Managing Financial Resources and Decision - Bubble Tea - Case Study Example

Managing financial resources and decision Table of Contents Table of Contents 2 Introduction and outline 3 Source of finance 4 Financial documentation 7 Return on investment 11 Accounting ratios 11 Venture’s potential success 13 Conclusion 14 Reference List 15 Appendix 16 Introduction and outline Bubble tea was first invented in 1980s in Taichung, Taiwan and since then it has become popular worldwide because of its sweetened tapioca or flavoured balls, which are poured in the drinks to give a texture of bubble (Focus on Globalisation, 2014). These balls are preferred by consumers as it gives a special mix of flavours. After its invention it was not successful internationally until it was telecasted in the television show by a Japanese businessman. Since then the product was catapulted to surrounding countries of Taiwan such as China, South Korea, Japan and many others. It also penetrated into Canada and Europe and gradually entered the US (Focus on Globalisation, 2014). The bubble tea became famous in Taiwan followed by its surrounding nations such as China. The tea drinking culture in China dates from the ancient times. Hence, the invention of Bubble tea was a spin in the Chinese tradition, which gave way for creative ideas for adding new tastes and interesting ingredients in the tea. The tea became popular in China particularly among the youngsters as they prefer different flavours of bubbles that are created by the special balls. The report lays emphasis on investment proposal of starting bubble tea franchise in Coventry, which is a metropolitan borough in Central England. The decision for opening a bubble tea franchise in Coventry is taken after performing a detailed market research pertaining to the taste and preference of the population in the area. In the Coventry, the Chinese population has increased with the immigration of Chinese students in the UK for post graduation degrees. In the UK, Chinese students were largest group of International students, who come to study in the UK universities (Mail Online, 2014; Gil, 2014). It is observed that around one-fifth of the students in the UK universities are Chinese and the figure is expected to rise to 44% by 2024 (British Council, 2015). The authentic Taiwanese bubble tea is not found in Coventry as a result the Chinese students are devoid of their favourite tea. Hence, if a bubble tea is opened in the Coventry the students can enjoy the taste of the authentic Taiwanese bubble tea. Chatime is s professional bubble tea maker who have franchises around the world. Hence, opening a Chatime franchise in the Coventry is wise idea as it will draw enough sales annually. For purchasing a franchise of Chatime excessive amount of money is required, which will also support the operation of the franchise. Therefore, potential investors are required, who can invest a supporting amount to the entrepreneur. The business idea is successful as bubble tea has gained popularity over the year in London (Nee Hao Magazine, 2013). The source of finance along with the financial statements is prepared in the investment proposal so as to examine the success of the business. The ratio analysis is carried with the predicted financial data so as to gauge the financial strength of the same in the Coventry. Source of finance Source of finance is an essential part of a start-up business without which an entrepreneur cannot succeed in starting the business. For purchasing a franchise, large amount of finance is required, which is not possible for the entrepreneurs to invest in the early phase. This amount of finance can be collected from a number of sources based on the nature and circumstances of the business. Generally there are two types of financing such as debt and equity financing. Debt financing takes into account borrowing of funds from the creditors, where the borrower has to repay the amount within a predetermined time frame along with the interest that is incurred during that time. Debt financing is both unsecured and secured (AG Decision Makers, 2013). The secured debt is seen to be collateral in nature i.e. a valuable asset that can be used by the lender to satisfy its loan if the borrower fails to pay back the amount (Wood and Sangster, 2012). Moreover, an unsecured debt does not involve any collateral agreement with the borrower and is used to finance a long term asset. Debt financing is obtained from banks and commercial lenders, who have gained prominence over the years. Banks and commercial lenders require an apporpriate business plan, which will depict the details of the business and track the changes in the financial data (Chartered Certified Accountants, 2013; Atrill and Mclaney, 2011). The business plan is referred as the blueprint of the actual business that is going to be set up in the due course of time. This plan is essential for a start-up business as it needs to collect fund for its operation from potential investors. The potential investors examine every aspects of the business plan so as to determine whether the business is profitable enough to generate revenue and profit over the years. They are concerned regarding the sales revenue of the business as they have to understand whether it has the ability to pay back the principle amount along with the interest within a stipulated time period. Other commercial lenders include any financial institutions and even any friends or relatives of the entrepreneurs who have the ability to lend a large amount of money to the entrepreneur privately (Dlabay and Burrow, 2008). In both the cases, the rate of interest is levied on the amount of the borrowed amount. The cost of borrowing is also examined in order to evaluate the amount that should be paid by the entrepreneur to the lender. Similarly the cost of debt is also considered in this case if the amounts are borrowed from bank. Another source of financing is equity financing. It is quite difficult for a start-up business to acquire fund through equity financing as it does not have any prominence in the market so as to attract shareholders. Hence, it is not possible for the entrepreneur to acquire fund with the help of equity financing. In order to open a franchise of Chatime in Coventry, Central England, the entrepreneur has to acquire enough funds. The cash is required both for purchasing the franchise from the owner of Chatime and also for operating successfully in Coventry. As per the franchise manager of Chatime, the going rate of the franchise of Chatime in London and Tier 1 city is about £75,000. Hence, the entrepreneur should keep its budget to about £ 1, 00,000- £ 1, 50,000. This amount is required for setting up the franchise and purchase raw materials for the franchise. The entrepreneur has to pay premise deposit of 50% of the rent per annum. The rent is assumed to be £75,000 per annum. The entrepreneur has to pay a 3 month advance of 25% of the rent along with 1 month stock order, which is dependent on the sales turnover of the business and the amount paid is 35.75% of the sales turnover. Other expenses include equipment and machinery, franchise fee, legal regulation compliance fees and other fixtures and fittings, which amounts to about 2.4 times of the return on investment (ROI). The mentioned investment guidelines should be considered before starting the franchise. For the initial start of the business, this amount is collected in form of borrowed amount from banks and commercial lenders. The main advantage of choosing debt financing over equity financing as the entrepreneurs can utilise the full amount for its operation and does not have to share with the lender as in case of equity financing. Debt finance is useful in the short run as the interest and the principle are paid back to the creditors (Needles, Powers and Crosson, 2010). This helps the borrowers to relieve form long term debt obligations. Moreover, the most significant reason for choosing dent financing over equity financing in this case is that the entrepreneur will get the tax advantage on the amount borrowed from the lender (Needles, Powers and Crosson, 2010). Financial documentation The financial statements are prepared so as to highlight the expected financial profit or loss and assets of the franchise. The financial statements include profit and loss account, balance sheet and cash flow statement. The following table indicates the predicted profit and loss account for the franchise of Chatime. Profit and Loss account Profit and Loss account   2015 2016 2017 Sales Revenue 250000 262500 275625 Cost of sales 125000 130000 135000 Gross Profit 125000 132500 140625 Expenses       Payroll 15000 15000 15000 Sales and Marketing and other expenses 5000 7000 8000 Depreciation   5000 5000 Rent 75000 75000 75000 Utilities (miscellaneous) 10000 4000 3000 Electricity 1000 1000 1200 Stock of goods 2500 5000 3000 Total operating expenses 108500 112000 110200 EBIT (Operating profit) 16500 20500 30425 Interest on borrowed amount 13000 13000 13000 Net profit 3500 7500 17425 In the above table the following assumptions: 1) The sales revenue is expected to increase 5% every year. Based on the taste and flavours of bubble tea that is sold in the Chatime franchise the increase is estimated. 2) The cost of sales of the franchise is based on the raw materials, which are used for preparing the bubble tea. It is expected to increase at a steady rate over the three years as estimated in the figures provided above. The price of the raw materials is subject to inflation and other macroeconomic agents. 3) The payroll is estimated to be £15,000 for the three years as the franchise expects to employ 10 employees including the managers (financial, branch and marketing). 4) The value of depreciation is calculated on the straight line basis from the second year of commencement of the business. The depreciation value is calculated on the necessary equipments of the franchise such as bubble tea sealer machine, bubble tea shaker, sugar dispenser and pint of sales system. 4) The annual rent is realised to be £75,000, which is paid to the Chatime owner for owning the franchise. 5) The utensils include stirrers, tea jugs, stove and shaker cups. Majority of the utensils are purchased in the year of commencement of the business. However, a significant amount is considered for next two years. 6) The operating expenses are also expected to increase as the franchise will be in a developing stage and it needs lots of development and innovative ideas that has high cost initially. 7) The profit of the franchise is expected to rise over the three years, which indicates that it will fetch good return to the owner of the franchise. The significance of the profit and loss account is that it highlights whether the franchise has the ability to generate enough profit. It helps the creditors to check the credibility of the borrower. It clearly depicts the each and every element that is associated with the transactions, which are made within a particular period of time; here the period is taken to be one year. Balance Sheet Balance sheet is defined as the summary of the financial data of a business, which can be sole proprietorship, business partnership or a corporation. It denotes the financial condition of the company or the business. A balance sheet usually contains three parts such as liabilities, assets and equity. The assets and liabilities can be compared in order to check the liquidity of the business or company. The difference between the current assets and liabilities indicates the working capital i.e. whether the business has enough cash balance to funds its daily operations. Hence, balance sheet plays an important role for the development of a new business as it highlights its financial strength to the creditors. The debt structure is visible in the balance sheet, which is an essential element from lenders or creditors. The following table highlights the estimated balance sheet of the franchise of Chatime. Balance sheet 2015 2016 2017 Assets Current assets Cash 165000 202500 225000 Inventory 2500 5000 3000 Trade receivables 1000 2000 3000 Total current assets 168500 209500 231000 Total assets 168500 209500 231000 Liabilities Current liabilities Accounts payable 15000 13000 10500 Short term borrowing 3500 21500 0 Total current liabilities 18500 34500 10500 Long term liabilities 150000 175000 220500 Total liabilities 168500 209500 231000 In the above table, both the assets and liability figures are assumed based on the expected income or sales revenue of the franchise. The cash and cash equivalents are predicted top increase because of the expected increase in sales revenue. This will be a positive approach on behalf of the franchise. However, the inventory is predicted to increase as the raw materials used for preparing the bubble tea are not used fully every year hence there is stock of goods. It is noteworthy that the franchise will concentrate on increasing its current assets base so as to maintain a stable working capital value over the years. The current liabilities are seen to be low as compared to the current assets; hence the financial condition of the franchise is expected to be stable enough to generate a positive feedback from the investors. Cash Flow statement The cash flow statement has three elements such as net cash flow from operating activities, financing activities and investing activities. This is the essential part of a cash flow statement as it identifies the total cash at the end of each period. The following figure depicts the cash flow statement of franchise of Chatime. Cash Flow statement   2015 2016 2017 Net cash flow from operating activities       Cash Sales 250000 262500 275625 Net cash flow from operating activities 250000 262500 275625         Net cash flow from investing activities       Capital investment 150000     Net cash flow from investing activities 150000 0 0         Net cash flow financing activities       Payment of long term debt 150000     Net cash flow financing activities 150000 0 0 Net cash flow -50000 262500 275625 The net cash flow for the first year is observed to be negative as the franchise will pay back its debt obligations. However, in the second and third year the cash flow is projected to be positive and increasing over the years, which is a positive indication for the franchise and ascertains that the franchise is ability to pay back the debt obligations. Return on investment The return on investment is calculated in order to examine whether the franchise will generate enough income by employing the capital that will be borrowed from the debtors. The following table highlights the ROI of franchise of Chatime if it is opened in Coventry.   2015 2016 2017 Return on investment       Return 250000 262500 275625 Investment 150000 150000 150000 ROI 66.66666667 75 83.75 The ROI of franchise of Chatime is predicted to increase over the three years due to the improvement in the sales revenue. Accounting ratios Ratio analysis helps in gauging the financial status of a company or business; whether it has a stable cash reserve for operating efficiently in the long run. In order to examine the financial condition of the franchise, the following ratios are calculated: leverage, activity, liquidity and profitability. Ratios   2015 2016 2017 Liquidity ratio       Current ratio 9.108108 6.072464 22 Acid test ratio 8.972973 5.927536 21.71429         Profitability ratio       Gross profit margin 0.5 0.504762 0.510204 Net profit margin 0.014 0.028571 0.06322         Leverage ratio       Interest coverage ratio 1.269231 1.576923 2.340385         Activity ratio       Accounts receivable turnover ratio 250 131.25 91.875 The following results can be deduced from the table provided above: 1) Liquidity ratio examines whether a business has the capacity to pay its suppliers and creditors in the short and long term without harming its inventory level. The liquidity position of the franchise of Chatime will be strong enough to sustain in the long run; this can be deducted from the above mentioned value of liquidity ratios. The current ratio indicates that the franchise will have enough current assets to pay back the current liabilities; moreover, the acid test ratio denotes that franchise does not have to harm its inventory level in order to pay back its suppliers and creditors in the shirt and long run. Hence, it can be stated that the franchise will have enough cash base to pay back its current obligations and this cash balance is derived from the sales revenue. This ascertains that the franchise will draw enough sales in Coventry. The Chinese students living in the Coventry will be overwhelmed to get the benefits of bubble tea, which is their favourite in their homeland. Apart from that the trend of bubble tea in the UK has also encouraged the general population in the UK to taste the different taste of bubble tea. 2) The profitability ratio measures the capacity of the company to draw sale and profit from the capital invested in the business. The gross and net profit margin of the franchise of Chatime indicates that it will be successful in collecting considerable sales revenue from the population in Coventry. However, the franchise has to concentrate on decreasing the operating so as to increase the net profit margin. 3) The leverage ratio of the franchise highlights the fact that it will focus on increasing the interest coverage ratio over the three years. It is predicted that the interest coverage ratio of franchise will increase over the years as its ability of paying the interest will rise due to the improvement in the sales revenue. 4) The activity ratio indicates the franchise will take time to receive its accounts from the debtors and customers in the first two years of commencement of the business; however, it is expected that the time frame will decrease as the franchise will prominence in the market. Venture’s potential success The factors that aims at establishing the fact that the decision of opening a franchise of Chatime in Coventry is appropriate for the entrepreneur: 1) There are high percentages of Chinese students in Coventry, who are devoid of the benefits of consuming bubble tea, as they used to do in China. In such a situation, a franchise of Chatime, which specialises in preparing bubble tea, will be an apporpriate venture plan. It will not only satisfy the needs of the Chinese students but also cater to the requirements of the UK students and population living in the Coventry. 2) The financial plan is very important for the franchise as it shows the expected financial status to the investors who will be interested to borrow cash for starting the venture. The financial plan ascertains that the franchise will have strong liquidity position to pay back its suppliers and creditors and sustain in the long run without harming its inventory level. The profitability position of the franchise is considerable and it is expected that the profit margin will increase over the years after it gains prominence in the Coventry. The return of investment (ROI) is also predicted to be high over the years from 2015 to 2017. Hence, the franchise will successful enough to expect potential investors, who can borrow cash to the entrepreneur. Conclusion The financial plan for starting a franchise of Chatime in the Coventry is observed to be appropriate over the three years. The liquidity, leverage, activity and profitability position of the franchise is considerable enough to get potential investor. Apart from the financial plan, the idea of opening the franchise in Coventry is apporpriate as large part of the population comprises Chinese students who like to consume authentic bubble tea, which they do not get in the UK. Reference List AG Decision Makers, 2013. Types and Sources of Financing for Start-up Businesses. [online] Available at: < https://www.extension.iastate.edu/agdm/wholefarm/pdf/c5-92.pdf > [Accessed 9 February 2015]. Atrill, P. and Mclaney, E., 2011. Accounting and finance for non-specialists. New Jersey: Prentice Hall. British Council, 2015. UK Universities Will Rely On China For Postgraduate Growth. [online] Available at: < http://www.britishcouncil.org/organisation/press/uk-universities-will-rely-china-postgraduate-growth > [Accessed 9 February 2015]. Chartered Certified Accountants, 2013. Source Of Finance. [online] Available at: [Accessed 9 February 2015]. Dlabay, L. and Burrow, J., 2008. Business finance. New York: Thomson South-Western. Focus on Globalisation, 2014. Bubble Tea. [online] Available at: < http://feo-english.weebly.com/bubble-tea.html > [Accessed 9 February 2015]. Gil, N., 2014. International Students In The UK: Who Are They Really? [online] Available at: < http://www.theguardian.com/education/2014/oct/13/-sp-international-students-in-the-uk-who-are-they > [Accessed 9 February 2015]. Mail Online, 2014. There Are Now Almost As Many Chinese Students On Postgraduate Courses At English Universities As British Students. [online] Available at: < http://www.dailymail.co.uk/news/article-2594935/There-Chinese-students-postgraduate-courses-English-universities-British-students.html > [Accessed 9 February 2015]. Nee Hao Magazine, 2013. New Bubble Tea Concept in Manchester. [online] Available at: < http://www.neehao.co.uk/2011/08/new-bubble-tea-concept-in-manchester/ > [Accessed 9 February 2015]. Needles, B., Powers, M. and Crosson, S., 2010. Principles of Accounting. Connecticut: Cengage Learning. Wood, F. and Sangster, A., 2012. Business accounting. New York: Pearson Business Studies. Appendix Read More