Introduction to Accounting and Finance: Marketing of An Energy Drink - Case Study Example

Introduction This report is intended for the prospective investors of ‘Salubrious Energy Drink’. The drink is meant to contribute to the well being of its consumers. The drink uses milk as one of its chief ingredients. Apart from that, sugar substitutes have been used to minimise the adverse effects of sugar in human bodies. It has been tested that human bodies do not suffer from any adverse consequences after consuming this energy drink. It has been decided that the drinks would be available in three flavours, orange, apple and pine apple in a can volume of 250 ml as of now. The organisation supports environment related activities. That is why the drinks would be available in the recyclable cans. The organisation values its investors are one of the significant stakeholders in the company. As a consequence, it is committed to offer a good return on their investment. It is for their information that this report has included the future income statement, the balance sheet and cash flow statement of the project. Apart from that, marginal cost statement and break even analysis of the project have been made to offer the investors a better insight of this venture. Marginal Cost Statement Marginal costing is an accounting tool which divides the costs into two categories. These are fixed and variable costs. The total cost includes both fixed and variable costs. The marginal cost of a product is also its variable cost. Marginal costing includes direct material, direct labour, direct material, direct expenses and the variable part of the overhead costs. In the marginal cost accounting, variable costs are charged to the cost units. Fixed costs are fully written off against the total contribution. The cost behaviour is required to be recognised and it is expected to assist in decision making. The difference between sales and marginal cost is known as the contribution cost. The term marginal cost either refers to the marginal cost per unit or total marginal cost of a department or batch of operation. Marginal cost considers costs which are direct to the specific project; that is why the cost technique is known as direct costing. In marginal cost statement, fixed costs are never charged with the production. They are considered as one time charge in a specific period and are fully written off in the period’s income statement. Marginal cost statement computes the marginal cost and the contribution, along with the excess of revenue over marginal costs (Hubpages Inc, 2010). The following is the marginal cost statement of the company. The direct labour cost for this project would amount to $ 2500 million. The company knows the significance of its workforce. The labours of this company are appropriately compensated for their work. The expected direct material cost of the company would be $ 2500 million. Direct materials of the organisation would include treated water, sugar substitutes, fruit flavours, caffeine, milk and other ingredients. Table 1: Marginal Cost Statement Direct expenses are those expenses which can directly be attributed to the production of energy drink. Here, the direct expenses include the repairing cost of machineries and other direct costs. Direct expense of this company is expected to be of $ 1000 million. Variable overhead costs comprise the expenses which vary with the changes in the production units. The variable overhead of the company is expected to be $ 1000 million. Total marginal cost for the financial year 2010- 2011 is expected to be $ 7000 million. The company has decided to produce some 300,000 cans of 250 ml energy drink. The marginal cost of a can of 250 ml energy drink will be around $23.33. Break Even Analysis From the business and accounting prospective, the break- even point is the point where the revenue of the company would be equal to the expenses. Table 2: Break Even Analysis In the financial year 2010 – 2011, the expected revenue of the company will be around $ 9000 million. The expected cost of sales will be around $ 7,000 million. The contribution margin is calculated by deducting the cost of sales from the revenue amount. In this financial year, the contribution margin has come around $ 2,000 million. As mentioned earlier, in the first year, the company would be producing 300,000 cans of 250 ml energy drink. Contribution margin per can is around $6.7. The fixed cost of the venture for this period is estimated to be $ 1200 million. The break- even point is calculated by dividing the contribution margin by the number of units produced. The company is expected to reach its breakeven point once it sells off 180,000 cans of 250 ml energy drink. The company can cover up its cost by selling 180,000 cans of energy drink in a year. However, at this point the company would not be able to fetch any profit. Cash Flow Statement A cash flow statement shows the impact of various transactions on a firm’s cash position. Three types of activities are included in the preparation of cash flow statement. The following is the prospective cash flow statement of ‘Salubrious Energy Drink’. The cash flow from operating activities is around $ 5,20,000. The net cash inflow from the operating activities has been calculated by deducting the depreciation and income tax from the profit amount calculated before taxation. In this financial year 2010-2011, the company has acquired property and plant amounting to $ 300000. However, at the same time, the company is expected to gain an interest of $ 90,00,000. The net cash inflow from the investing activities is expected to be of $ 60,00,000. Table 3: Cash Flow Statement The cash flow from the financing activities is estimated to be $ 1000000. Financing activities of the company would include issuance of debt, payments of debt, issuance of stock and purchase of stock. The company has no plan to pay off dividends in its very first year. However, the company knows the significance of its investors and intends to pay off dividends from 2012. The total cash flow from all activities is expected to come around $2120000. Balance Sheet The balance sheet is one of three significant financial statements of any business. The energy drink business has property, plant and equipments worth $ 1800000. Apart from that, the company has intangible assets amounting to $150000. The non –current assets or the fixed assets of this organisation amount to a considerable value of $2150 millions. However, the current assets amount more than double of the fixed assets. The company has an inventory level of $1900 millions. In the first year, the company would take considerable inventory on its accounting book. As of now, the pre-sales market research has revealed that the energy drink is going to have a considerable market share in its very first year as it is expected to experience a great demand in the US market. A considerable amount of this inventory would be used in huge marketing activities, to spread awareness about the product. The company has receivables amounting to $ 500,000. The organisation has acquired some assets which are expected to be replaced by some new ones. In such a case, the company would have assets worth of $100,000 for sale. The total current assets for the financial year are expected to be of $5900 millions. Some of the large distributors in this market have expressed their interests in buying off ‘Salubrious energy drink’. From this, the company is expected to fetch $ 200,000 as advanced payments received from the customers. In the first year, the company would have $1270 millions of current liabilities, while its long term liabilities and other payables will amount to $ 500 millions. The company does not want to keep more liabilities on its account. In the initial stage, the company would take more short term liabilities. However, with time, the company would concentrate more on long term goals. Although, the company prefers to finance its project with equity, still it would prefer to carry an optimal amount of debt. This debt would help the company to gain a tax shield over its profit amount. As a consequence, the company will be able to reduce its deductable tax amount considerably. The company intends to start its business with a share capital of $ 6280 million. The company will keep a low amount of debt on its accounting book, so that a major portion of the company’s cash inflow can be transferred to its shareholders. Table 4: Balance Sheet Income Statement The following is the estimated income statement of the company. As mentioned earlier, according to pre sales market research report, this energy drink is expected to fetch a good market demand in the first year. In the financial year 2010- 2011, the company is expected to earn revenue of $9,000 million. However, in its first year, the cost of sales is also supposed to be high. The cost of sales in this year is expected to be $ 7,000 million. Selling and administrative expenses would amount to a value of $ 1200 million, which is quite high. In this financial year, the company would be paying $ 100 million in tax. As a consequence, the estimated profit would be $ 700 million. Table 5: Income Statement Appraisal of this Venture It sometimes gets difficult to apprehend a large amount of data from the financial statement. To ease the process of understanding, some key financial ratios have been calculated. Undoubtedly, the investors would be able to fetch considerable amount of information by assessing these ratios. Financial ratios of the company can be divided into four key areas: liquidity, solvency, efficiency and profitability. In each of the segments, there can be different types of ratios. However, to facilitate proper comprehension, some ratios have not been calculated here. Rather, care is taken to include only those required from the investors’ perspectives. The revenue of the energy drink in its very first year is estimated to be considerably high. The reason behind this is that ‘Salubrious Energy Drink’ would contain no harmful ingredients; rather it would use the beneficial natural substitutes. As a consequence, the energy drink is supposed to experience a significant demand in the market. Apart from that, the company would be in collaboration with different gyms and yoga institutions. This is expected to contribute considerably in the sell of this energy drink product. Table 6: Key Financial Ratios The above table displays the key financial ratios of the company. Liquidity of a company is very significant as it evaluates the value of current assets in respect to the current liabilities of the company. Although there is no standard value of these ratios, a value of 2 can be assumed to be good for the company. The company is expected to take on a current ratio of around 4.65. This is surely good news from the company’s perspective as it reflects that the company would be liquid enough to sustain even in financial turmoil. The probability of distress for the company is quite low. However, sometimes the fair values of the inventories cannot be obtained by the company when needed. So, it gets difficult to transform the inventories in a short span of time. That is why this company believes that quick ratio values are required to be assessed as this ratio considers more cash like assets in its calculation. Quick ratios are calculated by dividing cash, cash equivalents, prepayments, receivables by the short term obligations of the company. The prospective quick ratio of the company is around 3.14. Undoubtedly, the ratio reflects that the company would have enough liquid assets to pay off its obligation, if required. So, the investors of the company need not worry about the liquidity of this company. Debt has both positive and negative sides. An optimal level of debt on the accounting book can give the company an opportunity to gain tax shield on its profit amount. This means that the company would have to pay less tax on its gross profit amount, thereby enhancing the profit margin. However, at the same time, keeping up a higher level of debt can increase the company’s probability of distress. The company prefers to finance most of its project with equity. As of now, the company has taken some short term debt in the capital structure. However, later, the company would be relying more on long term debt and shareholders’ equity. The estimated debt equity ratio for the company is 0.28. For this financial year, the company is expected to have around 28 % debt against its shareholders’ equity. The estimated debt would be around 22 % of the capital structure. The company can be expected to increase its debt amount in the near future. However, it would be ensured that the debt amount must not exceed the optimal level. The efficiency ratios reflect the company’s ability to manage its receivables and inventories. Higher inventory level may result in higher probability of distress. The prospective inventory turnover ratio of the company is around 4.74. The ratio is calculated as the revenue divided by the inventory level. Expected inventory turnover ratio is not quite satisfactory. However, from the very next year the situation is expected to enhance as the revenue would be much higher than the present financial year. From the very next year, the company would try to keep an optimal level of inventory to reduce the inventory handling expenses. Traditionally, profitability had been the most significant assessment of a company. However, this is not the case now –a-days. Though, profitability remains one of the significant key financial ratios in financial analysis, other factors has also gained importance. The expected net profit amount of the company in this financial year would be $ 700 million. The net profit margin of the company in its very first year is supposed to be around 7.8 percent. The organisation expects continuous positive growth in the years to come. From the investors’ perspectives, one of the most significant key financial ratios is return on equity. This ratio is calculated by dividing the net profit by the shareholders’ capital. In this financial year, the company would be offering a return on equity value of 11.14 % to its investors. With the increase in the profitability, the company will offer higher return on its investment. Overall, the company is expected to perform well from its very first year. The following years will experience more growth. The liquidity position of the company is satisfactory. Both the current and quick ratios of this company are expected to be high. However, the company must ensure that in the process its capital must not unnecessarily get stuck into its assets. In the very first year, the company’s inventory level would be a bit higher. However, the organisation has committed that it will never become alarming. The quick ratio of the company is high enough to reduce the probability of distress. The profitability of the company is decent enough to offer good return to its investors. Conclusion ‘Salubrious energy drink’ is different from its competitors available in the market. The ingredients of the drink consist of treated water, substitute of sugar, fruit flavours and other energetic ingredients, which are good for health. The energy drink would be available in three flavours: orange, apple and pine-apple. As the drink would consist of natural energisers, it is expected to create enough market demand. This is why the revenue of the company is estimated to be around $ 9000 million. The company is expected to reach its break even in its very first year. Moreover, the company assures that it would be able to sell off almost double the break-even units. Overall, it seems that the venture is a good investment opportunity as it encourages enough cash inflow into the company. The company would experience positive cash inflow in each of the cash flow activities including investing, financing and operating activities. Adding to it, the company would offer a good return on the shareholders’ equity and it can be expected that the ROE would be enhanced further to meet the expectations of the investors. As of now, the company does not intend to offer any dividends to its investors. The reason behind this is expected to be understood by the investors. As the company is new to this market, it will try to retain its earnings for further growth so that in near future the company can offer substantial capital gains to its shareholders. The company believes that its drive for excellence will help it to meet the expectation of its investors. Reference Hubpages Inc. 2010. Marginal Costing. [Online]. Available at: http://hubpages.com/hub/Marginal-Costing [Accessed on November 27, 2010]. Read More