PART 1
1. What net profit target should Julie aim for, based on the figures?
Given:
desired income ~ ,000 initial investment ~ ,000
allowance for loan ~ ,000 expected ROI ~ 9%
growth fund ~ ,000 estimated tax liability ~ ,500
Julie expects an ROI of 9% from her ,000 equity capital, that is, ,700 annually. If that is the case, it totals to ,700 of after tax profit. Since she estimated her tax liability to be ,300, therefore Julie should aim for a net profit target of ,000. In figures:
= ,000 * 9%
= ,700
= ,000 + ,000 + ,000 + ,700
= ,700
= ,700 + ,300
= ,000
Julie should aim for a net profit target of ,000.
2. What gross profit margin percentage should Julie’s business earn?
Accounting Fees ,500
Advertising ,000
Cleaning ,400
Electricity ,800
Insurance ,200
Interest on loan ,600
Rent ,000
Stationery 0
Telephone ,000
Total Overhead Expenses ,000
To know the sales required in order for her to know the gross profit margin percentage:
Overheads + Target net profit / Contribution margin %
= ,000 + ,000 / 47.5%
= 0,000 “ required dollar sales
Since gross profit is sales less cost of sales: let x = cost of sales
4,000 = 0,000 – x
x = 0,000 – 4,000
x = 6,000
Using the formula for knowing the gross margin percentage:
Gross profit $
Sales $
= 4,000 / 240,000 * 100
= 47.5%
Given that Julie’s research indicated that she could apply an average mark-up of 90% to the stock she purchases, the gross profit margin percentage that her business should earn is 47.5%.
3. How much would Julie have to sell to break even?
Julie plans to apply a 90% mark-up to her stock, and from the table in the module, this mark-up should result in a 47.5% gross profit margin. It means that for every sales dollar, 52.5% goes to the cost of goods sold and the remaining 47.5% is left over to pay for the fixed costs. In figures:
,000
$ 47.5%
Which, reflected in the income statement would mean that:
Sales ,789.743 “ 100%
Less: Cost of sales ,789.743 “ 52.5%
Gross Profit ,000 “ 47.5%
Less: Overhead expenses ,000
Net Profit (break even point)
To illustrate more clearly, below is the break even chart for the above computation:
Julie’s planned business would have to earn ,789.47 in order to break even with the costs for purchasing the products.
4. What sales target should aim for if she wishes to cover all of her costs and earning the net profit calculated in Question 1?
As with Question 2, the computation for the sales target is as follows:
Since gross profit is sales less cost of sales: let x = cost of sales
4,000 = 0,000 – x
x = 0,000 – 4,000
x = 6,000
Ultimately, using the previous solutions, the variable costs could be arrived at in order to cover all the costs that Julie has projected while at the same time earning the net profit of ,000 calculated in Question 1.
Sales 0,000
Less: Variable Costs 6,000
Gross Profit 4,000
Less: Fixed Costs ,000
Profit ,000
5. Draw up a Projected Profit Statement for Julie’s business.
>> in the attached spreadsheet <<
6. Set a new sales target using the following sales mix.
- Product A (150% mark-up) ~ represents 50% of sales.
- Product B (100% mark-up) ~ represents 25% of sales.
- Product C (50% mark-up) ~ represents 25% of sales.
PRODUCT A
6,000 * 50% = ,000
* ,000 is the cost of sales for Product A
,000 * 150% = 0,500
*0,500 is the total sales for Product A
PRODUCT B
6,000 * 25% = ,500
*,500 is the cost of sales for Product B
,500 * 100% = ,000
*,000 is the total sales for Product B
PRODUCT C
6,000 * 25% = ,500
*,500 is the cost of sales for Product C
,500 * 50% = ,250
*,250 is the total sales for Product C
Thus:
Product A – 0,500
Product B – ,000
Product C – ,250
0,750
LINE ESTIMATED VALUE MARGIN % ESTIMATED
OF SALES ($) GROSS PROFIT
A ,000 60% ,800
B ,500 50% ,750
C ,500 33.3% ,489.5
6,000 ,039.5
The average margin for the whole business is thus:
Margin % = ,039.5 / 6,000 * 100
= .50825 * 100
Margin % = 50.825 or 50.85%
Julie aims for a gross profit margin of 47.5%, which is less than the above amount which resulted from the new sales mix. This means that the pricing formula provided in Question 6 is acceptable.
Using the new gross profit percentages provided and the cost of sales figure from the projected profit statement in Question 5, the new sales target using the said sales mix is 0,750.
PART 2
1. If she purchases the non-current assets she needs for her business, what amount will she need to set aside?
NON-CURRENT ASSETS (NCA)
Shelving and display cases ,000
Cash register ,000
Desk and chair 0
Computer 00
TOTAL COST OF NCA ,000
Julie needs to set aside ,000 for the non-current assets that she plans on purchasing.
2. Calculate how much Julie should allow for start-up costs.
STARTUP COSTS
Business name registration 0
Promotional advertising ,500
Legal fees 0
Utilities connection 0
Prepaid rent ,000
TOTAL STARTUP COST ,200
Julie should allow ,200 for start-up costs.
3. Calculate the total capital Julie will require.
For Julie’s Jools, it was assumed that she will need non-current assets of ,000 and her list of start-up costs total ,200. Since these figures are exclusive of GST, the total capital requirement including an allowance for GST will be:
Non-current assets ,000
Start-up costs ,200
Working capital ,050*
,250
Add: 10% allowance for GST ,670
Total Capital Required ,875
* Working capital is the initial set-up of core stock plus the prepaid rent plus the fund allotted for growth plus prepaid loans minus the ,000 trade credit that she has managed to obtain from her suppliers, which in figures, would be:
Cost of sales / 12 months
= 6,000 / 12 months
= ,500
,500 * 3 months = ,500 “ initial stock
,000 “ prepaid rent
,000 “ fund allotted for growth
,000 “ allotted for loan payment
Total current assets = ,500
,550 “ additional 10% cash buffer
,050
,000 “ less trade credit limit
,050
Total capital required of the business will be ,875.
4. If Julie invests her total redundancy package of ,000, how much will she need to borrow?
= ,875 – ,000
= ,875
From the total capital required of the business, which is ,370 and from her total redundancy package of ,000, she would need to borrow ,875 from creditors to start running her business.
5. What type of funds do you think Julie should access to set up her business?
Julie has already managed to obtain a ,000 trade credit limit from her suppliers so there is only the need to look for additional sources of fund. A line credit would be useful for acquisition of part of the working capital, as they may offer a lower rate than a business overdraft and present greater flexibility than all the other sources of fund. However, as mentioned in the module, there is the need to exercise discipline and control in the withdrawal of credit, as the business may end up paying for only the interests accrued and not the line of credit in itself. And because lines of credit are available through a number of easily accessible financial institutions, such as banks, Julie would do well to adopt the line of credit as one of the source of fund for her working capital. Commercial loan financing, particularly lending involving banks and similar financial institutions, is invariably one of the important components of any firm’s capital structure. In many cases, the first funding that the business receives will come from a commercial bank which is induced to provide a loan on the basis of the firm’s business and financial plans and the guarantees of one or more of the founders and/or their associates. As the firm grows, its commercial lending relationships will become increasingly important, and the business may find itself using a wide range of lending tools on varying terms and with repayment dates that may range from a few months to several years in the future.
Government loan programs may also provide a good source of financing for the business. In most cases, the loan terms offered under these government programs are essentially similar to those that might be offered by private commercial lenders; however, it may be that a government loan will be available to a firm that might not otherwise qualify for a commercial loan at that particular stage of its business. If at all possible, Julie should make an attempt to acquaint herself with the resources of the federal and state business development offices in her area. Term loans can be applied to the ,000 purchase of non-current assets of her business, and since it allows Julie to plan for her cash flow, it is one of the more ideal types of fund that exists for business financing these days.
Although many businesses are started with venture capital funding, in many cases the initial capital is provided by private lenders, including the founders of the business and their friends and associates. Private debt financing is generally short term in nature, which would serve the end of Julie’s plans, as she wants to pay off her debts in the earliest time possible. It additionally may be accompanied by some form of equity investment or the right to purchase equity securities in the future. Depending upon the circumstances, the documentation associated with private lending may be minimal, with the parties relying on the delivery of a simple promissory note containing the principal amount of the loan, the terms of any interest payment obligations and the due date upon which the loan is to be repaid. In raising funds from private lenders, Julie needs to be sure that she does not unduly impair the ability of the company to secure funding from venture capitalists, banks and other more sophisticated investors. In many cases, it will be expected that the private debt will be repaid upon completion of a subsequent venture capital financing or that the outstanding amount of any indebtedness will be converted into the security that is to be issued to the new investors on the same terms and conditions. A private lender may request the opportunity to serve on the board of directors of the company; however, any agreement on this matter should be made subject to further amendment in order to satisfy the requirements of any new investors.
6. List the factors Julie should take into account when comparing different financial products to ensure she secures finance on optimal term.
There are many basic considerations relative to the comparison of different financial products to ensure money to start the business. Knowledge of the legal and business issues that continuously arise in the course of obtaining capital to operate the business should therefore be known to Julie, or anyone who wishes to start a business, for that matter. Interest rate, fees and charges, the option to lease, borrow or buy, and the choice of finance brokers are already mentioned in the module so the next paragraphs will focus on the other considerations that need to be taken into account when comparing different financial products to ensure that Julie secures her funds on optimal terms.
Funding can be provided for a variety of different terms or durations. For example, equity financing is generally permanent, unless the company has an obligation to redeem the security at same date in the future. However, in commercial loan, as well as debt financing from private investors, is provided on a fixed-term basis and must be repaid at some time in the future. Loans may be made on a demand basis, in which case they must be repaid at any time that the lender makes a demand for repayment, on a short-term basis, which generally is considered to be for a term of no more than one year, or on a long-term basis, which means that the loan must be repaid on some date outside of a year from funding. It is important for the managers to fix the funding duration in a manner that conforms to the anticipated business cycle and needs of the business.
Every type of funding, including commercial loans, involves a degree of risk capital. Julie should assume some degree of risk that the capital provided to the business will not be repaid or that she will not realize the anticipated return on the investment of funds. It can be anticipated that Julie will seek some security for the risks assumed in advancing the capital, and she must be cognizant of the effect that any sort of protection might have upon the operations of the business, the interests of the shareholders, and the ability of the business to attract additional funding. The amount of risk managers are comfortable with is likely to have a large bearing on the debt position of the firm, particularly for small firm owner/managers, who often must personally guarantee a loan in order to procure one. Their financial risk propensity would thus seem to directly affect the capital structure of the small firm. The risk propensity of the owner and financial characteristics of the firm affect the amount of debt lenders are willing to offer and on what terms. This thus states that Julie’s aversion to risk and the financial characteristics of her business suggest different levels of risk of default to lenders. Therefore, the amount of funds they are willing to lend or invest may affect the maximum debt level a firm can achieve, as well as the cost of that debt. The above reflects the external perspective most prominent in corporate financial theory.
As for the private lending, there is a legal consideration. Private loans are generally evidenced by a promissory note executed by the borrower in favor of the lender which contains a promise by the borrower to repay the borrowed funds together with interest at the time or times specified in the note. The note usually does not contain all of the various agreements between the parties regarding the loan. Instead, the parties may enter into a separate loan agreement which sets forth representations and warranties from the borrower to the lender, certain covenants to be honored by the borrower, and any events of default that may give the lender the right to accelerate payment of the loan. So long as the promissory note is retained by the original lender, the borrower will be entitled to all of the benefits that have been provided to it under the terms of any separate loan agreement. However, if the note is a “negotiable instrument” and is transferred to a third party who is deemed to be a “holder in due course,” the third party will have the right to enforce the payment terms of the note even though the borrower might have a valid defense against the lender under the loan agreement which would entitle the borrower to delay payment.
Loans, on the other hand, may be made on the basis of the raw material, work-in-process, or finished goods inventory of a business. As with accounts receivable financing, the maximum amount a borrower may borrow is fixed as a percentage of the cost or market value of its eligible inventory. However, since inventory is far more difficult to value, and less liquid, than account receivables, the maximum percentage of inventory value that a lender is willing to advance is generally much lower than with accounts receivable financing. This should also be considered as an avenue by Julie so that she should be open to the possibilities that her fund sources are offering her.
PART 3
Total Capital Required ~ ,875
Fund Sources:
Redundancy package ~ ,000
Loan capital ~ ,875
Trade Credit ~ ,000
Term Loan ~ ,000
Private Lending ~ ,000
,875
Since Julie allowed for a 90% mark up to the cost price of her jewelry, and the table in the module shows that this will result in a gross profit margin of 47.5%, this means that if she sells 0,000 worth in a year, she will make an annual gross profit of 4,000 if the 6,000 amount of the cost of sales will be deducted. Thus, the cost of sales percentage is at 52.5%. Shown in a table:
Sales 0,000 “ 100%
Less: Cost of sales 6,000 “ 52.5%
Gross Profit 4,000 “ 47.5%
From all the workings on this paper, I can say that the financial plan for Jule’s Jools is viable because the projected income statement has reflected a net profit which, an amount which is not bad for a starting business. The projected sales are also very minimal, as they can be raised up by 10% per month of operation, with what the demand for sterling silver jewelry nowadays, which have become the replacement for gold jewelry. The financial plan can be further improved though. The mark-up of 90% could be raised up to 110%, since it is the normal mark-up of jewelry business nowadays. This would result in an increase in the gross profit of the business, which will ultimately have an effect on the net profit. The allowance for tax liability is somewhat small, too, considering the examples presented in the module, which showed that a profit of ,000 is allotted a ,000 amount for its tax liability. The trade credit limit could be negotiated to increase up to ,000, and if the owner knows financing institutions who offer lower interest rates and longer duration for payments, then so much the better.
Credit:ivythesis.typepad.com
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