Budgets Forecast for Energy Drink Company - Essay Example

…………………………………………………………………………………….……….xxxxxx …………………………………………………………………………………………..xxxxxx ………………………………………………………………………………………………xxxxx Professor……………………………………………………………………………………………...xxxxx @2012 Introduction to accounting 1. Key assumptions used in the production of key financial data Variable costs such as Direct labor, direct material costs and other manufacturing costs will vary with the level of production Sales revenue varies with the level of production selling and distribution costs will vary with level of production Fixed costs are constant regardless of the level of production Appendix 1   Number of units produced Number of units sold January 2000 2000 February 2100 2,040 March 2200 2,081 April 2300 2,122 May 2400 2,165 June 2500 2,208 July 2600 2,252 August 2700 2,297 September 2800 2,343 October 2900 2,390 November 3000 2,438 December 3100 2,487 2. Marginal cost statement on the product on a ‘per unit’ and 12 months sales/production basis Marginal cost statement £ January Number of units sold 12 months 26,824 2,000 selling price per unit @ £ 2.50 67,060 5,000 Less:     Direct labor @ 0.5 (13,412) (1,000) Direct materials @ 0.2 (5,365) (400) variable manufacturing costs @ 0.3 (2,682) (200) contribution margin 45,601 3,400       Less:     selling and distribution costs @ 0.1 (2,682) (200) Factory overheads (6,000) (500) Net Profit 36,919 2,700 3. Break even analysis Appendix 2   units sold sales revenue Total cost January 2000 5,000 2300 February 2,040 5,100 2336 March 2,081 5,202 2373 April 2,122 5,306 2410 May 2,165 5,412 2448 June 2,208 5,520 2487 July 2,252 5,631 2527 August 2,297 5,743 2568 September 2,343 5,858 2609 October 2,390 5,975 2651 November 2,438 6,095 2694 December 2,487 6,217 2738 = Fixed Costs         Contribution margin per unit   = 6,000     (2.5-1.1)       = 4,286 units             Break even sales= BEP *Selling price per unit   = 4286*2.5         10,715.00   Margin of safety = budgeted sales –break even sales Assume budgeted sales is 20,000 then margin of safety is 9,285 Appendix 3 Forecast Income Statement Pro forma income statement             2012 2013 2014 2015 2016 sales 20,000 21,600 23,328 25,194 27,210 cost of goods sold 10,000 10,800 11,664 12,597 13,605 Gross profit 10,000 10,800 11,664 12,597 13,605 Expenses (2,000) (2,160) (2,333) (2,519) (2,721) Profit 8,000 8,640 9,331 10,078 10,884 Interest expense (1,500) (1,500) (1,500) (1,500) (1,500)   6,500 7,140 7,831 8,578 9,384 Tax @30% 1,950 2,142 2,349 2,573 2,815 Appendix 4 Forecast Balance Sheet BALANCE SHEET FORECAST           Fixed Assets 2012 2013 2014 2015 2016 Property, plant & Equipment 50,000 50,000 50,000 50,000 50,000             Current Assets           Inventories 2,500 2,625 2,756 2,894 3,039 Cash 61,196 63,766 66,505 69,425 72,538 Accounts receivables 1,304 1,369 1,438 1,510 1,585 Total Assets 115,000 117,760 120,699 123,829 127,162 Current Liabilities           Accruals 8,000 8,400 8,820 9,261 9,724 Payables 20,000 21,000 22,050 23,153 24,310                         Equity 40,000 40,000 40,000 40,000 40,000 Debt 30,000 30,000 30,000 30,000 30,000 Retained earnings 8,000 8,640 9,331 10,078 10,884 Dividends 9,000 9,720 10,498 11,337 12,244 Total Equity and liabilities 115,000 117,760 120,699 123,829 127,162 Cash budget Appendix 4   CASH BUDGET                         January February March April May June July August September October November December Balance brought forward 0 3,400 7,056 10,982 15,193 19,705 24,534 29,697 35,212 41,099 47,378 54,070 Cash inflow 6,000 6,300 6,615 6,946 7,293 7,658 8,041 8,443 8,865 9,308 9,773 10,262 Total inflow 6,000 9,700 13,671 17,928 22,486 27,363 32,574 38,139 44,077 50,407 57,151 64,332                           Expenditure                         Direct material 1,200 1,224 1,248 1,273 1,299 1,325 1,351 1,378 1,406 1,434 1,463 1,492 Direct labor 350 357 364 371 379 386 394 402 410 418 427 435 Variable manufacturing costs 400 408 416 424 433 442 450 459 469 478 488 497 Factory overheads 400 400 400 400 400 400 400 400 400 400 400 400 selling and distribution costs 250 255 260 265 271 276 282 287 293 299 305 311 Total expenditure 2,600 2,644 2,689 2,735 2,781 2,829 2,878 2,927 2,978 3,029 3,082 3,135 Surplus or deficit 3,400 7,056 10,982 15,193 19,705 24,534 29,697 35,212 41,099 47,378 54,070 61,196 Introduction Financial planning entails determining in advance the financial needs in order to allocate resources efficiently. Budgets or forecasts are used as planning tools. Forecasting starts with a detail budgets such as production forecasts, sales forecasts and others. The purpose of this report is convinces investors to consider investing in this company. The new company focuses in producing an energy drink. Therefore, marginal costing is used to aid understanding regarding the costs involved. Break-even analysis will also be discussed in the report as it an application of marginal costing. Marginal costing Marginal costing takes into account variable costs during production while Fixed manufacturing overhead is treated as period costs. It is believed that only the variable costs are relevant to decision-making and that the reason why they are considered in production. Fixed manufacturing overheads will be incurred regardless there is production or not. Marginal costing is useful in making decisions and is widely applied in the break-even Consideration given to fixed cost. Appendix 1 illustrates a cost statement using marginal costing. The contribution margin is positive; therefore the plan of manufacturing an energy drink is a viable one. The fixed costs are not useful in the decision making process that is why contribution margin is used as it excluded fixed costs. Break even analysis Break even analysis is used in showing the relationship between selling prices, sales volume, variable costs, fixed costs and profits at various levels of activity. It is also referred to as cost-volume profit analysis. It used in determining the break-even point. BEP is the level of activity where the total revenue equals the total costs. Therefore, no profits are realized at the BEP. Appendix 2 shows the workings for the break-even point of the energy drink. At the level of production of 4,286 all fixed and variable costs will have been covered by sales revenue. However break even analysis has its limitations. To begin with, breakeven analysis assumes that fixed cost, variable costs and sales revenue behaves are linear. However, this is not the case since some overhead costs may be stepped in nature. As a result, the straight sales revenue line and total cost line tend to curve beyond certain level of production Another limitation of break even analysis is that it assumes that all the stock produced is sold. Therefore, changes in stock levels are not taken into account in the breakeven chart. Finally, breakeven analysis is only suitable in providing information to relatively small companies that produce one type of products. Thus it’s not suitable for companies producing different product. Margin of safety Margin of safety measures the amount by which sales may decrease before a company incurs a loss. Appendix 2 illustrates the margin of safety. Forecasting Forecasting is used in estimating future performance of the business. It is useful in the financial planning process which entails assessing future financial needs. Outsides such as investors use forecasting to value a company and determine its security. Financial forecasting is done by use of pro forma balance sheet and income since items in the balance sheet and income statement vary and grow at different rates. In order to forecast we should have a clear understanding of past financial performance to help us predict future financial performance. In our case, we used competitors as a platform by considering their costs, pricing and other performance indicators. Pro forma statements show forecasts for periods ranging from 1-5 years. In the income statement forecast as shown in appendix 3 we assume: Sales grow at 8% and cost of goods sold grow at the same rate as sales Expenses will be at 6% on sales Tax rate of 30% is to remain constant Interest expense will grow at 5% on debt We stated preparing the forecasted Balance Sheet by determining the retained earnings since they are both linked. The financial forecast of the balance sheet also provided us with an estimate of the external financing is needed to support our estimated sales. In budgeting for the fixed assets, we considered production equipments which will be utilized in generating revenue. The level of external financial has been determined although we will need to revise these amounts in before production starts. In the case of the balance sheet appendix 4 the main assumptions are: Fixed assets remain constant and depreciation in fixed assets will be at a reducing balance basis Inventory and accounts receivables, accruals and payables grow at 5% each year Dividends increase by 8% per annum Debt and equity remains constant The cash budget is an example of short-term financial planning. We have used it in estimating future cash inflows and outflows. Cash budget are only limited to cash making them not widely used as budgeting tool but for decision making purposes by managers. We used previous forecast in preparing the cash budget for example by looking at the income statement we considered material, labor and overhead costs. We looked at the cash flow patterns by considering accounts receivables and payables. We also predicted other payments such as loan and interest payments. In appendix 5 we have assumed that expenses grow at the rate of 2% and the cash inflow at 5%. Summary Having prepared the budgeted financial statements, it is vital to carefully evaluate these financial forecasts with management. For example, our aim is to raise 40,000 capitals as indicated in Exhibit 4. Therefore, questions must be asked before budgeted financial statements are finalized. In addition, forecasts are prepared on an annual basis. Uncertain events can take place during the year and may lead to inaccuracy of our budgets. The only way to improve our financial planning is by simply forecasting on a quarterly basis instead of annual basis. The first step to improving our forecasting is through recognition of certain fundamentals about forecasting. First, it relies on past information and relationships and if such relationships change then our forecast is rendered inaccurate. Uncertainties are to be put in to consideration in order to make our forecasts more accurate and also create different scenarios by assigning probabilities to each scenario. Also, short- term planning should be considered since long period leads to a higher degree of inaccuracy. Other approaches in forecasting Apart from forecasting, other approaches such as the statistical approach can be used in financial planning. A good example is the regression analysis which relies on the average relationships between the dependent variable and independent variable. For example linking advertising costs and sales we can say sales is the dependent variable and advertising is dependent variable. Regression analysis is widely used in forecasting sales. Conclusion From the discussion above, it is recommendable for investors to invest in this company as the income statement reflects a profit. The cash budget also indicates that the cash flow is favorable. In addition, the balance sheet position of that company is good. There are other theoretical factors that may affect returns such as competition, technological changes, tax and inflation. These aspects have not been taken into consideration as the break-even analysis assumes a perfect market exists which is not the case. References Alice C. Lee, John C. Lee, Cheng Few Lee (2009). Financial Analysis, Planning & Forecasting: Theory and Application. World scientific. Birt and Gregory Boland (2010). Accounting: Business Reporting for Decision Making. Wiley and sons publishers. By Cafferky Michael Cafferky, Jon Wentworth (20102).Break Even Analysis: The Definitive Guide to Cost-volume-profit Analysis. Business express. Carey, M., Knowles, C. & Towers-Clark, J., 2011, Accounting – a smart approach, Oxford. Colin Drury (2004). Management and Cost Accounting. Cengage Learning. Frank Wood & Alan Sangster, Frank Wood’s (2012). Business Accounting. 12th Edition, FT Prentice Hall. Jae shim, Joel Siegel (2007). Handbook of Financial Analysis, Forecasting and Modeling, 3rd Edition. CCH Jawahar- Lal (2009). Cost Accounting. 4th Edition. McGraw- Hill Education. Owen, S. A., 2003. Accounting for Business Studies. Oxford: Elsevier Butterworth-Heinemann. Read More