So I recommend that the statements not be constrained by GAAP. It is imperative that you confirm with Banks, CRA and Organizing Committee that they will be willing to receive non-GAAP financial statements and they will not need an audit. I have some accounting issues and I will try to associate them with accounting items you provided me.
Accounting Issues
Nature of Business: I am assuming that business life is six months from January 2014 to July 2014.
Costs of Development of Business: I am assuming that the $15,000 you originally invested was used to develop the business. If any costs were paid by you personally, it must be added to $15,000.
Accounting item 1: In January 2014, $15000 deposited in bank in the name of venture is an asset and owner’s equity. Design cost of $1,200 paid in cash can be recognized as:
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Alternative 1: Assume $1,200 to be expense and decrease net income by $1,200.
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Alternative 2: $1,200 is the expense for 5000 souvenirs; recognize expense for only 1,500 sold souvenirs. Decrease net income by $600 and consider $1,400 be prepaid design cost in balance sheet.
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Recommendation: I would recommend you to use first alternative as it is business development cost.
Expense or Asset: In February 2014, you paid a license fee of $2,000. This can be recognized on the financial statement as:
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Alternative 1: Total $2,000 is an expense as cash has been paid. Considering it as an expense net income will decrease by $2,000 and cash will decrease by same amount.
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Alternative 2: Recognizing license fee as an asset (Prepaid) and depreciating it as per straight line method over six week period of business. It will be considered as an asset on balance sheet and depreciated.
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Recommendation: I would recommend you to follow first alternative as it is one of the expenses of developing business.
Interest Recognition: You took a loan of $30,000, for which you have to pay interest of $1,000 with principal.
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Alternative 1: Interest of $1,000 can be recognized as per cash based accounting at the end of business. There will be no entry in financial statement under this alternative.
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Alternative 2: Interest $1,000 can be recognized as an expense on income statement as per accrual accounting and it can be reflected on balance sheet as a liability (Interest payable).
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Recommendation: This is a cost of raising money which is used in the business. I would recommend you to use second alternative.
Expense Recognition: You had 5,000 souvenirs produced before the festival started. We can recognize the expense on the financial statement as:
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Alternative 1: We recognize the expense for 1,500 souvenirs and consider unsold souvenirs as an asset (Inventory). By this we will have expense for 1,500 sold souvenirs on the income statement and rest of the souvenirs will be recognized on balance sheet as an asset.
Alternative 2: As the cost of all the 5000 souvenirs has to be paid so we can consider all of them as an expense and decrease income statement by cost price $50,000.
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Recommendation: I would recommend using first alternative as rest of the 3,500 souvenirs is an asset of $35,000 (Appendix 3).
Van Cost and Depreciation: You purchase a van to transport souvenirs for $5,000. There is uncertainty over the depreciation of the Van.
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Alternative 1: Consider Van to be an asset. Since life of Van is much longer than the Festival period of six weeks, depreciation on Van can be considered to be 20%. This is going to add an expense of $1,000 (Appendix 1) to income statement and $4,000 will be added to assets in the balance sheet.
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Alternative 2: Consider Van to be an expense. Whatever is the amount Van sold can be taken as gain later.
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Recommendation: I would recommend using alternative 1 as it is practical and gives better performance of the business. Van be sold after the festival or could be used for personal purchases with the asset value of $4,000 (Appendix 3).
Revenue Recognition: Because the product and cash are not changing hands at the same time, there is some uncertainty as to when the revenue generated should be recognized.
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Alternative 1: “At the point of supplying it to vendor.” At this point the costs are known. However, there is uncertainty regarding the sales. Sales of $70,000 will be recognised in income statement under this alternative.
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Alternative 2: “At the point when customer has sold it to final customer.” This will give a better picture of earning but vendors might request for more discount at the end of business. Under this alternative sales will be $21000 (Appendix 1) and rest souvenirs will be $35,000 (Appendix 3) asset as per purchasing value.
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Alternative 3: “At cash collection.” This would reduce the estimation for discount request from vendor. Total $70,000 will be asset as vendors will be handing over the total cash after the festival gets over.
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Recommendation: In order to capture performance, we want to record revenues at the point at which the economic exchange took place, when customer pays to the vendor, occurs. Alternative 2 is recommended as discounted offered to vendor, if any, will be negligible.
Value of unsold Inventory: It is not known what will be the value of finally unsold souvenirs.
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Alternative 1: Unsold inventory should be written off after the business get over as the economic value of those souvenirs will be negligible as compare to the cost.
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Alternative 2: There might a chance to use them for something or returned them to recycle at lower rate but substantial as compare to cost.
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Recommendation: I would recommend using first alternative as it is difficult to assume the resale value, if any, right now. You should try to sell all the souvenirs by the end of the festival. Only 1,500 souvenirs are sold in first three and half weeks and 3,500 souvenirs are left to sell in last two and half weeks. 3,500 souvenirs taken as assets of negligible value after the festival.
Bank Covenant: I am not sure about the covenant bank had with you during providing loan to your business. I don’t see you following any bank covenant and I am assuming that you did not have any business specific covenant with the bank. If any, I recommend you to make sure that your business abides by the covenant.
Tax Payments: There was no information provided regarding the tax payment so I am assuming that there is no tax paid of any kind.
Feedback and Advice: So far your venture has not performed on expected lines. You have been able to sell 1500 souvenirs out of 5000 in first three and half weeks of the festival. It might be a challenge for you to sell 3,500 souvenirs in next two and half weeks. Even though I realize that souvenir is a symbol of remembrance and more people are expected to buy souvenirs in last week but you should aim to sell before business approach to last few days. Having said that, if you see large number of souvenirs left in last few days, you should offer special discounts so make sure you are able to sell all the souvenirs, as left over souvenirs will be of no economic value to you.
For request to withdraw money from venture, I would advise against that as your venture is undergoing a critical stage and is credited with $9,200 (Appendix 2). It is very important to have extra cash in hand to face any unexpected expenses. I would also suggest you to recover cash from vendors at the earliest.
Financial statements for me: As a banker, these financial reports are very helpful to me as they present me a present picture of business and give me an idea of what is expected in future. I am concerned that you are not collecting cash during the event and postponing it to the end. It is not a sign of a good business, you should try to reduce the account receivables and convert that to cash as early as possible. Another concern I have is over dependent on the sales in last week. You should try to advertise more and put more efforts in selling them before the end of festival to avoid last minutes changes in business strategy. You have to make sure to sell 2565 (Appendix 4) souvenirs more in next two and half weeks to breakeven the business.
These are the recommendations I have for you. Please note again that I have made some significant assumptions in my analysis. If these assumptions are incorrect, the analysis on which they are based has to be revisited. If that is the case, please contact me.
Appendix 1: Statement of income
|JEREMY LANGER |
|Income Statement |
|As of July 3rd, 2014 |
|Sales | | | | |$21,000.00 |
|Cost Goods sold | | | |$15,000.00 |
|Gross Profit | | | |$6,000.00 |
|Expenses | | | | |
|Souvenir Design Cost | | |$1,200.00 |
|License Cost | | | |$2,000.00 |
|Other Costs | | | |$1,000.00 |
|Van Depreciation | | | |$1,000.00 |
|Int Exp | | | | |$1,000.00 |
|Total Expense | | | |$6,200.00 |
|Gross Income | | | |-$200.00 |
Appendix 2: Statement of cash flow
|JEREMY LANGER |
|Statement of Cash Flow |
|As of July 3rd, 2014 |
|Cash from Operating Activities | |
|Net Income |-$200.0 |
|Sales¹ |-$21,000.0 |
|Depreciation |$1,000.0 |
|Interest Expense |$1,000.0 |
|Cash from Financial Activities | |
|Common shares |$15,000.0 |
|Bank loan |$30,000.0 |
|Cash from Investment Activities | |
|Equipment |-$5,000.0 |
|Souvenirs' Cost |-$30,000.0 |
|Total |-$9,200.0 |
|Cash at the beginning |$0.0 |
|Cash balance on 3rd July |-$9,200.0 |
¹ Assumed that sales were on credit and cash will be received in lump sum after the festival
Appendix 3: Balance sheet as of July 2014
|JEREMY LANGER |
|Balance sheet |
|As of July 3rd, 2014 |
|Assets | | | | | |
|Cash | |-$9,200.00 | | | |
|Account Receivable¹ |$21,000.00 | | | |
|Equipment² |$4,000.00 | | | |
|Inventory |$35,000.00 | | | |
|Total | |$50,800.00 | | | |
| | | | | | |
|Liability and Owner's Equity | | |
|Bank Loan | |$30,000.00 | | |
|Account Payable | |$6,000.00 | | |
|Common shares | |$15,000.00 | | |
|Retained earnings | |-$200.00 | | |
|Total | | |$50,800.00 | | |
¹ Assumed that sales were on credit and cash will be received in lump sum after the festival
² Considering that we will be able to sell Van for $4000 after the Festival
Appendix 4: Sales to Breakeven
Minimum Sales to breakeven
|Cash Outflow
|Interest on loan $1,000
|Inventory cost $50,000
|Other expenditure¹ $1,714 |=1000*6/3.5 | for 3.5 weeks=1000. Therefore for 1 week 1000/3.5.
|License Fee $2,000
|Design cost $1,200
|Van Depreciation $1,000
|Total $56,914
|Cash Inflow
|Souvenir sale price $14
|Number of souvenir to be sold to breakeven 4065 |=56200/14 |
|More souvenir to be sold to breakeven 2565 |=4014-1500 |
¹Other expenditure is considered as a continuous process. Therefore calculated for entire six week period.
Appendix 5: Expected Earnings
|Expected Earnings |
|Cash Outflow | | | |
|Interest on loan | | |$1,000 |
|Inventory cost | | |$50,000 |
|Other expenditure | | |$1,714 |
|License Fee | | |$2,000 |
|Design cost | | |$1,200 |
|Van Depreciation | | |$1,000 |
|Total | | | |$56,914 |
|Cash Inflow | | | |
|Souvenir sale price | | |$14 |
|Number of souvenir | | |5000 |
|Total Sales | | |$70,000 |
|Expected Net Income | | |$13,086 |
