of fixed asset turnover. Fixed assets turnover is calculated by dividing the total sales to total fixed assets (Lasher, 2010). This provides rationale position of business against the businesses low profitability with high turnover. Detailed calculations have been attached in the Appendix VI. BUSINESS VALUATION NPV Net present value shows the value of the future cash flows after being discounted by a discount rate or cost of capital (Brealey, Myers, Allen, & Mohanty, 2007; Ye, and Tiong, 2000). This allows investors to know the future worth of the business in present time (Tucker, and Lean, 2003). If the NPV of the project is positive, then investors accept it however if the results of NPV are negative then investors are not willing to invest in the project (Jensen, 2001). Based on assumption that the sales as well as the profitability of the company will increase in positive trends and in order to analyse the worth of the project, the project has been assessed over period of 5 years. With required rate of return at 15%, ABC ENERGY has the positive results as follows:   YEAR 0 YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 Initial Investment (40,000.00)           Net Income 17547.93 17986.6 18436.29 19358.11 20906.76 22997.43 Add: depreciation 1000 1000 1000 1000 1000 1000 Net Cash Flows (1,452.07) 18,986.6 19,436.2 20,358.1 21,906.7 23,997.43               VALUATION FOR 5 YEARS   NPV $41,388.42 It is noteworthy to mention, along with high discount rate to cater an unlikely event’s impact on cost and revenues, the NPV analysis has accounted the portion of Net Income attributable to investor and excluding the portion of Net Income paid to Project manager. Hence, the investor will be able to recover investment (with discounting) within period of less than 5 years. PROFITABILITY INDEX Profitability index is another important technique that has been used by investors around the world to analyse the worth of the investment (Ross, Westerfield, and Jordan, 2009). If the value of the profitability index is 1.0 or more than 1.0 then the project is accepted. However, if the value of profitability index is less than 1.0 then the project is not accepted. Profitability index is used at times in combination with NPV. Not only big organizations but even small organizations use profitability index to analyse the feasibility of the project (Friedlob, & Plewa, 1996; Groz, 2009). With the decision forming threshold of 1, the profitability index of the ABC ENERGY is:   YEAR 0 YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 Initial Investment (40,000.00)           Net Income 17547.93 17986.6 18436.29 19358.11 20906.76 22997.43 Add: depreciation 1000 1000 1000 1000 1000 1000 Net Cash Flows (1,452.07) 18,986.6 19,436.2 20,358.1 21,906.7 23,997.43               VALUATION FOR 5 YEARS   Profitability Index 2.03 Higher profitability index also asserts the feasibility of the project and it concludes that the investment should be made in the project. CONCLUSION ABC ENERGY being business proposal related to the energy drinks. The proposal has been presented mainly based on two factors; growing market of energy drink and second, the capacity of every business to beat the competition; lesson from success story of Dragon’s Den success of Levi Root’s Reggae Sauce. Based on the projected valuations and their assessment, ABC ENERGY has been found to provide highly attractive returns. The returns have also been assessed accounting the financial treatment techniques that incorporate the impact of time within accounting returns. Hence, the investment opportunity is a catch worthy investment option for Investors that are intended to gain attractive returns for the investment. List of references Anand, S. (2004). ‘Achieving Breakthrough Performance Using the Balanced Scorecard’. IBA Bulletin, vol. 12, no. 26, pp. 28-31. Arnold, R. (2008). Economics. Mason, South-Western Cengage Learning. pp. 79- 81 Besley, S., & Brigham, E. (2007). Essentials of Managerial Finance, 14 edn. USA: Thomson Higher Education. Brealey, R., Myers, S., Allen, F., & Mohanty, P. (2007). Principles of corporate finance, New York: McGraw-Hill. Brimson, J 1991, Activity accounting: An activity-based costing approach, J. Wiley, New York. Cravens, D.W. and Piercy, N.F. (2008). Strategic Marketing, 9th Edition. Cambridge: McGraw-Hill Publishing Co. Friedlob, G., & Plewa, J. (1996). Understanding balance sheets. New York: John Wiley & Sons. pp. 25-26. Gitman, L. (2003). Principles of Managerial Finance. Boston: Addison-Wesley Publishing. pp. 121. Groz, M. (2009). Forbes Guide to the Markets. New York, John Wiley & Sons, Inc. Hilton, R.W. (2010). Managerial Accounting – Creating Value in a dynamic business environment. (9th ed.). McGraw – Hill, New York. Jensen, M. C. (2001). ‘Value Maximization, Stakeholder Theory, And The Corporate Objective Function’. Journal of Applied Corporate Finance, vol. 14, pp. 8–21. Johnson, G., Scholes, K. and Whittington, R. (2008). Exploring Corporate Strategy: Text and Cases, 8th Edition. Harlow: FT Prentice-Hall. Kaplan, R., and Atkinson, A. (1998). Advanced Management Accounting. New Jersey: Prentice-Hall. pp. 146-148. Khan, M. (1993). Theory & Problems in Financial Management. Boston: McGraw Hill Higher Education. pp. 73. Lasher, W. (2010). Practical Financial Management. Mason, South-Western College Publication. Levy, H., & Brooks, R. (1986). ‘Financial Break-Even Analysis and the Value of the Firm’. Financial Management, vol. 15, no. 3, pp. 22-26. McLaney, E. (2009). Business Finance: Theory and Practice, Pearson Education: New Jersey. Ross, S., Westerfield, R., and Jordan, B. (2009). Fundamentals Of Corporate Finance Standard Edition, New York, McGraw-Hill. pp. 19-21. Tucker, J. and Lean, J. (2003). ‘Small firm finance and public policy’. Journal of Small Business and Enterprise Development, vol. 10, no. 1, pp. 50-61. Ye, S. and Tiong, R. (2000). ”NPV-at-Risk Method in Infrastructure Project Investment Evaluation.” J. Constr. Eng. Manage., vol. 126, no. 3, pp. 227–233. Read More