Financial Plan for New Energy Drink - Assignment Example

Energy drinks Table of Contents Introduction 3 Product’s features of the energy drink 4 Marginal cost analysis 5 Breakeven point analysis 8 Estimated financial statements 9 ‘Pitch’ to explain the financial information to the investors 10 Reference 15 Introduction The constant flux that characterises the external environment also regulates customer’s taste to a considerable extent. This project aims to address the changing consumption pattern in a more innovative and creative manner. This is contextualised with the help of a new soft drink that aims to revolutionise the soft drink industry. To begin with, a financial plan related to the development of the new energy drink will be discussed. Considering the features of the product, different costs related to the project will be analysed. Later on marginal costing will be used to determine what should be the breakeven point in units as well as in sales so that the business can attain minimum revenue of zero profit. Using the information related to production and distribution, certain estimations will be done. This will require the use of cash budget, forecasted income statement and forecasted balance sheet will be developed. A plan is also framed to develop a consortium of small number of investors interested in developing a new energy drink, wherein a discussion related to financial issues will be carried out. Hence after conducting the required financial analysis, a properly planned ‘pitch’ of the project will be developed. It will aim to convey the required information to the potential investors in a systematic manner and convince them for investing. Product’s features of the energy drink The intended drink is set to combine the best of a health and a soft drink. Not only will it have the replenishing quality of a soft drink but will also address the energy requirements of its consumers. This energy drink will be available in a ready-to-drink form. This drink is named ‘My Drink’ in an attempt to bring every section of the population under its fold. To keep the product eco-friendly, it will be available in tetra packs made up of bio-degradable material. Initially only 250ml tetra packs will be launched in the market but later on sizes varying from 400ml, 1000ml and 1500ml will be launched according to the demand. Though the product will now be introduced in a single continental flavour, in future the company might introduce certain flavours like orange, lemon, vanilla, strawberry, chocolate, mix fruit and so on. The company has decided to take the help of a distributing firm until it has gained pertinent knowledge about the market operations. This is because investing in developing personal distribution, in the initial days, is not only risky but also results in high investment cost. It has also been decided to hire a distributer who will take the responsibility of making the product available to retail sellers. This might increase the cost of sales but will minimise the financial burden of arranging venture capital. All these information will be used to develop a financial proposal of the product. Marginal cost analysis Marginal cost accounting is a cost finding technique that assists in accumulating information related to different cost incurred in the organisation. A marginal cost statement provides certain vital information that is used to conduct several other analyses (Martin, 2006, p.8). Before developing any financial analysis for the production of ‘My Drink’, it is essential to ascertain different cost component related to this venture. The report of market research predicts good demand and a consequent sell of at least 100,000 tetra packs in the first year. Using this information, the cost of producing 100,000 packs has been determined. Different materials needed for producing the required number of packs has been calculated under cost of raw material. For simplicity sake, bifurcation of the raw material cost has not been shown in the marginal cost sheet. However, if any investor is interested in knowing the details, a full discloser will be separately provided. Similarly, the cost of raw material along with the cost of labour has also been determined. Considering the productivity of the available labour, the labour rate prevailing in the market, the total time required for producing the product and cost of labour has been calculated. This is basically the direct cost of labour, however indirect labour cost has been separately treated while considering the overheads. To make the venture successful, marketing plan has an important role to play. Hence it has been decided to allot 4 to 5 percent of the total cost for marketing related expenses. While developing the marginal cost statement, all the expenses related to product promotion, packaging and distribution process has been presented under the head ‘selling and distribution’. As per the plan, the task of product distribution will be outsourced to the third party. This might increase the cost of distribution but will help in minimising the risk. It is difficult for the greenhorns to develop personal distribution channel since they are prone to market disturbances. Hence it is recommended to outsource this task for the time being. However, the success of the venture will automatically result in having its own channel. While ascertaining the administration cost, all indirect expenses such as salary provided to the accountant, salary of the clerks for maintaining paper works and salary of other staff that will be working in office and storehouses have been derived. Considering the usual salary paid to these people and the number of people required for back office task, indirect labour cost has been derived. Apart from indirect labour, indirect expenses incurred for miscellaneous purposes are also included in administrative expenses. The cost of raw material, cost of direct labour, works expense, selling and distribution cost and administrative expenses together provides the total variable cost that will be incurred for producing 100,000 units (tetra packs of 250ml). Apart from the variable component, some fixed cost will also be incurred. Unlike the variable cost, the fixed cost is indifferent of the number of units produced (Ehrlenspiel, et al., 2007, p.414). Cost such as the rent paid to the factory, rent of the office as well as of the storehouse, cost associated with security issues and all other costs that are independent of the production level are components of fixed cost. While starting a new venture, companies prefer to keep fixed cost as low as possible because high fixed cost leads to high operating leverage. This improves the profitability but also enhances the risk. As for example, if the market condition deteriorates and total sales are reduced, company has to pay this fixed cost irrespective of production and sales. As a result, the profitability of the firm gets adversely affected. However, when the market is booming, high operational leverage assists in improving the annual profit (Brigham & Houston, 2009, p.421). Therefore, the management should decide the fixed cost component as per the risk appetite of the business. To minimise the risk associated with the new venture, fixed cost will be kept comparatively low. With time, as the business will gain stability, the fixed cost will be marginally increased to improve return on investment. The fixed cost along with the variable cost provides the total cost of production. According to the market information, there are several substitute energy drinks available in the market, but none of them possess the dual quality of the proposed energy drink. However, this does not minimise the risk of competition in the market. Athletes using energy drinks are highly loyal to a specific brand, and to make them skip to the new product may prove extremely challenging at the initial stage but once the consumers identify the benefits associated with ‘My Drink’ there is a high chance that the product will be accepted by the consumers and its demand will increase. Considering all these factors it has been decided that the profit margin should be at least 30 percent of the total cost incurred in the business. This means that per unit cost of 250 ml tetra pack of energy drink should be $2. This price is almost similar to the price offered by other energy drinks prevailing in the market. To further understand the profitability of this venture, contribution margin has been calculated. Contribution margin is calculated as the total revenue (sales) less total variable cost incurred during the production process. To determine per unit contribution, the variable cost per unit should be subtracted from selling price of each unit. An organisation should have a positive contribution margin (Finkler & Ward, 1999, p.288-289). Therefore, to determine the profit generating ability of the new venture, its contribution margin has been calculated. The total sales, cost, profit and contribution margin figures are provided in the above given table. This data will be used while discussing the venture with the potential investors. Breakeven point analysis After analysing the product features, the company has decided to conduct breakeven point analysis to estimate how many units should be sold or what should be the revenue to retain this business. This analysis has been conducted with the help of Cost-Volume-Profit (CVP) analysis. This is one of the commonly used analytical tools that assist in decision making process. As per this technique, breakeven point is a point where profit earned is zero (Hansen, Mowen & Guan, 2007, p.591). Therefore, before developing the breakeven point, it has been decided to finalise the required information associated with the product. This information is available in the marginal cost statement related to ‘My Drink”. At first, breakeven point in amount has been calculated. This means what should be the minimum revenue of the year so that the business can earn enough to pay the cost incurred in the production process. Using the information from marginal cost statement, the breakeven point in amount and in units has been calculated. Estimated financial statements While analysing the financial stability of a new venture, it is essential to analyse its forecasted performance in nearby future. The estimated cash budget, forecasted income statement and forecasted balance sheet have been prepared accordingly. These financial reports are developed on the basis of estimated sales volume, production cost and other indirect cost that will be incurred in the course of business. These financial reports will assist in convincing the potential investors regarding the bright prospect of this business in future. ‘Pitch’ to explain the financial information to the investors Introduction The present market is flooded with several energy drinks, however majority of them are targeted to the athletes. People still possess a misconception that athletes are the one who require energy drink because they have to do a lot of physical task. In reality, each and every human being needs energy to perform their day to day activities. Therefore, it is not just the athletes who should take energy drinks but even common people belonging to different age groups should take them depending on the energy requirements. Main Body: Earlier, people had time to prepare food that looked after the energy requirement of the body in a healthy manner. People had a balanced diet that contained adequate amount of required nutrients. However, with time, people were left with little time to prepare their own food. In today’s fast moving life, consumers rely more on packed food that needs no further cooking. Teenagers are more inclined towards fast foods which fail to provide the necessary nutrition as a result of which they suffer from energy deficiency. Considering the need for energy supplements, several companies introduced several products but many of them failed to attract the target customers. This is because the manufacturer did not understand that people do not have much time to prepare these energy drinks. The fact is people prefer such drinks that can be used instantly as and when required. Considering this fact an innovative energy drink named ‘My Drink’ has been planned. ‘My Drink’ is basically an energy drink having all the similarity of a soft drink. However, this energy drink will be free from common problems that plague the ones available in the market. It will neither have a high sugar content nor alcohol. On the basis of a thorough market research, it has been estimated that this energy drink will have fair demand in the target market and the company will be able to sell 100,000 tetra packs of 250 ml in the first year. Using per unit cost of production different cost components has been derived. As per the marginal cost statement, the company will incur marginal profit of $46,000, which is 23% of the total revenue. Using this information, the breakeven point in sales as well as in units has been calculated. As per the above given calculation, if the company can manage to sell 39,474 tetra packs, it will be able to reach the breakeven point. In terms of sales, total revenue of $78,947 is enough to retain the business. Therefore, if the business succeeds in selling the predetermined units it will have a safety margin of 61%. This reflects that even if the business fails to attain the estimates sales in future, it will be able to run its business quite comfortably. The contribution margin ratio (per unit contribution divided by per unit selling price) is 38%, which reflects a healthy profitability of the venture. This makes the business quite attractive to the investors. To further analyse the financial performance of the venture in its first year, several estimation has been made. These estimations have been used to develop forecasted cash budget, forecasted income statement and forecasted balance sheet. A positive balance of the cash budget means that the business is capable enough to generate healthy cash inflow to meet the cash requirement. This means, in future, if the external business environment remains constant, the company’s risk of short term solvency will be low. Similar to the cash budget, the forecasted income statement of the year has been prepared. The main aim was to analyse whether this venture will be able to generate positive returns for investors or not. The given table reveals that the venture of energy drink production will be profitable. The forecasted income statement reflects a healthy gross profit of 38% and a net profit of 16%. This means, in future, the business will generate sound profit for its investors. Using all this information, forecasted balance sheet of the year ending has been formulated. The balance sheet reflects the financial health of the firm. Hence it is of great importance. It appears that the business will be successful in retaining sound liquidity because the current ratio is 2.4%. This means that the business will maintain healthy liquidity to minimise the risk of short term solvency. The working capital requirement (CA-CL) of $46,400 is met with both short term borrowing as well long term loans. This provides a moderately stable capital structure. It is known that more is the financial leverage, higher is the earnings for the investors. However, high leverage reflects high risk of long term solvency (Pratt & Grabowski, 2010, p.332). Using information provided in the estimated balance sheet of ‘My Drink’, it appears that the business will have a debt-equity ratio of 0.85. This is means that the business will maintain equity of one unit to pay the long term debt of 0.85 units. Therefore, it can be concluded that the business will enjoy moderate to low financial leverage. Taking such a conservative approach is a good strategy because if the business faces adverse situation in future and the earning ability declines, then it might not be in a state to pay the interest on long term loans. In such a situation, high financial leverage may result in high risk of insolvency rendering the entire project unfeasible. Conclusion: The information derived from the above mentioned tables is expected to motion the investments in favour of the venture. The forecasted financial reports indicate that it possesses a healthy financial state. To minimise the risk, a conservative approach has been taken but again, caution has been exercised to ensure the profitability of the venture. This innovative health drink is expected to bridge the gulf that exits between the conventional soft drink and energy drink providers, and gain a wide acceptance among the target customers. Reference Brigham, E. F. & Houston, J. F. 2009. Fundamentals of Financial Management. Cengage Learning. Ehrlenspiel, K., Kiewert, A., Lindemann, U. & Hundal, M. S. 2007. Cost-efficient design. Springer. Finkler, S. A. & Ward, D. M. 1999. Cost accounting for health care organizations: concepts and applications. Jones & Bartlett Learning. Hansen, Mowen & Guan. 2007. Cost Management: Accounting & Control. Cengage Learning. Martin, 2006. Managerial Cost Accounting Practices: Leadership and Internal Controls are Key to Successful Implementation. DIANE Publishing. Pratt, S. P. & Grabowski, R. J. 2010. Cost of Capital: Applications and Examples. John Wiley and Sons. Bibliography Blocher. 2006. Cost Management: A Strategic Emphasis. Tata McGraw-Hill. Chauvel, A. & Fournier, G. 2003. Manual of process economic evaluation. Editions TECHNIP. Read More