Table of Contents
EXECUTIVE SUMMARY
The aim of this report was to analyse the feasibility of a business project proposed by Uncle Xavier, a 60 year old man. His idea was to trade opals from Australia in the Swiss market. When Xavier told his wife about the new venture, she was pleased but still feared that the business could lead into financial loss. For this reason, careful assessment of different variables was important. The major areas examined in the study include the break-even analysis, Profit and Loss statement, balance sheet, and cash flow statement. Sensitivity analysis was also conducted with a focus on the net present value (NPV) determination. Some data used in the calculations were based on assumptions, estimates, and forecasts. The results showed that the company may not perform well in the first year of operation but will be able to succeed in the next four years. The break-even analysis proved that Xavier’s venture would perform well if he reduced price per opal since the market in Switzerland is highly price sensitive, and it would still yield him as much money as he would without changing the market price. The Profit and Loss Statement, on the other hand, reported that Xavier’s new venture would achieve a gross profit margin that would be a little lower for the service and manufacturing sector. The P & L statement also reported that the company would make losses in the end. The balance sheet, however, indicated that the company is better placed to fulfil all its short term obligations, since current assets were higher than current liabilities. The sensitivity analysis also produced a positive outcome, meaning that the project should be accepted. In conclusion Xavier should implement the business project but should make extra effort in controlling costs for future profitability.
THE MAIN REPORT
Summary of Assumptions applied in this Analysis
In this analysis, it is assumed that Australian dollars ($) are easier to work with. The money values have, therefore, been converted into Australian dollars ($) at an exchange rate where 1 Swiss Franc = ($) 1.35. For the first year cash flows, it is assumed that there will be a monthly increase of 20 sales from the second month to the twelfth month, so that the level of demand rises steadily from 30 opal sales to the full potential of 250 at the end of the first year of operation. Such a consistent amount will avoid confusion while enabling Xavier to place additional orders on opals in advance. The break-even analysis showed that reducing pricing by 20% would yield more revenue for Xavier’s company than when he raises pricing by 20%. The study, therefore, assumes the most appropriate price to use for the analysis is $183.6.
When calculating net sales, it is assumed that amount allowed for returns is 1% of the total sales. This percentage has been selected based on Bond’s (2017) explanation that the allowances usually vary between one and two percentage of the total sales. 1% is considered more appropriate because apart from being a small business, Xavier’s opal enterprise is a new venture hence has fewer returns ($183.6 is less than $229.5). Xavier’s opal business is also offering a pricing lower than the market price per opal in Switzerland. For this reason, trade discounts are assumed to be insignificant.
Under Profit and Loss statement, the study assumes that other income resulted from dividends. It is assumed that per share cost was CHF 2.50 and Xavier bought 1,000 shares by the end of the year. Moreover, it was assumed that Xavier paid total of $500 as depreciation on leased improvements. Deloitte (2015) reported that formal approval is not a necessity for foreign firms to operate in Switzerland hence this study assumes that Xavier will not pay for any state and local licenses. Since this is an online business, it is also assumed that insurance expenses are not applicable. Again, marginal tax rate is assumed as not applicable to the first year because the company has incurred losses and has no cash for investment. Since Xavier’s business is just started, it is assumed that there will be no investors in the first one year hence the balance sheet will not include shareholders’ equity. Finally, when calculating net present value (NPV) it was assumed that the discounting rate was 10%. Since most calculations used in this report were within the first year of operation, variables regarding transactions to be conducted one year in arrears such as: loan repayment of 4% per annum; and marginal tax rate of 30% investment or net income were not applicable. Moreover, the company made losses in the first year of operation hence had no extra cash to invest. With this the after-tax charge of 2% per annum on investment was not applicable.
Break-even analysis
Break-even point is a specific level that amount of sales or revenues must reach so that it equals expenses. At such a point, the company neither gets a profit nor incurs a loss (Sharma, 2014). Since break-even equals revenue to cost of the goods, it has become a crucial quantitative tool in decision making for managers. Break-even informs on whether or not revenue generated from a particular product or service has the capacity to account for the cost of producing the given product or service. Sharma (2014) explains that with this type of information, managers can easily make decisions concerning business aspects such as pricing, preparation of advantageous bids, and about loan application with various financial institutions.
Break-even analysis is therefore important of a working business plan which helps the managers decide if given ideas are worth investing into or not, and continues in the long run to help with setting appropriate pricing structure for the business (Kavian, 2014). It generally measures profits and losses at different rates of production and sales, forecasts possible outcome of alteration in prices, and analyses relationship between fixed variables. However, it uses some assumptions that may be misleading including: assumption that sales prices remain the same at different production levels, and that production and sales are the same.
For the calculation of break-even to be successful, however, three factors must be considered: fixed costs per month, variable costs per unit, and average prices per unit. According to Sharma (2014), fixed costs have no direct connection with the production level. This implies that fixed costs are not affected by rise or fall in production levels and can only be changed by alterations in rate of investment towards production capacity that result in additional production units. Examples of fixed costs include rent, machinery, and equipment costs. Variable costs, on the other hand, are costs that are directly affected by an increase of decline in the level of output. Examples include raw materials, shipping and sales commission, labour costs, fuel prices, inventory, and all costs that are connected to revenue (Kavian, 2014). Sharma (2014), however, states that in banking institution variable cost determined interest in deposit since there is a rise in cost of deposit due to increase in the amount deposited. In the case of Xavier’s company that produces a single good, the fixed costs and variable costs should provide the total costs for the production environment including: administrative costs, depreciation of equipment, and regulatory charges.
The formula for calculating break-even is as follows:
BEQ = Fixed costs/ (Average price per unit – average cost per unit)
BEQ is the break-even quantity. The BEQ shows the number of units that have to be sold in order to cover for expenses. Sales above this amount are profit for the business while amounts below indicate losses for the enterprise.
| Fixed costs | $30,375 |
| Average price per unit | $275.4 or $183.6 |
| Average cost per unit | $90 |
| BEQ for increased price ($275.4) | 163.835 |
| BEQ for reduced price ($183.6) | 324.52 |
Calculating Break-even for Xavier’s Business
Since Xavier’s business will be conducted online, one of the fixed costs is rent for the small office he has found at CHF750. Since 1 Swiss Franc equals Australian dollar (AUD) 1.35, CHF750 = 750 1.35 = AUD 1,012.5. Xavier also plans to buy racking and safe at CHF 3,500 (which equals $ (3,5001.35) = 4,725. Also Xavier plans to work with website designer for CHF 7,500, which equals $ (7,5001.35) = $10,125. Xavier has already spent CHF 8,500 ($ 11,475) on market research and will be required to provide security deposit which is three-times the rent (1,012.5 3) = $3,037.5.
Hence fixed cost = $(1,012.5+4,725+10,125+11,475+3,037.5) = $30,375
The price at the European market, as reported by the market research, is CHF170 per opal. This equals to AUD or $229.5. The pricing can be done in two ways: increase the price by 20% to maximize profit; or reduce the price by 20% to attract buyers, since the European market is highly price sensitive. If Xavier raises pricing by 20%, this will be 229.5 + (20/100 229.5) = 229.5 + 45.9 = 275.4. Conversely, if Xavier reduces the price by 20%, the pricing will be: 229.5 – (20/100 229.5) = 229.5 -45.9 = $183.6.
The pricing is therefore 275.4 or 183.6
OzJewels assumes the average sales of opals in Australia are AUD 150 per opal, hence plans to sell each opal to Xavier at a 40% discount. Therefore, the cost per opal will be: 150 – (40/100 150) = 150 – 60 = AUD 90.
Average price per opal thus = $90
BEQ = Fixed costs/ (Average price per unit – average cost per unit)
BEQ = 30,375/ (275.4 – 90) = 30,375/185.4 = 163.835 opals
OR
BEQ= 30,375/ (183.6 – 90) = 30,375/93.6 = 324.52 opals
For the First Month of Operation,
For the first month, the demand is predicted at about 30 opals. However, increasing the price leads to a fall in number of customers by 50%. If Xavier raises pricing in the first month, therefore, he will only have 15 sales (50/10030 = 15). This will be 15 163.835275.4 = $676,802.39.
If he reduces pricing however, he will experience 25% rise in demand. If demand was at 30, this will be 30 + (25/10030) = 30 + 7.5 = 37.5324.52183.6 = $2,234,320.2.
Xavier will sell more opals and generate more revenue if he reduces pricing per opal by 20%.
A Profit and Loss Statement for the first year of operations and Balance Sheet at the End of the First Year
A Profit and Loss Statement for the First Year of Operations
Donai (2014) explains that a Profit and Loss (P&L) statement gives an estimate of a company’s sales and expenses during a given period of time. It is also called income statement or earnings statement. The Profit and Loss statement, there sums all revenues sources and subtracts all the involved expenses so that a company’s progress within that specified time is determined. A P & L statement contains common components such as: net sales, cost of goods, gross margin, selling and administrative costs/operating expense, and net profit (White, Sondhi & Fried, 2002). It is a requirement by Internal Revenue Service (IRS) that revenues and expenses reported during a given period match hence the costs incurred during sales generation for the product must have a relation to the sales within the period.
P & L statement is important in that it acts as a monitoring tool to evaluate if the business is generating any money at all, hence should be prepared monthly or quarterly for new business. The statement offers timely details regarding revenues and expenses to enable operators make necessary adjustments that will help the business maximize profits. Moreover, P & L informs outside audiences about the ability of the enterprise to manage and utilize its resources. A P & L statement is also prepared by companies because IRS demands so (Bond, 2017). The record of business’ activities guides the assessment of taxes on profits gained by the business hence is the only financial statement that is useful to IRS.
The Profit and Loss statement make use of business data to conduct three calculations that will that will reveal the net profit (or net loss) of the company. It can be used as a tool to forecast future state of the business. However, it uses accrual method that accounts for a company’s revenues and expenses before they actually occur. This may lead to a greater differences from reality, hence is not very accurate. It can also be easily manipulated to impress investors who are interested in a given company.
Exhibit 1: Xavier’s Opal Trading Company: Profit and Loss Statement for Fiscal Year Ending 31st December, 2018
All amounts in Australian dollar ($)
| Net Sales Cost of goods sold Beginning inventory Merchandise purchase Freight Cost of goods available for sale Cost of goods sold Gross margin Gross Margin % | 381,704.4 -3,375.0 -185,625.0 -73,500.0 57,375.0 -262,500.0 119,204.4 31.23% |
| Selling, administrative, and general expenses Salaries and wages Purchase of racking and safe Web designing Market Research Rent Security deposit Packaging and shipping Other expenses State and local taxes and licenses (charges by credit card company) Depreciation and Amortisation on leasehold improvements | -76,140.00 -4,725.00 -10,125.00 -11,475.00 -12,150.00 -3,037.50 -48,195.00
-5,783.40 -500.00 |
| Total selling, administrative and general expenses | -171,630.90 |
| (Loss)/Profit from operations Other income (dividends) Other expenses (tax on dividends) Net (loss)/profit before taxes Provisions for income tax | -52,426.50 3,375.00 -168.75 -49,220.25 -3,853.95 |
| Net (loss)/profit after income tax | -53,074.2 |
Net sales
Net sales of a time period under analysis equals the total sales less allowances for returns and trade discounts. A small company like Xavier’s is likely to have fewer returns compared to others that are already stable. According to Bond (2017), the amount allowed for returns is approximately one or two percent of the total sales. This study will make use of 1% of the total sales as the amount allowed for returns. Since the analysis is already operating with a reduced price per opal, a pricing lower than the market price of opal in Switzerland, trade discounts will not be applicable. The Net sales are calculated below.
Calculation:
The first month sales should be 30 units of opals, and this study assumes that there will be additional demand of 20 opals from the second month to the 12th month of the fiscal year.
The total units sold should thus be:
(30+50+70+90+110+130+150+170+190+210+230+250) = 1,680
According to the market research report, there would be 25% increase in base opal volume is the price was reduced by 20%. The actual number of units will therefore be:
1,680 + (1,68025%) = 1,680 + 420 = 2,100
Total sales will then be: 2,100 183.6 = $385,560
Net sales = Total sales – allowances and trade discounts
Amount allowed on returns = 1% total sales = 1/100 $385,560 = 3,855.6
Net sales thus equals $385,560 – 3,855.6 = $381,704.4
Cost of goods sold
Also known as cost of sales, cost of goods sold is the total price paid for the products within the accounting period (White et al, 2002). In the retail sector of the economy, this is the actual accounting of price of goods according to the inventory or an estimated amount. For small retail businesses like this of Xavier, the cost of goods sold can be calculated by directly by adding the value of inventory at the beginning of the accounting period (original inventory) to the value of goods bought during the specified period (new inventory), then subtracting the remaining inventory.
Calculations:
Cost of goods sold = Beginning inventory + Purchased inventory – Inventory at hand at the end of the period
Merchandise purchases
If Xavier had a demand of 30 at the beginning of the financial year and had sold 2,100, he must have bought additional (2,100-30) = 2,070 opals. At the price of $90 in Australia, this equalled 2,070 90 = $186,300.
Freight
OzJwels airline freight charges AUD 35 from Australia to Switzerland, which is $35, and the packaging and shipment within Switzerland would cost CHF 17 or $ (17 1.35) = $22.95
= $35 2,100 = 73,500
=$22.95 2100 = 48,195
Cost of goods available for sales
Xavier planned to keep a stock of opals enough for at least four weeks’ sale. This means that at the end of the first year, he should have opals to meet the new market demand of 250. However, reduction in price should result in rise in opal volume demand by 25%.
The units available for sale therefore = 250 + (25025%) = 250 + 62.5 = 312.5
Given the selling price of $183.6, the cost of goods = 312.5183.6 = 57,375
Cost of goods sold
Cost of goods sold is = 2,100 90 (OzJewels discounted selling price) = $189,000. Plus freight expenses = $ (189,000 +73,500) = 262,500.
Gross margin
To compute for gross margin, net sales and cost of goods must first be determined.
Gross margin = Net sales – Cost of goods sold = 381,704.4 – 262,500 = 119,204.4
Selling and Administrative Expenses
For companies, Profit and Loss Statement records selling expenses, and general and administrative expenses. Selling expenses include all the expenses that are incurred either directly or indirectly during sales. They comprise of costs such as employee’s salaries, sales office rent, commissions, advertising, warehousing and shipping. According to Bond (2017) selling expenses comprise of costs incurred when taking and completing orders. The general and administrative costs, on the other hand, are expenses that have no direct association with sales of the involved products or services. It includes expenses like personal salaries, supplies, and all the expenses that are required to meet administrative duties of the business.
Net Operating Profit
Net operating profit is derived from the difference between gross margin and selling and administrative expenses.
Net operating profit = Gross margin – Selling and administrative expenses
Therefore, Net operating profit = $119,204.4 – 171,630.95 = -52,426.5
Other Income and other Expense
These determine the cost or earning made from activities that have no direct link to the business operations. Other income may therefore result from interest, dividends, rents, royalties, or earnings from capital assets (White et al, 2002). Alternatively, other expense reports any losses which are caused by factors in the external business environment. These are either added to or subtracted from the net operating profit, to arrive at Net Profit before Taxes. Deloitte reports that formal approval is not a necessity for foreign firms to operate in Switzerland hence this study assumes that Xavier will not pay any licenses. However, products are paid for online and Credit Card Company takes 1.5% per sale. 2,100 sales will therefore be (1.5% 2,100183.6) = $5,783.40
Assuming that the dividends cost CHF 2.50 per share and Xavier bought 1,000 shares in the first year, he will have CHF 2500 which is the same as $3,375. The 5% tax is charged on this amount (Deloitte, 2015). It will be 3,375 5% = 168.75
Net Profit
Net profit is the result of subtracting the estimated state or federal income taxes from Net Profit before Income Taxes. According to Deloitte (2015), Swiss state and federal government charges foreign direct investment same as local businesses and the effective tax rate is 7.83% of the net profit before tax. This will be 7.83% 49,220.25 = 3,853.95.
Net Profit/ (Loss) = Net Profit/Loss before Income Taxes – Income Taxes
= -49,220.25 – 3,853.95
= – 53,074.2
Balance Sheet at the End of the First Year
The following is the balance sheet for the above income statement.
Exhibit 2: Balance Sheet for the Fiscal Year ended 31st December, 2018
| Assets Current Assets Cash Inventory (opals available for sale) Other current assets | $28,125.0 $57,375.0 $3,375.0 |
| Total Current Assets | $88,875.0 |
| Long-term Assets (security deposit, website, and racking and safe) Accumulated Depreciation Total Long-term Assets | $17,887.5 -$500.0 $17,387.5 |
| Total Assets | $106,262.5 |
| Liabilities Current Liabilities Accounts Payable (including credit card company charges) Other Current Liabilities(transportation and packaging and shipping costs) Total Current Liabilities Long-term Borrowing ($94,500/CHF 70,000 at 4% per annum) | $28,985.63 $18,109.38 $47,095.01 $3,780.00 |
| Total Liabilities | $50,875.01 |
| Net Assets | $55,387.50 |
The balance sheet is the statement that shows financial position of the company within a specified date. It helps examination of the stability of the financial state of the business (Sharmila, 2016). The three major components are assets, liabilities, and equity (Lan, 2012). Assets are the possession of the company that it utilises for the purpose of the business. Assets are subdivided into two: current assets, and non-current assets. Current assets can be turned into cash within a year or less, since they are liquid. Non-current assets include fixed assets such as properties, plants and equipment used for production but cannot be changed into cash within a year. Conversely, liabilities represent the company’s debts which it should pay. Current liabilities must be completed in one year, such as salaries of employees. Non-current liabilities, therefore, are obligations payable within a period longer than one year such as bank loan. Shareholders’ equity thus is the contribution from investors interested in the company (Sharmila, 2016; Lan, 2012). It provides important information about a company’s assets and liabilities to investors, as it informs about financial stability of the company. However, it may provide inaccurate information since it is not complete representation of a company’s financial condition.
Monthly Cash Flows for the First Year of Operation
A cash flow informs about the amount of cash that is generated and the time period being analysed. It is very important to business analysts. A cash flow statement is usually divided into three sections: operating activities, investing activities, and financing activities (Khansalar & Namazi, 2017; Deo & Liu, 2016). Cash produced or used under the three categories is usually combined with the opening cash balance of the period to compute for the closing cash balance. Cash inflows and outflows are monitored for the purpose of comparing cash generated from operations to the net income so that the company’s efficiency is determined. Cash flow statement generally reflects a company’s profits more accurately compared to income statement which is developed under the accrual basis of accounting (Khansalar &Namazi, 2017) as revenues being matched with expenses may not have been gathered or the claimed expenses paid. However, cash flow on its own is not enough to derive Profit and Loss statement because the information it provides is simply related to a company’s financial situation.
Exhibit 3: Monthly Cash Flows for the First Year of Operation for the Fiscal Year ending 31st December, 2018
All amounts in Australian Dollar ($)
| January | February | March | |
| Operating Cash Flow Receipts from customers Payment to suppliers Payment to employees | 6,885 -3,375 -6,345 | 11,475 -5,625 -6,345 | 16,065 -7,875 -6,345 |
| Investing Cash Flow Investment in property and equipment Cash from investing | -14,845 -14,845 | – – | – – |
| Financing Cash Flow Issuance (repayment) of debt Cash from financing | 94,500 94,500 | – – – | – – |
| Cash Balance Net Increase (decrease) in cash Opening cash balance | 76,820 – | -495 76,820 | 1,845 76,325 |
| Closing cash balance | 76,820 | 76,325 | 78,170 |
| April | May | June | |
| Operating Cash Flow Receipts from customers Payment to suppliers Payment to employees | 20,655 -10,125 -6,345 | 25,286.25 -12,375.00 -6,345.00 | 29,835 -14,625 -6,345 |
| Investing Cash Flow Investment in property and equipment Cash from investing | – – | – – | – – |
| Financing Cash Flow Issuance (repayment) of debt Cash from financing | – – | – – | – – |
| Cash Balance Net Increase (decrease) in cash Opening cash balance | 4,185 78,170 | 6,476.25 82,355 | 8,865 88,831.25 |
| Closing cash balance | 82,355 | 88,831.25 | 97,696.25 |
| July | August | September | |
| Operating Cash Flow Receipts from customers Payment to suppliers Payment to employees | 34,425 -16,875 -6,345 | 39,015 -19,125 -6,345 | 43,605 -21,375 -6,345 |
| Investing Cash Flow Investment in property and equipment Cash from investing | – – | – – | – – |
| Financing Cash Flow Issuance (repayment) of debt Cash from financing | – – | – – | – – |
| Cash Balance Net Increase (decrease) in cash Opening cash balance | 11,205.00 97,696.25 | 13,545 108,901.25 | 15,885 122,446.25 |
| Closing cash balance | 108,901.25 | 122,446.25 | 138,331.25 |
| October | November | December | |
| Operating Cash Flow Receipts from customers Payment to suppliers Payment to employees Freight Market research Packaging and shipping cost Depreciation and Amortization Rent (for 12 months) | 48,195 -23,625 – 6,345 | 52,785 -25,875 -6,345 | 57,375 -28,125 -6,345 -73,500 -11,475 -48,195 -500 -12,150 |
| Investing Cash Flow Investment in property and equipment Cash from investing | – – | – – | – – |
| Financing Cash Flow Issuance (repayment) of debt Interest paid Cash from financing | – – – | – – | – -5,783.4 |
| Cash Balance Net Increase (decrease) in cash Opening cash balance | 18,228.00 138,331.25 | 20,565.00 156,556.25 | -115,548.4 177,121.25 |
| Closing cash balance | 156,556.25 | 177,121.25 | 48,923..05 |
The values in the above tables have been calculated based on the assumption that base volume for opals demands for the first month will be 30. However, since the pricing applicable to this analysis has been reduced by 20%, it is expected that demand for opal will rise by 25% to make the demand 37.5. The pricing being used is $183.6 per opal while the suppliers are offered $90 per opal. Moreover, it is assumed that the demand for opal will rise by 20 per month so that the 250 target is achieved in the twelfth month. The monthly rise in demand is also influenced by the 25% rise in demand.
Annual Cash Flow Statement
Exhibit 4: Annual Cash Flow Statement for the First Year of Operation
| First Year Cash Flow | |
| Cash flows from operating activities Net Income Depreciation and Amortization Changes in Working Capital Cash from operations Others Interest paid Tax paid | -53,074.00 +500.00 41,780.99 -10,793.01
-5,783.40 -3,853.95 |
| Cash flows from investing activities Payment for property, plants and equipment Payment for intangible assets | -4,725 -10,125 |
| Net cash outflows from investing activities | -14,845 |
| Cash flows from financing activities Issuance of debt Repayment of borrowings | 94,500 – |
| Net cash outflows from financing activities | – |
| Net (decrease)/increase in cash and cash equivalents Opening cash balance | 59,224.64 – |
| Closing cash balance | 59,224.64 |
Operating Cash Flow
This category has other subdivisions, as discussed below. Generally in this section, the cash added or subtracted are related to the changes in current assets, current liabilities, and non-cash accounts (Deo & Liu, 2016).
Net Income
This is often displayed at the bottom of income statement and shows that profitability of a company.
Depreciation and Amortization (D&A)
Depreciation is expense charged on assets in the course of use. It applies to tangible assets such as buildings, machinery, and in this case applies to the small office that Xavier should rent (assumed to be $500 per year). Conversely, amortisation applies to intangible assets like patents, goodwill, and in this case the software used for online business. The D&A is now added to cash flow as opposed to income statement where it reduced net income.
Changes in Working Capital
This represents the difference between current assets and current liabilities of a company. Any alterations in current assets and current liabilities, which are not related to cash, affect cash balance.
Cash from Operations
This represents a summary of the amount of cash generated from the core business.
Investing Cash Flow
This division reports on the alterations made to the capital expenditure (capex) and long-term investments. Capex can represent purchase of property, plant or equipment while long-term investment can be debt and equity instruments. Any changes made to long-term assets in the balance sheet are supposed to be reported under investing activities of cash flow.
Investment in Property and Equipmentj
It will include purchase of racking and safe, and web designing. Such an investment would be a cash outflow and will need to be subtracted from the net increase.
Cash from investing
This reflects the total amount from investing activities.
Financing Cash Flow
This section reports all the issuance and repurchases of stocks and bonds of a company along with the possible dividend payments earned. This category also includes changes made to long-term liabilities and stockholder equity reported in the balance sheet.
Issuance (repayment) of debt
It is possible for a company to issue debt to finance its activities as more cash supports rapid expansion of the business. As opposed to equity, issuing debt does not offer the company ownership. Debt issuance is cash inflow, since investors will act as lenders, but debt repayment is cash outflow. Xavier plans to borrow $94,500 (CHF 70,000).
Issuance (repayment) of equity
This will not apply to the company in its first year of operation.
Cash from financing
This is computed by adding up all the cash inflows and outflows related to changes in long-term liabilities and shareholder’s equity accounts.
Cash Balance
Net Increase (decrease) in Cash
This state is reached when all the details of the three major categories are already gathered and reported. The values are then summed up to realize either rise or decline in the net cash for the period being investigated. The resulting amount is then added to the opening cash balance to determine the closing cash balance.
Opening cash balance
This represents the closing balance from the previous duration. The amount if often found on the cash flow statement or balance sheet.
Closing cash balance
Closing cash balance is the outcome of adding up net increase or decrease in cash and the opening cash balance. It is often reported under current liabilities in a balance sheet.
Amount needed to get started
When creating the Profit and Loss statement, the data showed that net sales were $381,704.4, which however did not cover all expenses and resulted in losses amounting to $53,074.2. This means that Xavier would need more than $381,704 to cover all his expenses. To achieve a value at which Xavier neither makes profit nor losses, a sum of the net sales and the resulting losses should be determined. It will be $(381,704.4 + 53,074.2) = $434,778.60. Xavier therefore needs $434,778.60 to get started.
Sensitivity analysis
Sensitivity analysis is also known as what-if analysis. It is a tool in management accounting that organizations employ to determine possible relationships shared by various project variables including: sales, profitability, liquidity, and the general state of the working capital (Laidre, 2012). Sensitivity does not basically estimate the amount of risks since it only measures responsiveness of the net present values to the variables considered in its computation (Chenweike, 2013). It evaluates given situations and potential outcomes, as may be dictated by changes in the conditions. It is a decision making tool that also helps managers forecast future outcomes of the decisions they make at the present time. Sensitivity analysis is particularly important for Xavier who is starting his small business because there are several risks and uncertainties involved in introducing and managing businesses.
Apart from helping a business manager make informed business decisions, it communicates the business strengths to interested investors (Laidre, 2012). Advantages of sensitivity include that it is simple to compute, guides managers in making decisions, provides information needed for successful planning, and acts as a quality check by focusing attention on important control adoption. However, sensitivity analysis simply measures the level of change in variables but does not offer probability of the alterations. Moreover, sensitivity analysis does not offer complete solution since the data produced must be interpreted and investigated further before the final decision is made (Chinweike, 2012).
Prices for Xavier’s Business
In this case, Xavier is expected to choose between two ways of pricing. The market analysis found that price per opal in Switzerland is CHF 170. By increasing this price by 20%, Xavier will lose 50% of sales but when he decides to reduce it by 20% he will experience 25% rise in demand. This can be investigated using the first month whose demand was estimated at 30.
| Initial price | Reduced price | Increased price | |
| $229.5 | $183.6 | $275.4 | |
| Base volume | 30 | 37.5 units | 15 |
| Earnings | 6,885 | 6,885 | 4,131 |
Since 1 Swiss Franc (CHF) = Australian $ 1.35, CHF 170 will be 1701.35 = 229.5
Price
Increased price = 229.5 + (229.5 20%) = 275.4
Reduced price = 229.5 – (229.5 20%) = 183.6
Base opal volume
At increased price = 30- (3050%) = 30-15 =15
At reduced price = 30+ (3025) = 30+7.5 = 37.5
Earnings
For increased price = 275.4 15 = 4,131
For reduced price = 183.6 37.5 = 6,885
Explanation: The results above show that Xavier will still earn the same amount of cash if he either retains the market price or reduces the price. However, increasing the price per opal will make him lose $2,754 due to the reduction in base volume opal sales. While is not wise for Xavier to increase opal price, the best decision is to reduce pricing because his target market is price sensitive and he will not lose by reducing the price. The working price per opal therefore is $183.9.
Sensitivity Analysis/DCF Analysis
NPV
The net present value (NPV) method helps determine the effect of a project on the investment money, in terms of present value. To compute the NPV of a project, the future free cash flow is discounted using a discount rate. The resulting free cash flows are then added and the initial investment subtracted from the total (Joy, Benamraoui, Boojhawon, & Madichie, 2016). A positive answer leads to acceptance of the project while a negative outcome leads to project rejection. Since NPV calculation is built on particular assumptions, forecasts, and estimations, the results may be different from the actual situation due to uncertainty (Chenweike, 2012).
Since the first year revenue was $381,704.4 and the loss incurred at the end of the year is $53,074.2, the money Xavier should invest in the first year of operation is $381,704.4 + $53,074.2 = $434,778.6.
Starting the second year when the market is established, Xavier expects a minimum 250 sales of base opal volume. With reduced pricing, this volume will rise by 25%, hence he will sell 250+ (25025/100) = 312.5 per month. This means that from the second year to the fifth, Xavier will generate revenue amounting to $(312.5183.6) 12 months = $688,500 per annum. Assuming that the discount rate is 10%, NPV is calculated below for the next four years. Cash flow will be $(688,500-434,778.60) = $253,721.
| Year | Cash flow | Net present value |
| 0 | -$434,778.60 | -$434,778.6 |
| 1 | $253,721.4 | $230,655.82 |
| 2 | $253,721.4 | $209,687.11 |
| 3 | $253,721.4 | $190,624.64 |
| 4 | $253,721.4 | $173,295.13 |
| NPV = +369,484 | ||
NPV = – C0 +C1/ (1+r) + C2/ (1+r)2+ C3/(1+r)3 + C4/(1+r)4
=-434,778.60 +253,721.4/(1+0.1)+253,721.4/(1+0.1)2+253,721.4/(1+0.1)3+253,721.4/(1+0.1)4
= -434,778.60 + (230,655.82+209,687.11+190,624.64+173,295.13)
= -434,778.60 + 804,262.7
=369,484
The resulting NPV is a positive hence Xavier’s project is acceptable.
Appropriate Upfront Fee from Xavier to OzJewels
OzJewels intends to sell Exclusive distribution rights to Xavier. This contract is usually based on agreement that a supplier will sell products to the distributer for the purpose of resale in a specified territory (European Commission, 2010), which in Xavier’s case is Switzerland. This implies that Xavier will only sell the products in Switzerland and no other European country. The advantage of this kind of rights is that Xavier is likely to face less completion but the risk is that his business could take a monopolistic form after a period of operation. European Commission notice (2010) also informs that exclusive distribution rights are exempted by the Block Exemption Regulation for the period when the supplier and consumer’s market share is below 30%. This means that Xavier should be exempted for the first three months of his operation because it is only in the fourth month of the first year that he exceeds 30% market share (the full market demand is 250 and Xavier starts at 30, and demand is assumed to rise by 20 units). In the Fourth month, Xavier should achieve a demand of 90. (0 as a percentage of 250 will be (90/250100) = 36%.
After this period, Xavier’s business will become increasingly competitive and continue to grow its market share. Upfront payment is important in that it enables appropriate allocation of shelf space for the products that are new to the market. It is also beneficial to distributors because they often lack proper knowledge of possibility that a product will succeed in it’s the new market but the suppliers have this information (European Commission). However, it is only appropriate for the distributor to pay the fee if the estimated failure of product introduction is low. The advantageous implication is that upfront payment enables the distributor to shift risks of failures associated with product introduction to the suppliers.
Since Xavier’s business has potential of picking fast and succeeding in its future operations, making an estimated profit of $253,721.40, he will have made approximately $1,014,885.6 – 53,704 = $961,181.6 by the end of the fifth year. Paying 15% of this will not harm his business hence Xavier should pay $144,177.24 upfront fee to OzJewels because of the several benefits that he will gain in return.
Conclusion and Recommendation
The analysis proved that the best price to sell at is $183.6 per opal since this price level earns same returns as when no changes are made to the market price, and is better than when prices are increased. Moreover, this price well fits the Swiss market which has been determined to be highly price sensitive. However, the first year operation analysis reports that the company is not exercising adequate control over its cost. This is evident from two different perspectives. The first evidence for this finding is that the company has a gross profit margin of 31.23% which is relatively lower for the service and manufacturing industry, as the recommended rate should be at least 40% (Parker, 2013). A higher gross margin is particularly good for the business because it attracts investors and makes them willing to contribute large amounts of funds for the business. The second proof is that the company made losses of up to $53,074, meaning that expenses are more than revenues hence they do not balance. It is thus apparent that Xavier should invest extra effort in balancing revenues and expenses for a profitable future venture.
Apart from the gross profit margin and the overall results, however, the company has potential of generating profits in its future operations. This is true because at the moment, the analysis reports that Xavier’s company has more current assets than current liabilities, a difference of 41,780.99. This is a good sign because it means the company can pay for all its short term debt obligations, payable within a period of one year. Moreover, total assets also exceed total liabilities by $55,387.50. Sensitivity analysis has also helped with the investigation of viability of the business. Assuming that the initial amount was $434,778.60, the calculation for the next four years operation gave a result amount of $369,484. Since this is a positive value, the business project is accepted and is worth adopting.
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