Materials for Developing Entrepreneurial Ideas The market & competitive environment Testing

| June 3, 2016

Question
Materials for Developing Entrepreneurial Ideas

1. The market & competitive environment

2. Testing the viabilityof your business idea

3. More about market research

4. Sample Report Layout for Individual assignment part 2

5. Notes on the P&L account and Cash Flow Forecast

6. Example of a quarterly P&L projection covering years 1 & 2

7. Example or a quarterly cash flow forecast for years 1 & 2

8. Break-even analysis – an example

9. Accounting conventions

10.Sensitivity analysis

11. How to lose marks

12.Preparation for Business Plan Presentation

Indicative suggestions to help focus your research into your proposed new small business

1. What business do we want to be in?

2. Where shall we operate and what geographic markets shall we cover?

3. Identify our target market – segment the total market and identify target segments

4. Is the market growing or declining? What is the trend? How fast is it changing?

5. Will the market or the industry be affected by any new technologies?

6. What stage is the market at in its product life cycle?

7. Why do we think we want to be in this business? What is the nature of the opportunity?

8. Competition: who is it, how big a threat, is it profitable, are there gaps in the market etc.

9. How are our competitors positioned in the market?

10. Who will be our customers and what do we need to know about them? Demographics etc?

11. What do our customers want? Product/service type, quality, price, etc (marketing mix)

12. What are our own skills and strengths and weaknesses – save the full SWOT for the main plan

13. What shall we need in terms of premises, equipment etc and what will it cost?

14. What will it cost us for premises, rents, deposit, etc and are there suitable premises available?

15. Are there other operating costs that we need to research? (hosting web site, running costs, etc?)

16. What laws and regulations will particularly affect us? e.g. food hygiene? Health & Safety, etc?

17. Identify our target market – segment the total market and identify target segments

18. How can we achieve a competitive advantage?

19. What reports and other sources of good secondary data can we identify to help our research?

20. How long is it likely to take before we reach break-even? (approximations only at this stage)

Note: This list is not exhaustive. It is intended merely to help focus your thinking and to remind you about some of the topic areas we have discussed in our lecture sessions

Before we invest all this additional effort and/or expense in drawing up detailed business plans, we need to be as sure as is reasonably possible that the idea is ‘a goer’ or in proper English, that our business is likely to be VIABLE.

Viability depends on many factors but probably the most important ones are:

a) Is there a real market opportunity and what can we find out about it ?

b) Can such an opportunity be fulfilled AT A PROFIT/ACHIEVING THE ORGANIZATION’S GOAL?

After all there are plenty of jobs available for unpaid volunteers but most of us need to earn a living! …And indeed, hopefully, there will be some members of the class who want to become ‘big-time’ serial entrepreneurs: people like Richard Branson who have started and succeeded with a number of enterprises.

The research report, therefore, is designed to answer the two questions above.

First we need to establish the market opportunity – and doing this will be different for each individual business idea. Some questions that come to mind include:

o Is there a demand for our product/service?

o Who are we planning to sell it to?

o Are there specific market segments that we plan to or perhaps ought to target?

o Do they want it – in the form we propose …or perhaps in a slightly different form?
(i.e. Might we need to make some modifications for our business idea to succeed?)

o Can our target market afford it and how much are they willing to pay?

o What differences/USPs should we emphasise to ensure a competitive advantage?

o How often will they buy it?

o Are we looking for loyal customers with repeat business or is ours a one-off purchase

o Who shall we be competing with and how should we ‘manage’ our competitiveness?

These are just a few questions. More details have been examined in lectures to date and a more comprehensive list of points that to consider appears in future handhouts.

Next we need to look at the likely financial viability of our plan. Here we need to examine the following:

o What kind of premises and facilities shall we need?

o Where will these be located (remember location can be critical dependant on the type of business)

o Can we make a rough and ready estimate of our ‘fixed overheads’ –

§ Rent

§ Rates

§ Light

§ Heat

§ Vehicle running costs

§ Phones

§ Staff salaries

§ Major consumables and maintenance costs e.g. web site & computers, etc.

§ Advertising and Marketing* (see note 1)

o What will be our average sale value – e.g. a typical customer ‘order’

o What ‘contribution’ do we expect on such an average customer order (SP–direct cost)

o How many such ‘typical’ or ‘average’ orders do we need to break even? **(see note 2)

o What does this equate to in terms of customers per day/week/month etc.?

o Is this a realistic (i.e. readily achievable) figure? Also how long is it likely to take for the business to reach this ‘break even volume?

VIABILITY CALCULATIONS should be in broad, general, terms at this stage (ball park figures, with very little detail) but quite detailed figures will be need for the final business plan.

For example, you might need to check on the cost of renting (and perhaps refurbishing) a suitably sized, suitably located, property- and to include in your calculations a fairly good estimate of the cost of business rates but would not be expected to show a priced list of equipment, fixtures and fittings, etc., needed in the business.

Note 1

Advertising and marketing, such as the cost of yellow page adverts may be considered fixed costs, when these cannot be directly related to a ‘cost per order’. Sometimes certain forms of direct marketing could reasonably be treated as ‘direct’ costs, dependent on the type of business.

Note 2

See the handout on ‘Testing Viability’. For example, if, to break even, you need 30 customers or 30 average orders per day this might be achievable for a small restaurant but is unlikely to be realistic for an estate agency.

Please remember that the purpose of the research is to prove – or disprove the market opportunity details or your business idea – and/or to provide information so you can modify the plan to be reasonably sure it can succeed. Hence there are substantially more marks for the analysis, evaluation and conclusions.

The Market and Competitive Environment

Consider external factors which impinge upon the firm.

1. PESTLE

A brief outline of PESTLE factors which might affect a company:
(Note: There are very many more: these are only a representative sample)

Political

Government actions & policies

Fiscal policy (taxation & public spending)

Government incentives, grants, etc.

Foreign Policy

Local Government actions & policies

Competition & Fair Trading controls (e.g. monopolies, etc)

Military policy

Economic

The economic system

The prevailing economic climate

Interest rates

Inflation

Wage rates

Taxation (direct & indirect)

Competition

Social

Customer preferences

Demographic trends

Taboos

Fashions & trends

Buyers perceptions

Availability of labour

Changing lifestyles

Technological

Emerging technology

Substitutes

Changing user requirements

Impact of new technology on lifestyles

New production methods

New packaging, promotional and communication methods

Legal

* always look at factors likely to impact particularly on ’your’ business

Legislation – many laws relating to or affecting businesses*

Commercial and Industrial Regulations
Legal (continued)

Employment Law (now having a huge impact on all employers)

Industry specific laws

e.g. food, hygiene, construction industry, vehicle construction & use, consumer protection, financial services, etc., etc.

Environmental

All environmental issues and social concerns in relation thereto.

Examples:

Global warming, health concerns, noise, emissions, dust, GMOs, pollution, waste disposal, recycling, etc.

These and all others likely to impact upon YOUR business should be considered from the perspectives of a) risk analysis, b) customer concerns, c) public perceptions, d) adverse publicity, e) costs (to ameliorate risk or compensate victims), f) potential impact of or upon influential groups, markets, users, etc.

Firms should consider the impact of their operations upon:

§ Neighbours,

§ Customers,

§ Dealers and distributors,

§ Transport contractors, ( e.g. hazardous loads)

§ Your own workers (e.g. all health & safety issues, solvent risks, ergonomics, RSI, etc.,)

§ Animal rights groups,

§ Anti- nuclear groups,

§ GMO objectors

§ And many more…..

IMPORTANT NOTE

ALL firms are subject to all the laws of the country and or countries in which they operate. All individuals are similarly covered by all the laws of the countries in which they live, work and visit.

For environmental analysis purposes the ONLY factors to be highlighted in a your analysis, are those considered likely to have a KEY impact on the activities of the business.

For example, although it is highly important and legal compliance is always essential, one would not normally expect any strategic threats to arise from Health & Safety issues in most office environments. I other words, normal good practice would be sufficient and hence one would not be deterred from opening a business because staff MIGHT fall downstairs (assuming the stairs to be normally safe).

Clearly competitive forces within the market can have a major impact, depending on who the competitors are, their power, their aggressiveness and their own primary aims. (Even a large, powerful competitor might not be interested in certain segments of the market)

Factors affecting industry structure(Michael E Porter)

(taken from: Competitive Advantage, The Free Press, 1980)

Porter says that there are five forces which can act upon the structure of an industry. These are shown below with someof the influences each can exert:

Power of Buyers

Power of Suppliers

Threat of Substitutes

Threat of New Entrants

Industry Rivalry

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Testing the VIABILITY of your business idea

To be ‘viable,’ for the purpose of this exercise, a business must be able to show that it can be profitable.

In fact, most new businesses are NOT profitable in the first year …or perhaps two and there have been examples of highly successful businesses that have not become profitable until perhaps five or six years after. Consider Amazon.com – which was launched as a company in 1995 and which continued to stack up massive losses for over five years, before recording its first profit in the fourth quarter of 2001. We all know that since then the Amazon.com business has gone from strength to strength but it is interesting to reflect that were it not for almost continuous capital investment by confident shareholders, the company would have folded…and indeed in early 2001 it looked as if it might do just that.

PLEASE NOTE that YOU should be able to show that your business will become profitable by the end of the second year – or possibly (exceptionally) in year three, if you can show a strong upward trend towards profitability in year two.

So, what do you need to show?

In the final business plan, detailed figures will be needed but for the purpose of the first assignment – it is necessary only to show a rough indication. This means you will need a very approximate idea of your likely FIXED OVERHEAD expenses (e.g. rent rates, light, heat, telephone, salaries for employed staff, and of course loan interest payments, etc.).

But remember I said a roughidea – so you can do some ‘back of an envelope’ type calculations to prove it. You will need to have a reasonable idea of your annual costs for rent, business rates (local council taxes), utilities – perhaps you can make a sensible guess – and similarly you should be able to estimate, in ‘ball park’ figures, the other fixed overhead costs.

Added together this should give a total annual figure for your fixed overheads.

Next, you should consider the products and/or services that you will be selling. At this stage it should be possible for you to make a fairly accurate guess as to the AVERAGE value of the typical order. For a sandwich bar the could be the average spend per customer visit or for a computer consultancy, the average value of a client project.

Hopefully you can estimate the actual cost (known as the variable cost) of providing the products/services for this ‘average customer order) This might include some materials, some labour and possibly some purchased items. OK, now it’s easy. Work out the ‘contribution’ made on each ‘average order’ by deducting the average cost from the average selling price. See the example below for a sandwich bar.

Average order: SELLING COST

PRICE PRICE

1 Sandwich, at say, 2.95 1.05*

1 Packet of crisps “ “ .45 .30

1 Canned soft drink “ “ .75 .45

1 Banana “ “ .25 .15

* including variable labour costs

Total order value £4.40 £2.15

Hence the Contribution per average orderwill be £2.45 (56%)

Now, if we assume, for the purpose of this example, that you have established that your fixed overhead expenses will be, say, £1000 per week….

To BREAK EVEN you will need to serve 1000 ÷ 2.45 = 408 customers per week.

This means – no profit – just enough to pay your way and pay your employees, without paying yourself any wages! If you decided that you must have, say, £300 per week for your own personal living costs – these represent additional ‘drawings’ from the business, so you must increase the ‘overheads’ figure by this amount, as below:

B/even = 1,300÷ 2.45 = 530 customers per week

Now you can take a look at other sandwich shops and see how many customers they serve each day, before deciding what you can REASONABLY expect to achieve in your business. You well need to ask yourself…

How many days opening per week?

How many customers per day?

Will you open on weekends and bank holidays? – unlikely if your business is serving local office workers, for example.

Of course, you need to think about opening hours and when your customer will come in to buy. For a sandwich shop, there is often a peak period between say 11:30am and 2:30pm, with the rest of the day being very quite indeed. So…if you really have only three hours of serious trading each day, and you need to serve 530 customers per week – in say, a five day week, we can work out that

530 ÷ 15 hours = 36 customers per hour

…and hence you can calculate how many staff you will need behind the counter during the peak periods…so further refining your estimates for staff costs.

Now, if the figure for fixed overheads had been £2,000 per week and if, at the same time, your contribution per customer order was only £1.00p you would have needed to serve and average of 134 customers per hour (in the peak period) and you might be forced to conclude that such a target would be impossible to achieve. In such circumstances, the business simply would not be viable.

All this should enable you to get a fair idea of the viability of your business idea. Perhaps you will find that the sandwich shop can be successful if the rent is not too high or if you do not employ too many staff – it might mean that you cannot afford an expensive location and perhaps it might mean longer hours for you and your co-owners until you can increase the volume of business.

Finally, DON’T CHEAT – if you ‘tweak the figures’ upwards so that the project appears viable on paper – you will simply be deceiving yourself …and can look forward to pain, suffering and heavy losses. On the other hand, if you find the figures don’t work out quite as well as you would have hoped, there is nothing to stop you from revising your ideas, perhaps moving a bit more ‘up-market’ and selling a higher value (note: value – not just higher price) product or service on which a higher contribution per customer order can be achieved. Equally you could move ‘down-market’, with a lower priced product and by achieving increased volume, (especially if, at the same time, you can manage to reduce overhead costs) it might be possible to develop a profitable business.

More about market research

What we need to know might include some or all of the following:

1.­­ Segment the market and select your target market

2. ­­­ Examine the attitudes and opinions of the people in this market

3.­­­ Look at their motivations, lifestyles and psychographics

4.­­­ Look at buyer behaviour, how they buy, when, where and in what circumstances

Is the purchase carefully considered, discussed and evaluated or is it an impulse buy? Do different elements within the target market behave differently or have different needs?

5.­­ Consider what needs and wants the product/service fulfils for these users/buyers

6.­­ Are the users and buyers the same people or different? Who buys the product and who else influences the decision?

7.­­ Next examine the buyer/user needs in terms of the marketing mix:

Product/service

– How can we satisfy those wants/needs even more closely and effectively?

– Is the packaging right?

– What else does the user need at the same time?

– Will bundling help? eg computers? ‘package’ holidays?

– What pack sizes/quantities does the user want?

Price:

– Is the market price sensitive?

– Would a higher price bring higher sales?

– Consider price elasticity of demand

– Can discounts be used?

– Do distribution channels also require their own pricing strategy?

– Should be price include delivery?

– Will the price vary according to channel/time/season?

Place:

– Where does the market expect to obtain the product?

– Are there alternatives? eg: mail order?

– What other channels should we consider?

Promotion:

– Identify the target audience – is it the buyer?

– How can we best reach the target audience?

– Media?

– PR?

– Exhibitions?

– Sponsorship?

– Direct Marketing?

– Sales promotion – is it appropriate?

– Should we spend a lot or a little?

8.­­ Competition:

Who are they?

How does the market perceive them?

What are their strengths and weaknesses?

9.­­ In order to research our target market …where will we find them?

What type of information are we seeking? Eg: attitudinal/motivational or quantitative

What form of research is likely to be most effective?

consider:­­­­ telephone questionnaires

face to face interviews

mail questionnaires

observation/experimentation

in-depth interviews

discussion groups

consumer panels, audits

How should we select our sample?

10.­ What are the risks and dangers involved in our survey?

Asking the wrong people

Asking the wrong questions

Asking the right questions badly

Poor analysis of the results

Failing to allow enough scope for them to say what they mean

Leading the respondent

Failing to select a truly representative sample

11.­ Generally the underlying principle behind market research is that by asking relatively few people we can take their responses as being representative of the ‘population’ as a whole.

—————————-ooooooooooo———————–

Some methods of asking questions:

1.­­ Straight Yes/No

2.­­ Free text – very difficult to analyse and categorise

3.­­ Scaled responses: e.g.­­­

Likert scale­­­­­­­­­­­­­­­: Score

+ve­­­ -ve

Strongly Agree­­­­­­ 5­­­ 1

Agree­­­­­­­­­­ 4 2

Uncertain­­­­­ 3­ 3

Disagree­­­­­­­­­­­­­­­ 2 4

Strongly disagree­­­ 1 5

Semantic differential:

Where the respondent is asked to mark with a cross, the point that most accurately reflects his/her view, on the dotted line between two bipolar values (see below)

space­­­­­­­­ 1­­ 2 3­­­­­ 4­ 5 ­­­­­­6 7

score­­­ +3­ +2­ +1­ 0 -1­ -2 -3

Fair­ .­ .­ .­ .­ .­ .­ .­ .­ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . …… Unfair

Large ­ .­ .­ .­ .­ .­ .­ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . …..Small

Often .­ .­ .­ .­ .­ .­ .­ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ……Rarely

Specific ratings: (with appropriate choices offered)

eg:­ How often do you wash your hair? Please tick below:

Daily or more frequently ­­­­­­

Three or more times weekly­­

Once or twice weekly­­

Roughly once a week

Less than once a week­

Report layout for End of Module Assignment – do yourself a favour!

Some hints for setting out reports in an effective and user friendly layout. ALL of the points listed below are important and apply in 99% of report writing situations.

1) Cover Page: Show Title; author/s; recipients; date; other key data, e.g. course/module

2) Pages should ALWAYS be numbered – if the report is worth reading someone is likely to want to comment upon part of it and this is greatly facilitated by page numbering and section numbering.

3) Contents page should appear as show in the following page

4) Numbering: each section should be numbered with sub-paragraphs also numbered using the decimal system.

5) Layout Keep numbers aligned vertically and then indent text so it ALL text appears to the right of the numbers

6) Spacing – double spacing is preferable but not obligatory

7) Use of the page: Leave an adequate margin on all sides of the paper: we can afford it and the text becomes MUCH easier to read. In general shorter lines (as used in newspaper columns are easier and quicker for the eye to scan – but do NOT normally use multiple columns in reports – except where it is clearly most appropriate in the context.

8) Looking at the repeated version of these notes below will show that they are easier to read when a clear line is left between each numbered point – report writers should leave a clear line between paragraphs and between sections – sometimes it may be appropriate to leave two clear lines between sections…so we’ll start again below.

Some hints for setting out reports in an effective and user friendly layout

ALL of the points listed below are important and apply in 99% of report writing situations:

1. Cover Page: Show Title; author/s; recipients; date; other key data, e.g. course/module

2. Pages should ALWAYS be numbered – if the report is worth reading someone is likely to want to comment upon part of it and this is greatly facilitated by page numbering and section numbering.

3. The ‘Contents’ page should appear as shown on Page 37.

4. Numbering: each section should be numbered with sub-paragraphs also numbered using the decimal system.

5. Layout Keep numbers aligned vertically and then indent text so it ALL text appears to the right of the numbers

6. Spacing – double spacing is preferable but not obligatory

7. Use of the page: Leave an adequate margin on all sides of the paper: nowadays we can afford it and the text becomes MUCH easier to read. In general shorter lines (as used in newspaper columns) are easier and quicker for the eye to scan – but do NOT normally use multiple columns in reports – except where it is clearly most appropriate in the context.

8. Looking at the repeated version of these notes below will show that they are easier to read when a clear line is left between each numbered point – report writers should leave a clear line between paragraphs and between sections – sometimes it may be appropriate to leave two clear lines between sections

9. Underlining, emboldening and italics: these facilities should be used where appropriate but – sparingly – too much use of an emphasising technique will have the opposite effect to that which is desired- as the reader’s eye is no longer ‘surprised’ by a different style. In fact, a hotchpotch of emphasis can make the whole thing look very messy.

10. Please remember your report is meant to communicate:so it is worth practising to develop an effective style – there will be many times in your life when your style may be more important than content.

11. .0/msohtmlclip1/01/clip_image003.gif” alt=”Text box: this is a rather poor example of text being ‘flowed around a text box. the same can be done for imported pictures and charts. word is a very powerful report-writing tool. “>When using illustrations, remember that word is capable of quite smart positioning and can flow text around pictures and text boxes: practice with Word so you learn to get the best out of the software – you’ll find it rewards you time and again in the future.

12. In report writing one should never use the first or second person (either singular or plural) –“I, you, we” and it is best to avoid ‘they’ when possible. Hence the last point – item 11, would be modified to read:

“When using illustrations, it is important to remember that Word is capable of quite smart positioning and can flow text around pictures and text boxes. The writer should practice with Word in order to get the best out of the software – it will be found to yield rewards, time and again, in the future.”

13. .0/msohtmlclip1/01/clip_image005.gif”>While it is important to avoid stultified prose, the end result, done properly reads and sounds infinitely more professional.

14. .0/msohtmlclip1/01/clip_image007.gif”>On the subject of pictures, while one should avoid creating a ‘comic’ there can be no doubt that “a picture says a thousand words” and certainly the writer of this short text would propose that most people can be rather daunted by page upon page of pure text. So there is a strong case for ‘lightening up’ a little and at the same time hammering home the message even more effectively with one or two well chosen pictures, charts or graphs.

15. Sometimes it looks better if text is fully justified (left andright) but there can be times when because of the actual words being used and the space available, it can look odd. One should treat a report or an essay – or even a letter – as an artistic presentation and ask oneself how it will look to the ‘eye of the beholder’. Making one’s presentations look ‘pretty’ is not a childish or ‘sissy’ thing to do – it is an effective way of ‘selling’ the content to the reader, who as in advertising needs sometimes to be ‘seduced’ by the imagery and style of the advertisement in order to be persuaded to respond to the product being offered.

16. Word can sometimes be difficult to ‘manage’ and it is true that creating a well-designed and effectively laid-out piece of work can take time but the writer can assure all those reading this text that the effects of creating the right impression upon the reader amply justify the extra effort taken.

17. Next it is necessary to demonstrate the decimalised system of numbering sections and sub-sections so the text below is probably going to be less than interesting

17.1.This is the first level of sub-paragraph and it will be seen that the decimalised numbering starts immediately below the text of the previous section.

17.1.1.Similarly it will be seen that at the next level of sub-paragraph the positioning of the numbers once again is immediately below the text above. When the report is set out in this way it is much easier to read and the logic becomes more obvious to the reader

17.1.2.Subsequent paragraphs may be inserted like this one but once a new subject arises it becomes necessary to revert to a higher level numbering format as will be seen below.

18. The second level paragraphs as shown above are appropriate while discussing points which are contingent upon or closely related to the content of the higher numbered text but If the writer now wishes to address a different subject, he/she will move to a new section as shown below.

19. Headings

There is a great deal to be said for the use of headings and sub-headings in a report. These create interest, draw the eye and help to focus the reader’s mind on the writer’s message. Once again it can help it they are emphasised in some way, such as under-lining but writers should take care to avoid creating the effect of a tabloid newspaper with so many ‘screaming’ headlines that they become self defeating. Note that the section numbers look better if they are NOT underlined!

20. Almost finally, it is necessary to say a word about conclusions.All reports should have them; otherwise the reader may be left ‘in the air’, uncertain what the writer wanted him/her to believe. This cannot be good. After all the purpose of most reports is to ‘sell’ the content to the reader and usually the writer is hoping for a decision in line with his wishes…so let’s be sure to make our report really effective and achieve the desired outcomes.

21. Finally, ALL reports mustbe read by the writer before being issued to the recipient. The writer of this little treatise has been subjected to wrong words, wrong spellings, laughablesubstitutions made by automatic spell checkers when ‘unsupervised’ by the writer and sometimes content which by the omission or incorrect substitution of key words conveys an impression of severe carelessness on the part of the writer – definitely NOT what is needed to score those few extra marks that can result in a degree ‘one grade higher’!

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Happy readers give higher marks!

Post script

The way you present your report indicates to the reader how seriously you take the report’s content and purpose. Some reports received are scruffily presented, to say the least. Remember: you really cannot expect good marks from a tutor who has just broken a fingernail trying to fight his/her way into a bundle of sheets that have been badly stapled inside a cheap plastic envelope.

Contents

Section Title Page

Number

1 Introduction 3

2 Second section 5

2.1 First sub-section 6

2.2 Second sub-section 7

3 Third main section 9

4 Fourth section 12

etc …etc..

Appendices

1 First appendix (description) 27

2 Second appendix 29

3 Third appendix 30

etc etc….

Some notes about the Profit & Loss account (P&L) and the Cash Flow forecast

The P&L account is designed to show whether the activities of the business have produced a profit (or a loss.docx#_ftn1″ title=””>[1]). The Cash Flow Forecast is designed to forecast the overall net cash position of the business – i.e. whether there will be positive or negative cash balances – and to what extent.

For a business, profit and cash are very different, so it cannot be assumed that because a business has made a reasonable profit, that it will also have a positive cash balance in the bank. For example, a business might have a substantial amount of cash at the bank but might also have large invoices that will soon become due for payment

TIMING ASPECTS

First it is important to understand how profit is calculated. Accountancy rules say that in calculating profit we must deduct from our revenues (i.e. the value of sales turnover) in any given period, all the costs that were incurred in order to achieve those sales. So, apart from the obvious ‘direct’ costs (previously explained in lectures) there are other costs to take into account: the fixed costs or overheads. Because of what is known as the ‘accruals principle’ the accountant preparing the P&L must take into account ALL the costs incurred to generate the revenue – not just those for which bills have been received. This means, for example, that if the electricity bill comes quarterly, the cost of electricity for each month must be charged monthly to the profit and loss account. Hence the majority of fixed overheads will be spread evenly over each month of the year. The exception to this would be certain ‘sunk costs’ so that if a specific advertising campaign were run in March the cost would normally be charged to the P&L in March, even though some benefit from the campaign might come in later months.

Cash Flow, on the other hand, is concerned ONLY with the timing and amounts of actual cash coming into or going out of the business. Hence a cash flow forecast will show the amounts that are expected to be actually received and actually paid out during each period (in our case, each month) regardless of when they were incurred or became due. If a bill is expected to be paid in September, even though it might be for goods supplied in July and was due for payment in August, the amount concerned will appear in the cash flow forecast in September – when the payment actually happens.

WHAT SHOULD BE SHOWN

Certain items will appear in the P&L and not in the cash flow and vice versa. The main differences are explained below:

Depreciation

Depreciation is a NON-CASH CHARGE, Therefore it appears in the P&L as a legitimate cost incurred in eth generation of revenues BUT because it does not involve any movement of cash, it does NOT appear in the Cash Flow.

VAT

The P&L account always excludes VAT, so that ALL the figures in the P&L are shown exclusive of VAT. On the other hand, VAT should be INCLUDED (where appropriate) in the Cash Flow. This is because the actual cash flowing into and out of the business DOES include VAT.

Loan repayments

In the P&L only loan INTEREST charged should be shown and this will be shown in the period to which it relates, regardless of when it is actually paid. On the other hand the capital repayment portion of any loan instalments will NOT appear in the profit and loss account because it is merely a movement of the company’s money from one place to another. Money used to repay capital is actually cash moving out of current assets in reducing either current or long term liabilities.

Note:

The amount charged as interest on loans usually declines as the ‘principal’.docx#_ftn2″ title=””>[2] (i.e. the amount of capital outstanding) declines, so that, for example, 1% of £90 is less that 1% of £100. Hence, if the interest is charged at the rate of 1% per month and last month’s outstanding balance was £100, the interest would be £1 but if the repayment made was actually £11, including a £10 reduction in the principal, then this month, the interest chargeable will be only £0.90p – being 1% of the £90 balance outstanding.

VAT calculations

The examples shown in the handouts show a slightly simplified VAT calculation but one that is nevertheless, sufficiently close to the real thing. It has been calculated as follows:

VAT payable = VAT received on ‘outputs’ (i.e. from customers) LESS VAT paid on ‘inputs’ (i.e. paid to suppliers)

For small firms, VAT is usually paid quarterly so the VAT due by the end of May will actually represent the net amounts for the months of February, March and April.

The calculation goes like this:

VAT on outputs = Total of all sales in the period Feb – Apr at VAT inclusive prices times 7/47 (i.e. 17.5/117.5)

LESS

VAT on inputs = Total of all VATABLE purchases (including services) in the same period times 7/47 (i.e. 17.5/117.5) – based on the VAT inclusive costs of all VATABLE ‘inputs’

Note:

In almost all cases, VAT is charged at 17.5% but note that some products are ’zero rated’ in other words they are not eligible for VAT. (These include all foods, excluding restaurant meals, and medicines)

Some products and services do not incur VAT and these include: insurance, interest charges, rents (usually) postage and travel fares for bust, train and plane travel.

Energy for domestic use only is taxed at only 5% rather than the 17.5% charged on all other VATABLE commodities.

QTR 1

QTR 2

QTR 3

QTR 4

TOTAL

QTR 5

QTR 6

QTR 7

QTR 8

TOTAL

Sales

Yr 1

Yr 2

Cash

1,000

1,150

1,100

1,500

4,750

1,190

1,610

1,540

2,100

6,440

Credit

14,960

20,240

19,360

26,400

80,960

20,944

28,336

27,104

36,960

113,344

Total sales

15,960

21,390

20,460

27,900

85,710

22,134

29,946

28,644

39,060

119,784

Cost of Sales

Variable Materials

3,990

5,348

5,115

6,975

21,428

5,534

7,487

7,161

9,765

29,946

Variable Labour

4,213

5,647

5,401

7,366

22,627

5,843

7,906

7,562

10,312

31,623

Total cost of sales

8,203

10,994

10,516

14,341

44,055

11,377

15,392

14,723

20,077

61,569

Gross Profit

7,757

10,396

9,944

13,559

41,655

10,757

14,554

13,921

18,983

58,215

Gross Margin (%)

48.6%

48.6%

48.6%

48.6%

48.6%

48.6%

48.6%

48.6%

48.6%

48.6%

Overhead expenses

Directors’ remuneration

3,600

3,600

3,600

3,600

14,400

3,600

3,600

3,600

3,600

14,400

Directors’ pensions

450

450

450

450

1,800

450

450

450

450

1,800

Rent

1,200

1,200

1,200

1,200

4,800

1,200

1,200

1,200

1,200

4,800

Rates

900

900

900

900

3,600

900

900

900

900

3,600

*

Electricity

777

777

777

777

3,108

927

927

927

927

3,708

*

Gas

384

384

384

384

1,536

384

384

384

384

1,536

*

Telephones

162

162

162

162

648

162

162

162

162

648

*

Mobile phones

196

200

196

204

796

204

204

204

204

816

*

Yellow Pages advertising

114

114

114

114

456

114

114

114

114

456

*

Marketing & other advertising

723

553

510

510

2,296

573

573

573

573

2,292

*

Vehicle expenses

39

39

39

39

156

39

39

39

39

156

*

Fuel & oil for vehicles

384

384

443

561

1,772

561

561

561

374

2,057

*

Accountancy & audit fees

222

222

222

222

888

222

222

222

222

888

Postage & stationery

75

75

75

75

300

75

75

75

75

300

Insurance

360

360

360

360

1,440

360

360

360

360

1,440

Bank charges & interest

135

135

135

135

540

135

135

135

135

540

Loan interest

435

413

390

368

1,605

345

323

300

278

1,245

Depreciation

1,434

1,434

1,434

1,434

5,736

1,434

1,434

1,434

1,434

5,736

Total overhead expenses

11,590

11,402

11,391

11,495

45,877

11,685

11,663

11,640

11,431

46,418

Profit before tax

(3,833)

(1,006)

(1,447)

2,065

(4,222)

(928)

2,891

2,281

7,553

11,797

Cumulative Profit/(Loss) since start-up:

(8,098)

(14,012)

(17,359)

(16,092)

(5,150)

(2,259)

22

7,575

Depreciation calculation

Capital- machinery (10 yrs)

Capital- vehicles (5 yrs)

Capital- misc (4 yrs)

Example of a quarterly P&L projection covering years 1 & 2

Sales Forecast

Sales Forecast: 2007-8

Sales

Cash

1,175

1,351

1,293

1,763

1,398

1,892

1,810

2,468

Credit

17,578

23,782

22,748

31,020

24,610

33,295

31,848

43,427

Cash Flow Forecast:Years 1 & 2

Qtr 1

Qtr 2

Qtr 3

Qtr 4

Qtr 5

Qtr 6

Qtr 7

Qtr 8

Opening Balance:

0

5,442

2,076

169

(1,855)

(1,672)

(2,239)

(537)

Cash Inflows (inc. VAT where applicable)

Cash Sales

1,175

1,351

1,293

1,763

1,398

1,892

1,810

2,468

Payments from debtors

8,272

20,680

23,782

25,333

28,642

28,953

33,296

35,466

Capital Introduced

30,000

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