Breakeven Analysis
The break even analysis is used to predict the sales volume, given some price, required to recover total costs. At the breakeven point, Yorkshire Building Society will have covered all its costs but will not have made any profit. In other words, it is that point of sales where neither losses nor profits will be made. Among the assumptions used include:
- Units produced are the units sold but in reality, most firms maintain stock and are unlikely that the opening stock will be equal to the closing stock.
- Volume is the only factor affecting cost and revenue, but costs and revenues are influenced by multiple factors
- Marginal reporting is used in reporting; thus, absorption costing cannot be used
- There is a linear relationship between cost/ revenue and volume, costs, and revenue functions are no strictly linear as in economic they are curvy linear
- Total costs can accurately be classified into fixed and variable components, most costs are mixed.
- The unit selling price and the variable cost remain constant – the SP is influenced by competitors’ prices, inflation while VC is influenced by material prices, labour rates, etc.
- The fixed costs remain constant at any level of activity or decision period, even though, budgeted fixed costs cannot be the same as actual costs.
- A single product is produced and if more, then a constant sale ratio/sales mix is maintained – most firms produce more than one product and not necessarily at a constant ratio.
- There is certainty in future i.e. costs, sales and volumes can reasonably be estimated in advance, but in reality, the future is inherently uncertain.
Projected Profit and Loss
While projecting the profit and loss that the Yorkshire Building Society is likely to realize after executing its plan to start the new venture, I started by forecasting the sales over the course of the three year. The sales were estimated by multiplying the estimated units’ sale for each product by its respective price. Equally important under this category is the cost of these sales and which are direct costs. This was necessary in order to establish the gross margin and would be a useful item for comparing with different benchmarks. An educated guess was involved because the home furnishing market will be a new line of business for Yorkshire Building Society. Therefore, some past data from the market was relied upon in making these forecasts. The fundamental principle is that there would be no inflation that would influence the purchasing power of the pound and consequently the acquisition costs and selling prices with a significant magnitude.
To run this business venture efficiently, other expenses are inevitable. As a result, I estimated the expenses to be incurred. Among these expenses are those that would be incurred in supporting the forecasted sales. Both fixed and variable costs will be incurred. Among the variable costs are the advertisement and promotional expenses, administrative costs, and sundry expense would vary in the same proportion as sales while the interest expense costs would depend on the outstanding debt amount and the corporate taxes would depend on the operating incomes made by Yorkshire Building Society. The projected amounts are presented in the spreadsheet.
Projected Cash flows
The physical pounds movement in and out of our new business was also estimated. While projecting these cash flows, the forecasted sales and balance sheet items were factored in. The forecasted profit and loss could be viewed as the heart of our business while the cash flows will be its blood. The availability of the cash will enable Yorkshire Building Society to pay its bills. The start-up costs, preliminary expenses, and operating expenses are included in this part of our financial plan. In addition, any required reserves, borrowings, and cash balances were also forecasted. However, the projected cash flow statement should regularly be updated and used afterward. Through these projections, Yorkshire Building Society will be able to foresee shortages in time and take the necessary actions upfront. Among the available options would be to negotiate for a loan or perhaps cut expenses. The operating activities form a large part of these projections and include the inventory purchases and sales. The cash flows were also projected in a manner that would ensure that Yorkshire Building Society will have adequate working capital. The presentation of this is in the spreadsheet, projected cash flows.
Projected Balance Sheet
The balance sheets were prepared by projecting the assets and liabilities. Through these projections, the net worth of Yorkshire Building Society is projected. This report assumed that, Yorkshire Building Society would only have two non-current assets, the storehouse, and a van to be purchased for transportation efficiencies. Its current assets would only be the cash and inventory balances, and it would not have accounts receivable in the short-term as its sales would be on cash. In the same context, Yorkshire Building Society would not have short-term liabilities. Yorkshire Building Society will, however, borrow some loan to supplement its equity capital. This has been presented in the spreadsheet, projected balance sheet.
Ratio Analysis
This report conducted ratio analysis, which involved the act of quantifying and comparing relationships that subsists between the variables in the statement of comprehensive income and the statement of financial position among other financial statements. The ratios computed were the profitability ratios, short-term solvency ratios, long-term solvency ratios, and efficiency ratios.
Profitability Ratios
These ratios are used to evaluate entity’s earnings in relation to a given level of assets, a given level of sales, owners’ investment or share value.
Table 1: Profitability ratios
| Ratios |
2016 |
2017 |
2018 |
| Return on net sales = operating income/sales *100 |
= 300/10,000*100
= 3% |
=1130/11000
= 10.27% |
= 1283/12100
= 10.6% |
| Net profit margin = net profit/sales *100 |
= 35/10,000*100
= 0.35% |
=616/11000
= 5.6% |
= 723/12100
= 6% |
| Gross profit margin = (sales-cost of sales)/sales*100 |
= 4000/10,000*100
= 40% |
=4050/11000
= 36.82% |
= 4445/12100
= 36.73% |
| Return on equity (ROE) = net profit/ common shareholders equity*100 |
= 35/5035*100
= 0.7% |
=616/5651
= 10.9% |
= 723/6374
= 11.34% |
| Return on total assets = operating income/ average total assets*100 |
= 300/6,000*100
= 5% |
=1130/6,000
= 18.83% |
= 1283/6,000
= 21.38% |
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Figure 1 Graphical presentation of profitability ratios
From table 1 and figure 1 above, it can be seen that all profitability ratios are increasing except the gross profit margin. The return on net sales is anticipated to be 3%, 10.27% and 10.6% in 2016, 2017 and 2018 respectively. Over the same period, the net profit margin is projected to increase from o.35% in 2016, 5.6% in 2017 and to 6% in 2018. The return on equity will be 0.7%, 10.9%, and 11.34% while the return on total assets will be 5%, 18.83% and 21.38% in 2016, 2017 and 2018 respectively. The gross profit margin is however expected to drop slightly and will be 40%, 36.82%, and 36.74% in 2016, 2017 and 2018 respectively.
Efficiency Ratios
Efficiency ratios are used to establish how efficiently the management uses an entity’s assets and other resources to generate sales revenue.
Table 2: Efficiency ratios
Figure 2 Graphical presentation of Inventory turnover
Figure 3 Graphical presentation of Inventory turnover in days
The inventory turnover is used to establish the number of times an entity sold its inventory during the fiscal period. From the forecasted results shown above, the inventory turnover will be 3, 3.97, and 6.12 times leading to inventory turnover in days of 121.67 days, 91.94 days and 59.64 days in 2016, 2017 and 2018 respectively.
Short-Term Solvency Ratios
These ratios measure a firm’s ability to meet its short-term maturing obligations as and when they fall due. From the forecasted results, Yorkshire Building Society will not experience liquidity problems as it will not have short-term liabilities during the forecasted period. The assumption was that Yorkshire Building Society will have enough liquidity to make its purchases on cash.
Long Term Solvency Ratios
These ratios are used to measure the entity’s capital structure, and they show the extent to which the business has borrowed to finance its assets and other resource acquisitions for it to efficiently carry out its normal operations. From the forecast done, Yorkshire Building Society will require to borrow some long-term loans to finance its operations. It will borrow £5,000,000 in 2016, and £1,000,000 in 2017 but no borrowings in 2018. Over these years, Yorkshire Building Society will be required to make an interest payment of 5% of the outstanding loan balance and a principal repayment of £1,000,000 per year.
Table 3: Gearing ratios
| Ratio |
2016 |
2017 |
2018 |
| Debt ratio = (total debt/ total assets) *100 |
= 4,000/9035* 100
= 44.27% |
= 4,000/9651*100
= 41.45% |
= 3,000/9374
32% |
| Debt to total equity ratio = Total liabilities x 100 Equity capital |
= 4,000/5035* 100
= 79.44% |
= 4,000/5651*100
= 70.78% |
= 3,000/6374
= 47.07% |
Figure 4 Graphical presentation of gearing ratios
From the projected debt to total equity ratio as illustrated by table 3 and figure 4 above, the relationship between Yorkshire Building Society’s debt and equity financing will continue to improve as it continues its operations. This is illustrated by the increasing capital/owners’ equity while the debt is decreasing. This is also shown by the debt ratio that indicates an improving trend. It indicates that the less and less debt will be used to finance its assets as it continued its operations. This implies that, in the long run, Yorkshire Building Society could be able to finance its operations without using debt.
