Detailed Analysis Accounting Essay

Business and Accounting Detailed Analysis

Capital Budget

The firm has a capital budget of 18,399 for the full year, with the majority of expenditure planned in April. Whilst this does show prudence, as even if a proposed expenditure is delayed, it is still recognised at the start of the financial year, I would have to raise questions over the level of proposed capital expenditure. Whilst it is possible that the total expenditure for knives, utensils, cookware and food storage, other cutlery, crockery, tableware and glass ware would be as low as the budget predicts, given that the restaurant predicts almost 50,000 customers per year, with total revenue of over half a million pounds, I would predict that shrinkages, breakages and general losses would mean that further expenditure on these items would be necessary throughout the year.

The other expenditure classified under Equipment also seems to have very low amounts of expenditure budgeted. Assuming the 64.37 allocated to janitorial is to be used to purchase brooms, mops, buckets, vacuum cleaners, dusters and other cleaning products, I find it difficult to believe that such a busy restaurant will not spend many times more than this, especially given the high levels of wear and tear on the cleaning equipment that would be incurred through their required daily usage. Even worse, assuming that the 136.22 allocated to safety is also covering health and hygiene, both very necessary parts of any restaurant business, this seems a ridiculously low amount. A restaurant serving almost 50,000 customers should be spending much more that 0.003 per customer on health and safety, or it risk being investigated by food hygiene agencies and closed down. The budgeted amount would barely even cover the equipment required to keep flies and mice out of the kitchen.

With regards to the other expenditure: on machinery, tables, chairs, counter, television and vehicles (car), it is plausible that these are reasonable levels of budgeted expenditure, although there appears to be a noticeable lack of contingency, as for the equipment. Indeed, as a potential investor, I would have to raise questions about the lack of detail in this proposed capital budget, given that there are no details at all about number of items bought under each category, and the necessary contingencies which should be a part of any business.

Finally, one potentially major problem for the business in the future is that such a low level of proposed capital expenditure for a business with such lofty revenue and profitability aspirations is that this low level of expenditure may discourage investors from putting extra money into the business, if the business is not seen to be investing it. Investors may be worried that, in the case of the business failing to meet its financial targets, and being forced to borrow to fund further investment, there will be insufficient assets to secure any debt against.

Sales, Purchases and Overheads Budget

The sales budget is very detailed, showing a breakdown of expected sales and revenue from each category. However, the weekly sales figures have been arrived at by assuming that the number of customers will be the same each day, this does not seem to account for the inevitable increases that will occur on Friday night, and over the weekend. Although appearing to be an inconsequential detail, it could potentially mean that not enough dishes have been purchased to cope with the increased demand, and experiencing shortages during the restaurant’s busiest periods of the week could do great harm to the restaurant’s image and popularity.

This consideration is even more important when taken in context of the purchases budget, where the closing stock level at the end of each month is almost always less that 20% of the cost of goods sold in that month, and in February and March falls to 2% of the cost of goods sold, thus leaving very little contingency. Whilst it is important to maintain as low a level of surplus stock as is feasibly possible, to avoid excess inventory costs, such a low level of stock relative to sales in two of the busiest three months of the year could result in major shortages, or possibly even in complete stock outs, which would be disastrous. As a result, I would recommend that a more systematic method of stock ordering, such as the economic order quantity or the minimum stock level method should be used to ensure that the stock level is always at a reasonable level to avoid shortages.

Again, the company’s overheads budget has been completed in far too little detail for any real concrete analysis. For example, the car expenses of 100 per month could be viewed as a combination of petrol, insurance and tax, but why have they risen to 300 in September and March? Will the car be used more in those two months, or is this when insurance premiums or road tax will be due? Also, staff costs are predicted to be constant for the whole year, despite the wide variation in savings. The business should thus look into varying staff hours throughout the year, in order to ensure that there are more staff working on the busy weeks, than on the quiet ones.

Following on from the above concern, I would have to question the method used to calculate the predicted level of sales, and the seasonal variations. If the level of sales is based upon previous experience, or on focused research to determine the likely size of the market, then both these budgets appear both reasonable, and highly profitable. However, if the budgets aren’t based on any solid facts, then I would have to question whether the business is setting predicted sales and profitability levels too high, and thus risking raising expectations too high, especially given the lack of contingency planning that has so far been evident in the capital, sales, purchase and overhead budgets.

Cashflow Forecast and Profit and Loss Account

From a first look at the cashflow forecast, the business appears to be likely to experience a very healthy year, with cashflow rapidly increasing throughout the year, leading to a closing balance of over a quarter of a million pounds. However, the vast majority of this cashflow will only be realised after the restaurant has been open for nine months, but it is in the first two months of opening that the restaurant will have to be most careful.

For example, in the first month of opening, the restaurant starts with an initial capital of 10,000 and a loan of 15,000, and immediately incurs capital expenses of 17,400 for fixtures and fittings, vehicles and equipment. Given that further expenses for the month are predicted to be 22,800, it is clear that the business does not have enough capital to survive the first month, and without making at least 15,200 of sales, it risks bankruptcy. Once again, there is virtually no contingency, further reinforcing that the business is being run on a very risky, albeit potentially highly profitable, basis, given that predicted sales are only 17,700 for the first month.

Even if the business makes it through the first month as predicted, it will have only 2,500 in the bank at the start of May, a month in which its predicted cash outflows are 20,800. In fact, if rent is due in advance, then the business is completely unfeasible, as it will have to pay 3,000, with only 2,500 on hand. Even if rent isn’t due in advance, buying sufficient stock for May will cost around 5,000, and if this is all purchased in advance of being sold, then the business is taking a huge risk if there is any wastage, or if the goods are unsuitable for use when they arrive. Finally, the fact that the business has a negative cashflow in May means it will experience the same problem in June, starting the month with only 2,000 on hand.

Once the business is through these first three months, it has a bit more leeway, but it is still not until the start of January that it has enough cash on hand at the start of the month to pay for all expected expenses during that month. As such, I believe the most needed alteration to the business plan is to raise at least 25,000 more capital or loans, in order to provide a margin of safety to get through the first three months. With overhead levels of less than 30%, I don’t believe the business needs to aim to reduce overheads or increase sales revenue; it merely needs to raise more starting funds to ensure a feasible start to the year. However, the cashflow forecast does include 40,000 of drawings over the year: assuming that these are forming the owner’s salary, the business definitely generates enough income to live off.

Also, if the four budgets can be taken as being calculated in a robust and prudent manner, then the business plan does appear to be very financially viable. Given that overheads are predicted to be less than 30% of sales, and purchases are predicted to be less than 25%, the business stands to make 287,000 of profit from an initial capital investment of 10,000: a return on capital employed of 28.7, which is very high. Equally, the gross profit margin is equally to 75%, and the net profit margin is equal to 46%, showing that the business plan is very profitable and viable, provided the figures are realistic: a fact which depends strongly on the location of the restaurant, and any market analysis conducted.

Balance Sheet and Prices

From the balance sheet, the business certainly makes enough profit to reward investors handsomely: if capital was invested as 10,000 1 shares, then the earnings per share would be 28.68, which is an incredibly high level of return, provided the shareholders were willing to wait until year end to realise this. However, there is a risk that these high results, combined with the low level of assets, would lead to a hostile takeover from a rival, or possibly a rival would attempt to flood the market, in order to acquire some of these supernormal profits. As such, I recommend that the business re-examines its pricing strategy, once it has reached December, in order to ensure that these supernormal profits are controlled and sustained for the long term.

Currently, the margins on some products are 90%, and although this may be necessary in the short term, due to the lack of contingency in the capital funds, it leaves the market open to entrants who are willing to operate at lower margins. Thus, I propose that the business should look at expanding its capacity and lowering its prices in January or February, taking advantage of the huge profits earned in those months to take on new staff and premises. Thus the business will lower its margins, but offset this by increasing its demand, thus keeping high profitability levels, without excessively high margins.

The marketing plan seems to have been well thought out, with the majority of advertising taking place just after launch, and again just before the busiest period of the year. However, with the exception of April and January, there are no months where the advertising has been timed to occur at the same time across all media, which would have maximum impact. Assuming that the leaflets are being distributed constantly; then the impact of both the leaflets and the internet will be roughly constant throughout the year. As such, it would seem logical to time to the newspaper and radio advertisements to coincide with each other, and also design the campaigns to reinforce each others message, ensuring that the restaurant is at the forefront of its potential customer’s attentions.

Financial Plan and Breakeven Analysis

My financial plan for the business would be strongly based on the current plan, from the financial documents; however I would make the following alterations:

Increase the initial levels of investment to 10,000 of capital and 40,000 of long term debt. Even taking into account the additional loan repayments of more than 500 per month, this would ensure that the business would have enough cash on hand at the start of almost every month to cover its planned expenditure for that month. This would thus result in the business being better able to make prompt payments to suppliers, generating further discounts receivable, and building better relationships with suppliers, as well as ensuring that if the business fails to hit its planned sales figures one month, it can still survive that month It will also allow some contingency into the planned capital budget for breakages and shrinkage.

Reassess predicted overhead levels, looking to take on more part time staff at busy periods, and thus have less staff working during quieter periods, particularly April and May, when sales are lowest, and cashflow is at its tightest. I would also look to alter the levels of purchases, so that predicted closing stock levels for each month are at approximately 20% of planned cost of sales, in order to provide a healthy contingency for each month, and thus avoid shortages which could be disastrous during the early stages of operation.

In January, I would look to use approximately 50,000 of the 105,000 opening balance to fund expansion of the restaurant, provided performance has been as predicted, or better. I would then look to lower prices by around 25%, reducing net profit margins to around 21%. In order to counter this, I would expand my advertising, to increase the size of my market, and also leverage my increased levels of purchasing against my suppliers, in order to obtain more discounts receivable. This would not only increase the assets of my business, and thus decrease the likelihood of a buy out, but it would also discourage potential entrants, by reducing the margins they would expect.

Finally, I would alter the predicted advertsing schedules, so that I would have reinforcing newspaper and radio adverts at the same times in the months of April, May, November and January. This would give me the maximum exposure both when my business was starting, and as it reached its busiest predicted period.

Breakeven Analysis

• Gross Profit margin = 75.15%.
• Contribution to fixed costs per of purchases is 3.02
• For the full year, capital expenditure is 18,399.62 and overheads are 188,442.40
• Thus the breakeven point is 200,842.02 divided by 75.15% = 267.257.60 of revenue
• The restaurant predicts 623,459.90 of revenue from 47,460 customers. Thus each customer will spend 13.14.
• Thus breakeven point is 267,257.60 divided by 13.14 = 20,345
• And the margin of safety is 47,460 – 20,345 = 27,115 customers.

As such, it appears that the restaurant is definitely viable, provided its predicted numbers of customers have been based on rigorous market research, and the restaurant has a healthy margin of safety, provided it can survive its first nine months of operation.

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