Cost and Revenue Assumptions
Preparation of estimated financial statements requires certain assumptions concerning the likely gains and expenses of the proposed business. These assumptions will form the basis for the calculation of profit and cash flow from the business during the first year or first three-year period. In the case of this proposed venture of hair care product, the estimates of financial calculations are made for the first year of the business.
Therefore, predicted sales revenue for the first year is one of the major assumptions required for calculating estimated profits and cash flow. There must be other assumptions, which are related to the cost of producing and selling the products. These assumptions help in preparing the forecast income statement and cash flow. The costing assumptions include fixed costs, which are otherwise known as period costs. The fixed costs do not change with the volume of production or sales (Investopedia, 2011). Examples of fixed costs are factory rent and administrative staff salaries. Variable costs include costs like raw material cost and direct labor cost.
These costs change according to the volume of production or sales. The preparation of financial statements also requires other assumptions about the proposed investments in fixed assets like plant and machinery. The business needs some amount of working capital, which can be borrowed from banks or other financial institutions. The financial assumptions must state the proposal as to how the required capital will be arranged by the promoters. Estimated balanced sheet prepared based on the forecast income and expenses will show the financial strength of the company as at the end of the first year of operations of the proposed business.
Marginal Costing Cost Statement
Marginal costing system is a core concept in the traditional management accounting practices (Horngren et al., 2002). This system is one of the costing systems generally adopted to determine the cost of products. This system of costing is particularly useful in profitability and sales accounting. Since there is difference in profit margins on sales through different distribution channels, it becomes important to calculate individual profitability of different products sold through different channels to assess the relative profitability and make appropriate business decisions. Under this system of costing, the expenses incurred for production and sales are classified based on their nature, in to direct expenses and fixed expenses (Offenbacker, 2004).
Direct expenses are those incurred for producing the products. These include direct material cost, direct labor cost and other direct expenses like the power and freight costs (Lucey, 2002). The marginal costing system focuses on the behavior of different costs rather than the functions of the costs (Docstoc, 2010). Marginal costing system is useful in making pricing decisions by the managers. Companies use the marginal costing cost statement to arrive at the marginal cost of a unit of production. Marginal cost represents the addition to direct costs because of every additional item produced.
Marginal costing information enables the business managers to take short-term business decisions affecting the business of the company. For example, managers can decide on accepting a special order at an offered price, based on the marginal cost and the likely revenue from the volume of the special order. The assumption here is that fixed costs remain constant over a certain volume of production/sales and that the profit will increase by the contribution margin earned from the sale of the extra unit. Contribution margin is the amount of difference between the sales revenue and the direct expenses incurred to produce the additional unit.
The main advantage of marginal costing is that it shows the relationship between the additional sales, costs involved and profitability. Through an analysis of this relationship, firms may be able to make quick decisions whether to continue to produce an item or to stop the production if that particular product line does not provide any contribution.
Although the calculation of marginal costing leads to meaningful managerial decisions, the system has certain drawbacks. The marginal cost of a product is subject to the influence of so many other factors. This makes the application of marginal costing to the real world difficult. For example, sudden market changes and price discrimination by the supplier is likely to have a significant effect on the marginal cost of the products and thus on the contribution margin from the product (Scribd.com, 2011).
The marginal costing statement of the New Hair Product is presented below.
‘COOL’ Hair Care Cream
Marginal Costing Cost Statement
When the company is able to keep its marginal cost low, it adds to the competitive advantage of the company (Porter, 1985).The marginal costing statement for the hair product shows the contribution margin of £ 5.50 per unit of the new product. With the expected annual sales of 150, 000 units for the first year the contribution margin amounts to £ 825,000. After charging fixed cost of £ 555,000, the net profit works out £ 270,000. This profit works out to 12.85% of the total sales revenue for the first year.
Break Even Analysis
Breakeven analysis is an analytical technique to study the relationship between sales and fixed and variable costs. It is the point of sales at which the sales amount will be the same as the cost of production (Holland, 1998). At this volume of production, the firm will not be making any gain or loss from its business. Breakeven analysis works based on distinguishing between variable costs and fixed costs (Tutor2u).
Variable costs are those costs, which increase or decrease in accordance with the unit of production. On the other hand, fixed costs are not normally related to production volume. Breakeven analysis is based on the assumption that sales and variable cost of the units sold will remain constant. The concept also assumes that variable costs will change with the level of production. There will not be any change in the fixed cost. However, in the long -run variable costs may change for different reasons. Similarly, fixed costs may also increase in the course of time.
Breakeven analysis helps managers to decide on the volume of production/sales to be achieved by getting the required costing information (Drury, 2006). It also helps firms in different areas such as planning, decision-making and monitoring of expenses. “Buy or lease” decisions are taken by undertaking a breakeven analysis and it helps in the pricing decision of managers.
Normally the sales targets of firms can be fixed based on the breakeven point. Once the breakeven point is reached, the marketing manager can assume that the company has sold enough number of products to cover the fixed costs of the company (Harvard Business School, 2007). Sales of every additional units will enable the company generate profit (Sai). One of the major disadvantages of breakeven analysis is that it does not deal with the likely sales at different price points, except that it talks about costs of products only.
Another drawback is that the analysis assumes that the proportion of each product produced by multi-product companies is constant. In practice, this cannot be true. Another assumption of breakeven analysis is that goods produced by the firm is the same as the number of units sold and variable costs associated with each unit of output are the same in different levels of production.
The contribution margin per unit of production or sales is calculated as below:
“Contribution Margin per Unit = Revenues per Unit – Variable Expenses per Unit.”
Breakeven point can be arrived when fixed costs are divided by contribution margin per unit. The breakeven point is calculated based on the figures calculated under Task 2.
Fixed Costs
= £ 555,000
Contribution per unit = £ 5.50
Breakeven Point = Fixed Expenses/Contribution per unit
= £ 555,000/£ 5.50 = 100,909.09 = 100,909 units
From the breakeven point analysis, it is reported that when 100,909 units of Cool Hair Cream are sold, the business will be able to meet the total cost of producing the units; the business at this point will not make any gain or loss. Once the breakeven point in units is found, it is possible to convert the breakeven point to breakeven sales value or percentage of capacity.
Breakeven point in sales value = BEP in Units x Sales price
= 100,909 x £ 14.00 = £ 1,412,726.00
Breakeven point as a percentage of capacity = BEP in Units x 100/Capacity in Units
= 100,909 x 100 /150,000 = 66.67%
Break Even Table.
The above information can be presented graphically as below.
Financial Documents
The financial documents convey the forecast income and financial status of the proposed business. The purpose of financial documents is to enable the readers know about the ability of the firm to generate cash out of its operations. The forecast income statement will present the estimated profitability of the proposed business. Forecast balance sheet is an important part of the financial documents, which shows the financial strength of the proposed venture. Budgeted cash flow statement will show the ability of the venture to generate enough cash out of operations. While the forecast income statement will present the profitability of the operations, the forecast balance sheet will show the financial position of the proposed company as at the end of the first operational period usually at the end of the first year of its operation.
The financial documents of the new business of COOL HAIRCARE CREAM form part of this section. The business operations will start during January 20xx and the financial documents have been prepared for the 12 months period commencing January 20xx.
The promoters propose to £ 250,000 as their capital. A loan finance of £ 500,000 will be arranged to fund the fixed and working capital needs of the business. The company has to pay interest at the rate of 12% on the loan funds and the interest is payable every quarter. The loan will be repaid over 4 years time. The sales are assumed to take place on both cash and credit terms, with a credit period of 15 days provided for accounts receivable.
The business will enjoy a credit of 15 days from the suppliers. For running the business, investment in fixed assets like plant and machinery and other equipments will be £ 400,000, and these assets will be subject to depreciation at different percentages. Depreciation is treated as an expense against profits. At the beginning, the company will be functioning from rented premises. An amount of £ 90,000, being 12 month’s rent is assumed to be payable in advance.
According to the estimated cash flow statement, at the end of the first year of business, the company will generate operating cash flow of £ 274,000. This cash balance is after repaying the first installment of the loan of £ 125,000. With the cash flow at this level, the company will be having cash surplus to meet its short-term financial commitments. The financial situation of the company at the end of first year therefore can be considered as sound.
The operating profit of the business before interest and depreciation is estimated to be £ 494,000 and the operating profit margin on sales works out 23.52%, as per the forecast income statement. After charging interest and depreciation of £ 80,000, the business will earn a profit of £ 414,000 at the end of the first year of business. This shows the profitability of the business at 19.71% of the total turnover. It is assumed that the company may have to pay income tax at the rate of 30% on its net profits. Net profit after taxation is calculated at £ 289,800, which is 13.8% of the total sales. No stock of materials or other items has been assumed for calculating the estimated income.
With the case generation from the operations because of higher profitability, the business will be having a sound financial position as at the end of the first business year. The proposed capitalization of the company with loan funds of £ 500,000 forms a good basis for furthering the business of the company, with debt-equity of 60%. The current assets are sufficient to meet the current liabilities with a current ratio of 1.59.
Pitch
Business Plan for New “COOL” Hair Care Cream
Introduction
The changes in customer preferences especially in the field of consumer goods including cosmetic and beauty products provides many opportunities for new products to enter the market. People always try to experiment new products and test the quality to meet their needs. If the product is of required quality, there is no hindrance for the product to capture a reasonable market share within a certain period. It is also important that the price range of the product is within the affordable limits of the consumers and must be able to meet the competition from other products in the market, in terms of price.
With this objective in mind, the new hair care cream “COOL” is proposed to be produced, and will be introduced in the market as early as possible. This product is targeted at customer belonging to the young and middle-aged women, with the product helping them to keep their hairstyle intact. Apart from maintaining the hairdo, the cream will give a cooling effect it helps the hair grow faster. The cream also protects the hair from heat and dust. This memorandum consists of a note on the proposal for funding including the financial documents.
Background
The proposed product is aimed for the target customer group of women aged between 20 and 40, consisting of both employed women and homemakers. Although the hair care products market is flooded with number of branded and unbranded products, the customers are highly quality conscious and word of mouth is an important marketing communication for promoting the product. The proposed product has been subjected to all the prescribed quality tests and is approved for commercial production and marketing. The target market was identified and the marketing plan has been prepared based on a customer survey among the women of all age groups in different cities.
A professional consultant company was appointed to conduct the survey and report on the findings. The survey results indicated that the product could capture a significant market share in the first few years of introduction. The quality and price of the product has been appropriate for taking up the competition from the top three products of the same line available in the market. With the proposed marketing strategy and marketing communication, the product will achieve success in the first few months of entry.
Marketing Plan
The marketing approach for the proposed new product is based on the marketing mix principle of 4Ps of marketing. The 4Ps of marketing enables the decisions on “product, price, place and promotion of the product. Identifying 4 Ps will significantly influence the consumer buying behavior ((Brassington and Pettitt, 2003). Although the concept was introduced in the mid 1960s (McCarthy, 1964), there has been later research to develop the concept to suit the current marketing environment (Kent, 1986; Low and Tan, 1995; Palmer, 2004; Moller, 2006).
It is important that not only the quality of the product is competitive, but also it must be presented in an attractive way in the market place to attract more number of customers. The concept of 4Ps helps the company to decide its marketing strategy (Londre, 2009). The product decision includes decision on various elements like branding, functionality and styling among other things (NetMBA, 2010). “COOL” hair cream will be packed in attractively designed containers and outer packs, which will be superiority to the product as compared to other products in the market. The volume of containers will be decided based on the optimum consumption for two to eight weeks; it has been proved with the tests on consumption of the product, that it would meet the desired levels of satisfactory consumption.
The product is priced in comparison with other branded products in the market, so that it will be able to penetrate into the market. The price of the proposed product will rank third as compared to other two competitors. There will be an inaugural price reduction offer for introducing the product in the market. Various considerations like, sales and distribution cost, distributors and dealers’ commission have been taken into account while fixing the initial price of the product.
Being a cosmetic product, the new product will be made available at all retail points of sale including chain stores, supermarkets, convenience stores and pharmacies. The distribution arrangements will involve the services of dealers, distributors and agencies. Attractive margins for the distribution chain partners have been worked out in the form of commission on turnover, so that they would be interested in distributing the proposed product in large volumes.
The most important part of the marketing strategy is to adopt effective marketing communications. The customers should be made aware of the superiority of the products and the value they get for their money, by appropriate marketing communications. Direct marketing strategy will be engaged for promoting the sale of new product. The customers will be contacted directly through their email ids to explain the quality and comparative placement of the product in terms of the price. The marketing communication will elaborate on the superiority of the product by highlighting the salience of the quality and use of the product. Commercial media like the print and television media will be used for promoting the product. Appropriate marketing communication is an important element in the success of marketing (Kotler, 2009).
Financial Excellence
A review of the estimated financial performance of the business as shown by the financial documents annexed to this note will indicate the expected profits and return from the business from the first year of introduction onwards. With their own capital of £ 250,000 that will be introduced, the promoters are looking for financial assistance of £ 500,000 for meeting the fixed and working capital needs of the venture.
The promoters are willing to consider payment of interest at the rate of 10% per annum, with the possibility of converting the loan in to equity, if the investor would like to capitalize his investments. From the financial documents attached, it can be observed that the business has a payback period of less than three years. The business is expected to provide a rate of return of 38.64% on total investments. The net profit margin on sales is 13.8%, which is higher than any firm operating in the industry is.
Conclusion
The proposed product will sustain its competitive strength and win over the competitors, because of its placement in the market in terms of both price and quality. The product is cleared for human consumption and the laboratory tests have indicated potential benefits from using the product by the consumers, With the strategy on the proposed direct marketing communication and commercial promotion together with the inaugural price reduction offer, the product will penetrate the market soon an capture significant market share within a reasonable period. The market survey findings substantiate this premise.
The financial documents of the company indicate sound financial position of the business with the chance of higher returns on investments and substantial cash flow prospects. Therefore, the investment in the proposed business venture can be considered feasible and profitable.
Appendix
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