Investment - PIZZA-DOT - Case Study Example

Business an investment proposal for a business (pizza delivery) Table of Contents Task Executive Summary 4 Task 2 – Sources of Finance 5 2 Sources of Finance 5 2.2 Implications of Different Sources 6 2.3 Evaluation 6 2.4 Cost of Different Sources of Finance 7 2.5 Impact of Finance on Financial Statements 7 Task 3 – Return on Investment 8 3.1 Assessment of Information Requirement of Different Decision Makers 8 3.2 Budget Analysis 8 3.3 Investment Appraisal 9 Task 4 – Potential Success of Venture 10 4.1 Evaluation of Appropriate Sources of Finance 10 4.2 Viability of Project 10 4.3 Unit Cost and Pricing Decision 11 Task 5 – Financial Documentation 12 5.1 Financial Statements 12 5.2 Comparison of Appropriate Formats 14 5.3 Business Comparison 15 5.4 Ratio Analysis & Interpretation 16 Conclusion 17 References 18 Appendix 19 Table 1:- Profit and Loss Statement 19 Table 2:- Balance Sheet 20 Table 3:- Cash Flow Statement 21 Table 4:- Cash Budget 22 Table 5:- Ratio Analysis 23 Task 1 - Executive Summary Financing of Project is deals with the actions related to raising, planning, and controlling funds required for investment. Primarily there the sources of finance can be broadly classified into debt capital and equity capital. When a company has not yet been incepted funds are primarily raised from long-term financial sources. There are mainly three types of sources from where a company can get it start-up capital for long term during its inception period- Venture Capital (VC), Private Equity (PE), and Small Business Administration (SBA) loans. This report is an investment proposal for a pizza delivery business named, PIZZA-DOT (Delivery on Time). The benefit of financing by venture capital is that it is a gamble on the new potential business venture that has the capabilities to earn higher returns in future. Assuming that business succeeds then the VC will earn high rate of return. Proper financial planning assists the new venture to develop sound business models based on financial information. Management of financial resources serves to distinguish key regions which are less profitable and thus require management consideration for improvement. The objective of this assignment is to present a business proposal to the investors identifying different sources of funds and what funding will be used in the venture. The report also indicates why a particular stakeholder is approached for funding and returns on investment can the investor expect from the venture. Task 2 – Sources of Finance Financing of Project is deals with the actions related to raising, planning, and controlling funds required for investment. Primarily there the sources of finance can be broadly classified into debt capital and equity capital. When a company has not yet been incepted funds are primarily raised from long-term financial sources. There are mainly three types of sources from where a company can get it start-up capital for long term during its inception period- Venture Capital (VC), Private Equity (PE), and Small Business Administration (SBA) loans. This report is an investment proposal for a pizza delivery business named, PIZZA-DOT (Delivery on Time). The amount of fund required for this project is approximately $50,000 whose detailed cost analysis and justification is shown in consequent part “Budget Analysis”.  2.1 Sources of Finance Venture Capital - A privately owned business that is yet to begin and not yet prepared to strive for open offerings may look for a venture capital financing. Organization gets venture capital as a manifestation of value capital. It represents risky financing and hence it can expect higher returns in future. Small Business Administration - SBA encourages loans and advance for another business venture through an outsider bank or helps the business to discover venture capital financing. It gives financial assistance related to supporting the business which are successful and are intending to expand. In the event of debt financing, SBA does not give credits specifically to the business. It is analogous to commercial business loans. Private Equity – It is similar to private equity investment or venture capital financing where the company invest in companies that are not yet equipped to raise finance from public. Private equity firms are those which have their own particular pools of capital contributed by diverse individuals and run by such managers who have profound information on financial markets and business sectors. 2.2 Implications of Different Sources The benefit of financing by venture capital is that it is a gamble on the new potential business venture that has the capabilities to earn higher returns in future. Assuming that business succeeds then the VC will earn high rate of return. However in the event that the firm comes up less than expected successes then they are likely to suffer huge losses. The promoter of the new organization is responsible to the private equity firm for any important decisions. Control over the business gets weakened as the promoter additionally cant gain access to the financing as it may stop the new business to issue equity stake. In the event of bank loan the new firm need to repay principal along with interest even if it incurs losses whereas however here no commitments. 2.3 Evaluation The discussion in section 1.2 suggests that VC is the most appropriate source of financing the new venture of Pizza Delivery. This is because a VC or PE assumes both the risk and reward of business and it does not involve regular cash outflows. It is thus recommended that equity capital is used to finance the project which will minimise fixed obligation and keep the financial statements healthy. 2.4 Cost of Different Sources of Finance The cost of capital or financing the new business will depend on investor’s expected rate of return in case of PE and VC. While the minimum return on investment can be discussed by promoters and investors at the time of entering agreement but actual return would depend on business performance and economic circumstances. According to the government policies, SBA’s terms and conditions may vary from time to time. Therefore it is better to check the present guarantee requirements before seeking assistance (SBA, 2013). SBA allows ventures to avail loans of maximum $150,000 with maturity more than one year at 3 percent. But current domestic and macroeconomic scenario is not very favourable for new venture to break-even before 3 to 5 years. The initial cost of capital or investor expectation is assumed to be 15 percent excluding long-term obligations.  2.5 Impact of Finance on Financial Statements If the promoters of this business choose to include debt capital to finance this project then it is very important for the business to have healthy financial statements. Since debt capital is a fixed obligation that requires regular repayment of interest along with principal. The business will have to pay regular interest on outstanding capital even if it incurs losses and has to liquidate assets. If the business is not able to earn more than its cost of capital then the net-worth of the investors will turn negative and business will be a failure. Task 3 – Return on Investment 3.1 Assessment of Information Requirement of Different Decision Makers The information requirement of investors can be obtained from the pro-forma financial statement like Profit and Loss Statement, Balance Sheet and Cash Flow Statement (see appendix section). The most important variables required for conducting are determination of initial cash outflow of the business proposal, expected cash inflows over sufficient time horizon, and expected rate of return or cost of finance. This basic information can be available only after preparing a budget analysis. 3.2 Budget Analysis The necessary start-up expense to setup a pizza delivery business is estimated as follows: The information on start-up expenses shows that cash at the beginning of the year is £5,000 only. The total income from sales/service is expected in first quarter is assumed to be £17,650 which is further assumed to be constant in shorter time horizon. The total fixed cost and total variable cost for the first quarter is £9,250 and £3,000 respectively. The subsequent fixed costs during next quarters are expected to be £3,180, £3,371, and £3,573. There will be cash surplus of £1,150 at end of first quarter if assumptions remain constant. The cash budget for the first year (shown in appendix) estimates the net cumulative cash flow of the business to be positive and approximately £15,215 at the end of year. 3.3 Investment Appraisal The choice of accepting or rejecting any project can be made by analysing the project using time value of money concept and using discounted cash flow techniques such as internal rate of return (IRR) and net present value (NPV). The NPV for a series of cash flows (outflow and inflow) is the summation of present value of each cash flow discounted at appropriate discounting rate which the investors expect to earn during the period of investment. The technique compares the present value of money on present day with the money expected to be received in future. The process is recommendable because it considers practical factors such as inflation and returns. The expected cash flows of respective projects are multiplied with present value of €1 received at the end of year at different discount rates (Gallagher and Andrew, 2007, pp.269-271). The IRR is very widely used in the industry to compare and measure profitability of investments. The method considers the concept of time value of money and is sometimes also called discounted cash flow rate of return. More specifically, IRR is the discount rate of investment at which the net present value of investment becomes zero (Campbell, 2003, p.44). Task 4 – Potential Success of Venture 4.1 Evaluation of Appropriate Sources of Finance As analysed, utilization of fixed obligation capital like debt finance can amplify the impact of earnings per share of shareholders. Debt financing is also cheaper form of raising funds for ventures compared to equity funds. The utilization of debt funds in capital structure of the firm increase the rate of profit for equity to the shareholders as long as the rate of return surpasses the expense of debt. Since financial risk is connected with inclusion of debt capital, this implies that if there is no debt funds then there will virtually be no financial risk. This also implies that activities which are totally financed by equity convey no financial risk. Subsequently, equity capital is the over the long-term has the potential to generate superior returns for the investors and is thus considered as appropriate source of finance especially for new business ventures. 4.2 Viability of Project The investment appraisal techniques reveal that the net present value of investment is £19,538.43 with an IRR of 29 percent. As the return on investment is more than cost of capital it is apparent that project is viable and investors may accept this project.  4.3 Unit Cost and Pricing Decision  Deliver Charges First Time Large Pizza Medium Pizza Any Size Stuffed Crust     Customers         Total ( For spending above £25) £ 3.30 £ 7.59 £ 6.57 £ 5.59 £ 8.09 £ 31.14 The average per unit cost of delivering pizza is expected to be £20 for sale of 8,825 units (in first year) and considering the demand of product and current competition in market the management could expect sales turnover of around £176,500. This means that average revenue per unit of pizza delivered will be £31.14 (shown in price chart above) making a profit of £11.14 per unit. The detailed cash budget for the period is shown in the appendix section. Task 5 – Financial Documentation 5.1 Financial Statements The main financial statements are pro-forma Profit and Loss Statement, Balance Sheet, and Statement of Cash Flow. The financial statement of a company aims to provide information about enterprise’s financial position on a given date. Such information helps the decision makers like potential investors to strategize correct course of action. 5.2 Comparison of Appropriate Formats The Profit and Loss Statement provides information regarding total revenues, cost of sales, and gross profit. It also provides administrative and operating expenses and profit. The net profit for the period is shown in the reserves and surplus section of balance sheet. The balance sheet reflects the total assets, liabilities and equity capital of the promoters. The assets and liabilities are also classified according to time period (long-term or short-term). The cash flow statement represents movement of cash inside and outside business. It is divided in three segments namely operating (net cash flow due to normal business operations), financing (cash flow due to financing activities), and investing (cash flow due to business related investments in assets) activities. 5.3 Business Comparison 5.4 Ratio Analysis & Interpretation The financial statements in isolation are not enough to give meaningful information unless it is compared with other financial statements. Accounting ratios is an important tool for financial statement analysis. Accounting ratios have immense application in interpretation of financial statements by helping perform both intra-firm and inter-firm comparison. The important ratios are depicted in details in previous section. Basically, the important types of ratios may be classified into profitability, liquidity, efficiency, and debt ratios. The ratio analysis reveals gross margin as percentage of sales will be 85.33 percent for first year which is expected to decline in consequent years due to very stiff competition from established market players like Dominos, Pizza Hut, Papa John, etc. External comparison of industry shows that gross margin as percent of sales at present is 60 percent. The liquidity ratio, shown by current ratio, is 3.62 percent compared to industry average of 0.98. The asset turnover ratio, which is an efficiency indicator, is 9.22. This is because this business does not require huge capital investment compared to revenues. The capital structure is moderately leveraged with very insignificant financial risk. This is revealed from the debt-to-asset ratio which is just 22 percent constituting mostly short-to medium term loans. Conclusion The report discussed an investment proposal for a pizza delivery business. The proposal outlines a business idea of what funding will be used and what the hopes to accomplish. The report also discussed why a particular stakeholder was approached for funding. The proposal analysed all possible sources of finance and implications of each on the financial statements of new venture. Appropriate investment appraisal techniques were used to evaluate attractiveness of investment. The important financial statements including profit & loss account and balance sheet reflects the possible financial position of the company and ratio analysis was used to interpret the financial statements. Conclusively, the business can expect over 11 percent growth in two years after inception while the industry is currently experiencing 7.6 percent growth and the investors can expect an IRR of 29 percent by investing in the business. References SBA, 2013. What SBA Offers to Help Small Businesses Grow. [Online]. Available at: http://www.sba.gov/content/what-sba-offers-help-small-businesses-grow. [Accessed on February 27, 2014]. Campbell, H. F., 2003. Benefit-Cost Analysis: Financial and Economic Appraisal Using Spreadsheets. United Kingdom: Cambridge University Press. Gallagher, T. J. and Andrew, J. D., 2007. Financial Management: Principles and Practice. 4. United States: Pearson Education, Inc. Appendix Table 1:- Profit and Loss Statement Table 2:- Balance Sheet Table 3:- Cash Flow Statement Table 4:- Cash Budget Table 5:- Ratio Analysis Read More