On top of this Halifax can supply an unsecured business loan for £20000 and at 8.9% apr over 5 years, which will cost £414 per month and includes 3 months of payment holiday.
The payments for the stock is given 1 months interest free credit by our supplier, the payment for this will be paid on the first of each month for the entire purchases made in the previous month.
The peak season for sales are in the Easter period, school holidays and at Christmas, because of this the Sweet Shop will invest in a small amount in marketing just before these periods. All purchases will be made by cash, with the intention of installing a credit and debit card facility in the future.
The costs of opening and running the shop will be the same no matter how many items are sold, as essentially the shop will be open the same number of hours each day and it will therefore require the same level of energy, etc.
Having invested heavily in to fixed assets the depreciation rates for each will be assumed as the following:
- Premises – 5%
- Van – 20%
-
Fixtures – 10%
Accounts
Analysis
Profitability
Mark Up = (Gross Profit) 66820/ (Cost of Sales) 75200 x 100 = 89%
Margin = (Profit) 8/ (Selling Price) 18 x 100 = 44%
The Mark Up is the profit as a proportion of sales revenue. The mark up is profit as a percentage of cost whereas Margin is a percentage of price.
The percentage shown are higher than that of most industries which works well in a small business as less stock turnover is required. The figures that are shown would allow for prices to be reduced and still allow for profit to be made, this may be something to consider if the sweets are proven to be Price Elastic.
Liquidity
Liquidity looks at a firm’s ability to meet its short-term debts.
Liquidity Ratio = (Current Assets) 38054/ 28520 (Current Liabilities) = 1.3
The accountants recommended result is about 1.5; however the trend is thought to be more important. A value at or below 1 would be concerning and a value greater than 2 would mean that too much of the company finances are tied up in short-term assets. I am happy with a value of 1.3 as it demonstrates a good level of efficiency by the business.
Acid Test = (Current Assets - Stock) 38054 – 8000/ (Current Liabilities) 28520 = 1.054
The Acid Test does not include stock as it is often difficult to turn in to cash and is therefore not that ‘liquid’. Accountants recommend that the outcome of the Acid Test should be about 1 (£1 of liquid assets for every £1 of short-term debt). Therefore the results in this case are near perfect.
The liquidity of this business is healthy because all sales are paid for immediately, whereas the purchase of stock is made with one month’s credit. If I was looking to improve the results of the ratios I could introduce a Just In Time system, which would minimise stock levels. Another alternative to this would be to increase capital and therefore cash by selling more shares.
Gearing
Borrowing Ratio = 72000 (Total Borrowings)/41,184 (Total Equity) = 175%
At 175% The Sweet Shop is very highly geared, being highly geared makes the company very vulnerable and in a recession sales may not be as high as one would hope, which may result in the business struggling to finance its borrowings.
The best way for the sweet shop to raise equity is to create more shares. Shareholders do earn dividends, however, in bad times dividends are not paid. The borrowings in place at the moment incur interest and this interest will need to be paid whether time are good or bad.
Efficiency
Stock Turnover = (Sales at Cost) 78900/ (Stock) 8000 = 9.86 Times
The result of the stock turnover is relatively high at 9.86 times. There are advantages and disadvantages to this. Obvious advantages are that stockholding is spread over many units and that the working capital that is tied up in stock is minimised and therefore frees up capital for other uses. It also ensures that stock does not go out of date.
Turning stock over frequently is made easier as the business are in control or collecting their own stock by visiting cash and carry organisations and collecting their stock using their own van. The problem with doing this frequently is that special offers and savings associated with bulk buying may be missed out on, which will increase variable costs.
Return of Total Assets
ROTA = (Operating Profit) 21184/ (Total Assets) 121704 x 100 = 17.4%
This is a ratio that measures a earnings before interest and taxes (EBIT) against its total net assets.
It is said that the greater the result from this calculation the more coefficient a company must be; meaning that they are using their assets efficiently. In time the sweet shop should look to increase the result of this ratio, however, at the same time it would be impressive to have such a healthy ratio (as the result is positive and not negative) in the first year of business.
Break Even Analysis
Break Even Point = 46786 (Fixed Costs)/ 8 (Contribution) = 5848.25 Units
The above formula shows the level of activity required for the sweet shop to break even. This calculation can also be represented in graphical form, shown below:
The break even analysis can be employed to aid management decisions in changes made to constituent element, such as a change in selling price. Other factors would also need to be considered before making a decision to change something like selling price. If selling price was to be reduced then the breakeven point would increase and it would therefore be wise to check the elasticity to see if a reduction on the price would increase sales significantly to maintain or preferably increase the level of profit made.
Investment Appraisal
As you can see in the accounts a van has been purchased at a cost of £10500, an alternative to getting a van would be having the stock delivered to the shop three times a week at a cost of £20 each time. However, having a van would increase flexibility, as having stock delivered would need an anticipation of what was need 2 days in advance, which would inevitably put the shop out of stock at times and therefore costs sales.
Payback
(Initial outlay) 10500/ (contribution per month) 262 = 3 years and 4 months
It is useful to know that given 3 years and four months the Sweet Shop could repay the funds that they would need to invest to purchase the van. However, as the van is being financed by a unsecured personal loan this would not be the case as interest would need to be taken in to consideration.
The problem with looking at payback is that it focuses on time, but ignores profit, making it of limited use unless supplemented by other methods such as average rate of return.
Average Rate of Return
4400 (Surplus)/ 10500 (Cost)/ 5 Years = 8.1%
It seems an easy decision to reject the idea of investing in to the purchase of the van as the average rate of return is lower than the costs of the finance.
Despite not raising enough to cover the borrowing cost (8.9% on the loan), as it is only marginal I would still choose to invest as the residual value would be in excess of £3000 and I would also hope to get more than 5 years of service from a new van.
Internal Rate of Return
Below I have used 12% as the cost of capital, as I have borrowed an unsecured loan at 8.9% and wanted to add a risk premium of 3.1%. I have also assumed 0% inflation, as I recognised that this would not affect the result and therefore improve understanding.
As long as the surplus is a positive value I would go ahead with the investment as it could prove critical to have the flexibility of collecting stock at critical times of the year. Therefore the value of the van could be more valuable than the figure allow you to believe. What must also be considered is the customer satisfaction (and therefore repeat purchases that would be made) as a result of always having stock available.
Summary
Taking in to account the investment, hours that would be worked and the stress of being self employees I would say that this investment is not viable. From investing the same amount of time and no capital risk, the directors can have the same return doing a menial job. On top of this I cannot see much more room for growth for an organisation such as this.
However, if the directors did decide to go ahead they should reduce their salaries to £6035 as this is a tax free amount and take any further returns by way of dividends, as dividends are only subject to 10% tax.
Bibliography
Benedict, A., Elliot, B. (2001) Practical Accounting, Prentice Hall
Jones, M (2006) Accounting, Second Edition, John Wiley
Lines, D, Marcouse, I, Martin, B (2000) the complete A-Z Business Studies handbook, Third Edition, Hodder & Stoughton
Robertson, J (2007) Accounting Principles for Non-Accounting Students, Second Edition, The Bath Press
Reflection
I entered this module having a vague knowledge on the subject, as I had studied an accounting module 5 years previous and now I feel the module has given me a good refresher and stable foundations to enter employment with.
I am a typical marketing student whose strengths do not sit with figures and finance, but with hard work and research I feel that I have produced a decent assignment. The assignment has proved to be the most significant part of this course as it has taught me skills that could essentially help me in my career when assessing investments.
I found that despite not working in a financial position figures and accounts will still play an important role in my career and it is important to have a fair understanding.
During the assignment I learned about the purpose of each of the different types of accounts and how to extract information for analysis. More specifically the investment appraisal showed me that I should not always take for granted what my common sense tells me, just because it looks like a good investment it doesn’t necessarily mean that it is and I should always have a closer look.
