MHC601: Accounting and Finance for Managers Assessment

December 26, 2017
Author : Alex

Solution Code: 1ABFA

Question: Accounting Assessment

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Accounting Assessment

Case Scenario/ Task

As a future leader in Hospitality and Tourism, you will use accounting to make better business decisions. Choose one type of Hospitality and Tourism business that you might manage, for example, hotel, restaurant, airline, event company, cruise company etc. Apply accounting decision-making concepts with your company to structure your Report:

1. Use the Balanced Score Card approach to present key business assumptions and justify your choices by research and analysis undertaken, including the management of all Triple Bottom Line initiatives.

2. Prepare a Sales budget for two (2) products, Direct materials budget, Direct labour budget, Overhead budget, Selling expenses budget and Administration expenses budget for your business based on the given numbers.

3. Prepare an Income Statement in appropriate format for your business.

4. Calculate and evaluate the Weighted Average Contribution Margin (WACM).

5. Calculate and evaluate the Contribution Margin Ratio (CMR).

6. Calculate and evaluate the sales volume in units and sales dollars at breakeven point.

7. Calculate and evaluate the Operating Leverage and Safety Margin, carefully explaining what this means in terms of the risk of your business.

8. Critically evaluate the best ways that your business can increase its profitability. Discuss critically key results that would impact on your future decision-making including a fully supported explanation of how you could improve this business by making any changes. Make recommendations to the proposed investors including ideas for the next steps to progress the business concept.

{*** offer code can be varied from 1-5***}

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Solution:

1. Introduction

I would choose to run a Café cum Restaurant in Melbourne which is being set up by 2 friends who have agreed to fund the project with an estimated $200,000 form their pockets. The café would be set up in the central business district of Melbourne adjacent to the new Metro station and would be located on the upper ground floor of an upcoming office cum shopping complex in the area. The complex is located directly across the street and overlooking the Metro station and just a 100 meres away from the main and existing business district. Most of the offices and shops are already booked by businesses as the estimated footfall around the metro station is expected to be more than 100,000 on weekdays and more than 120,000 on holidays.

The area remains crowded on almost all days since many tourists visit the area for shopping purpose and office goers flock the area each day. The site has already been identified and a lease agreement is finalized with the owner of the site for an annual lease rent of $60,000 to be paid in equal monthly payments. Further the owner would be paid a lease mortgage amount of $60,000 and the same would be returned by the owner with a 2% interest by the owner if the site is vacated by the café. The site measures approximately 70 feet by 40 feet and is ideal for running the café cum restaurant chain at this location. When the interiors are done, the site would be able accommodate approximately 100 people at any given point of time. The emphasis would remain around the pricing of the products that would be on offer and the owner-management has chosen to pursue an all-out low-price and best quality product offering to wean away customers (Weirich, 2013).

2. Balanced scorecard Approach to Key Assumptions

Strengths of the New Business

  1. The new café cum restaurant would be situated at a premium place often frequented by large no of customers.
  2. The location would ensure a large client inflow from the beginning.
  3. The USP of the new café would be low price and high quality combo. The aim is to make a disruption in the market and attract a slew of customers.
  4. Would provide a great ambience with large product mix.

Weaknesses of the new business Café

  1. The foremost weakness would be the existing set of old and established cafes in the central business district and their clientele.
  2. New and inexperienced staff and new management style.
  3. Unlike established businesses, the new café has budget constraints. It needs to be selective for its expenditure so that revenue is maximized (Belverd E. Needles, 2012).

Opportunities for the café cum restaurant

  1. Lower price coupled with the large product offering (best quality) is expected to draw customers to Friends café.
  2. As the market is expending in a new direction (with the new metro coming up) there is a new market which is expected to emerge around the central district and this would provide an opportunity to create a new set of clientele.
  3. Special discount packages for frequent visitors who spend more than a minimum in a month
  4. Special packages and combo offers.

Threats for the Café Business

  1. The market is ripe for new entrants and thus more new business of the same nature can’t be ruled out.
  2. Need to compete on product quality offerings and not pricing alone.
  3. Increasing input costs seen by the market in recent months.
  4. Minimum wage packages are on the higher side.

Triple Bottom Line initiatives.

Triple bottom line initiatives were first brought into practice by John Elkington in 1994 which is aimed at creating a sustainable business value for most enterprises. The measurement is aimed at providing a measure of the company’s social impact and measures taken for maintaining social ethics, economic value creation and the final impact of the operations of the business on the immediate environment. This is very important since the business we undertake consume many resources created by the environment but we help in the gradual destruction of the same and don’t think about preserving these resources for the posterior generation (warren, 2012).

Social & Ethical Practices

The friend’s café project would think about maintaining the business line along with an ethical conduct and using green technology to reduce energy consumption and save limited resources available worldwide. For example, the business would ask the suppliers of the frim to adopt ethical means of supply and adopt a standard business supply agreement and pay the labour a fair rate. While the aim of the café is to produce premium products, it would ensure that the producers of the raw materials are paid a decent input price and not exploited by the middlemen (Weetman, 2013).

Environmental concerns

 

The café being planned in a manner so as to make sure there is recycling of products, wastages are disposed of in the right manner and sustainable practices are undertaken in consultation with the industry norms. For this purpose, the management has decided to make use of the most modern ovens, bakery machines, refrigerators and other electrical equipment’s etc. so that the energy consumption is minimized. The management has okayed the use of plates, glasses etc. which are made of recyclable wastes and are more environment friendly than traditional plastic materials used. For this purpose, the management has entered into agreement with the suppliers to collect the wastages on a daily basis so that it can be sent to the recycling plant regularly (Weetman, 2013).

Financial Bottom Line

To run every business successfully one needs to generate adequate bottom line so that the business is not only becomes sustainable on a financial basis but also gather enough reserves to make growth strategies possible in the medium to long run. To make a sustainable practices long term the firm and its management has a human resource strategy which is to link the earning capacity of the employees grow with the growth of the venture. Employees would be provided with opportunities to grow along with the company’s business and take the share of the profits on a commission basis. This would make sure they are less stressed and more engaged. This would enable them to be loyal and help in the improvement of the forms financial operations and their participation would be more in the times to come (Weygandt, 2014).

3.Preparation of various Budgets

The primary product offering that would be emphasized by the new Friends café are the range of cappuccinos and latte coffee and the variety of burgers. In the beginning the management has kept it simple by deciding to keep the prices at two levels for all the varieties to see how the market reacts. The initial market research undertaken by the management has indicated towards very positive reaction and the pricing would be expected to generate a favorable market demand for the new café. Each of the above categories have three sub variants and all of them are priced at two levels. While the larger Cappuccinos would be priced at $7 the lower cappuccinos would be priced at $5. The burger varieties would be priced at $10 and $7 for the triple layer and double layer categories (Tracie Nobles, 2015).

3.1 Sales Budgets for two Products

The market research undertaken by the firm has thrown up the following data regarding expected demand of the products in the year 1. Demand is expected to grow by 15% in year 1 and 18% in year 3.

The management has estimated the followings:

Products
Cappuccinos Lattes Burgers
Big 7 7 10
Medium 5 5 7
Demand
Cappuccinos Lattes Burgers
Big /Day 50 50 100
Medium/Day 80 100 150
Direct cost (materials)
Cappuccinos Lattes Burgers
Big 4.2 4.2 6.3
Medium 2.9 2.9 3.9

Form the above estimations the sales budget ( annual) for the New Friends Café is being estimated as follows:

Sales Budget of New Friends Café-Restaurant

Year 1 Year 2
Cappuccinos Lattes Burgers Cappuccinos Lattes Burgers
Big 126,000 126,000 360,000 144,900 144,900 414,000
Medium 144,000 180,000 378,000 165,600 207,000 434,700
Total sales 270,000 306,000 738,000 310,500 351,900 848,700
Estimated Annual Revenue 1,314,000 1,511,100

As can be deciphered from the above table the New friend’s café would generate an annual revenue of $1,314,000 in the first year of operation. And the revenue would be expected to be at least 15% higher in the second year and 18% in the year 3. As shown above year 2 revenue is expected to be $1,511,100. However, the market research has also thrown up interesting possibilities for the café. It would have to increase the menu to include many other items and the management is looking for the ways to accommodate the same (Lanen, 2013).

Note: Estimated sales for each category = no of product * selling price / unit * days*month

3.2 Direct materials budget

The materials budget of the café consists of bread, buns, butter, sauce and vegetables along with the required amount of cheese, olive oil etc. the cost of direct material involved is as follows for each category of product.

Direct cost (materials)
Cappuccinos Lattes Burgers
Big 3.6 3.6 5.3
Medium 2.7 2.7 3.6
Direct Materials Budget
Year 1 Year 2
Cappuccinos Lattes Burgers Cappuccinos Lattes Burgers
Big 64,800 64,800 190,800 74,520 74,520 219,420
Medium 77,760 97,200 194,400 89,424 111,780 223,560
Total 142,560 162,000 385,200 163,944 186,300 442,980
Annual Direct Materials 689,760 793,224

The total direct materials cost for year 1 is expected to be $689,760 and for year 2 the same is estimated to be $793,224. This calculation is based upon a 15% increase of direct materials in the second year and does not include the price increases for the year as the same is expected to be stable for year 2 (Peter Atrill, 2014).

Note: Estimated materials cost for each category = no of product * materials price / unit * days*month

3.3 Direct labour Budget.

The direct labour component of the budget is associated with the reparation of the products when ordered by customers. The same would be expected to be as follows:

Direct Labour cost
Cappuccinos Lattes Burgers
Big 0.5 0.5 0.5
Medium 0.35 0.35 0.35

As the café has decided to improve the productivity of the manpower the payment of the chefs and preparers in the kitchen would be on a per unit basis.

Direct Labour Budget
Year 1 Year 2
Cappuccinos Lattes Burgers Cappuccinos Lattes Burgers
Big 9,000 9,000 18,000 10,350 10,350 20,700
Medium 10,080 12,600 18,900 11,592 14,490 21,735
Total 19,080 21,600 36,900 21,942 24,840 42,435
Annual Direct Labour cost 77,580 89,217

Direct labour cost for the year 1 is $77,580 and $89,217 for year 2. The direct labour would be shared between three kitchen chefs to be hired for the frost and second year. However, if the demand goes beyond a certain level the management would hire an additional direct labour (Horngren A. B., 2014).

Note: Estimated Labour cost for each category = no of product sold * labour rate / unit * days*month

3.4 Overhead budget

Overheads Budget -fixed
lease rent of the Café 36000
Electricity Expenses 18,000
upkeep of the Restaurant 15,000
utilities 12,000
supplies 15,000
96,000

While the overheads are estimated to be $60,000 in the year 1, the same is expected to be 10% higher in year 2. Rent which is included in the overheads would be constant for the first three years after which it would increase by 5% each two years (Mclaney, 2013).

3.5 Selling expenses budget and Administration expenses budget

Selling & Administrative Budget
salary of the café Manager 36,000
salary of billing clerks (2 no’s) 36,000
salary of helpers and cleaners 36,000
salary of Guards 19,200
Annual Overheads Expected 127,200

While the overhead is estimated to be $127,200 in the year 1, the same is expected to be 10% higher in year 2.

The total fixed overheads for the firm is $187,200 ($60,000 + $127,200) for the first operational year.

4. Preparation of Income Statement

Income statement is the most important statement prepared by the café or any other business to assess the financial performance of the company in a particular financial year. The income statement would include the gross revenue for the year, the cost of material and direct labour and overheads along what the fiancé costs if any for the year. The bottom line after tax would be final and only measure of financial; performance and a decent profit % would ensure that the growth of the café would be sustainable in the future years (Garrison, 2013).

Preparation of Income Statement
Year 1 year 2
Gross Revenue 1,314,000 1,511,100
less:
Direct Material cost 689,760 793,224
Direct Labor cost 77,580 89,217
Total direct cost 767,340 882,441
Gross Profit 546,660 628,659
less:
General Overheads 96,000 96,000
selling and administrative overhead 127,200 127,200
Finance cost 6,000 3000
Total operational Expenses 229,200 226,200
Profit before tax 317,460 402,459
less:
Corporate tax @ 30% 95,238 120,738
Profit After Tax 222,222 281,721

Thus as can be seen form the above the café would be expected to generate a net profit of $222,222 in year 1 and the year 2 profit after tax is expected to rise to $281,721.

When the cafe is started the partners started by paying $100,000 each and also taking a loan of another $100,000 at 6% per annum from a bank on personal guarantee. And initially the café would have to pay an amount of $50,000 as a lease mortgage to the property owner (Dyson, 2007). Thus the interest paid for year 1 would be $6,000. However, because the firm’s management is expected to have adequate cash flows at the end of the year 1 half of the loan would repaid and the other half would be paid at the end of the year 2.

The net profit margin, gross margin of the new Friends café would be as follows:

Year 1 year 2
Gross profit Margin % 41.60% 41.60%
Net margin % 16.91% 18.64%

Because the cost of goods sold of the café are all direct costs , the gross margin of the frim remain constant for both the years at 41.6% and the net profit of the café for year 1 is 16.91 in year 1 and as the volume increases in the year 2 the net margin has shown an increasing trend at 18.64%. so overall the net profit margin of the firm after tax is good and impressive (Datar, 2012).

5. Calculation of Weighted Average Contribution Margin (WACM).

The weighted average contribution margin is found out by multiplying the sales percentage of particular product either products contribution margin ratio.

Calculation of Weighted average contribution margin
Cappuccinos Lattes Burgers
BIG Variety 2.90 2.90 4.20
sales 126,000 126,000 360,000
Total sales 1,314,000 1,314,000 1,314,000
% of sales 9.58% 9.58% 27.4%
WACM 0.28 0.28 1.15
Cappuccinos Lattes Burgers
Medium Variety 1.95 1.95 3.05
sales 144,000 180,000 378,000
Total sales 1,314,000 1,314,000 1,314,000
% of sales 10.96% 13.70% 28.77%
WACM 0.21 0.27 0.88

While the Medium sized burgers have a weighted contribution of .88 the same for the big variety is slightly higher at 1.15. the Burger range has a higher WACM as against that of the coffee range because of higher % of sales (Duchac, 2011).

6.Calculation and Evaluation of the Contribution Margin Ratio (CMR).

Contribution margin ratio of Big Variety of products are as follows:

Cappuccinos Lattes Burgers
BIG
SELLING PRICE /UNIT 7 7 10
LESS:
DIRECT MATERIL /UNIT 3.6 3.6 5.3
DIRECT LABOUR /UNIT 0.5 0.5 0.5
TOTAL VAIRBALE COST PER UNIT ' 4.1 4.1 5.8
CONTRIBUTION MARGIN PER UNIT 2.9 2.9 4.2
contribution Margin Ratio (CMR) 41.43% 41.43% 42.00%

Contribution margin ratio of Medium Variety of products are as follows:

Cappuccinos Lattes Burgers
Medium
SELLING PRICE /UNIT 5 5 7
LESS:
DIRECT MATERIL /UNIT 2.7 2.7 3.6
DIRECT LABOUR /UNIT 0.35 0.35 0.35
TOTAL VAIRBALE COST PER UNIT ' 3.05 3.05 3.95
CONTRIBUTION MARGIN PER UNIT 1.95 1.95 3.05
contribution Margin Ratio (CMR) 39.00% 39.00% 43.57%

As can be seen form the above the Medium sized burgers have the highest amount of contribution margin ratio while both the coffee of medium sizes is having a lower 39% margin.

7. Calculation of sales volume in units and sales dollars at breakeven point.

Breakeven point is very important for a business to achieve as soon as possible because it allows the firm to plan and strategies much ahead. And if the business is able to reach the breakeven point early then the firm would be in a positon look back and push for a different strategy to increase demand. BEP is important because at this point of revenue the company is in a positon to avoid losses even if here is no profit and thus theoretically the company has been able to recover all the costs of operations. Form the look of the revenue projections and the income statements it looks like the New Friend’s café would be able to break even operationally in the first year itself (Cottrell, 2012). The calculations are as follows:

Calculation of BEP (in volume & Quantity of units)
General Overheads 96,000
selling and administrative overhead 127,200
Total Fixed costs for the year 223,200
Revenue for year 1 1,314,000
less:
Variable costs 767,340
contribution margin 546,660
contribution Margin ratio -CMR 41.60%
(contribution / sales)
Break Even Point (BEP)
(fixed costs / CMR) 536,503 (223,200/41.6%)

So the firm overall has maintained a contribution margin of 41.6% and in order to break even in terms of the dollar sales it needs to generate a revenue of $536,503. Any sales above this amount would mean there would be operational profit for the firm.

The respective shares of the two different categories of products and their units which were required to be sold to break even is calculated as shown below:

Calculation of Units to Break Even
Total BEP revenue required 536,503
BIG Medium
Cappuccinos Lattes Burgers Cappuccinos Lattes Burgers
Revenue Share needed to break even 9.59% 9.59% 27.40% 10.96% 13.70% 28.77%
Dollar revenue needed - Annually 51,446 51,446 146,987 58,795 73,494 154,337
Dollar revenue needed per month $4,287 $4,287 $12,249 $4,900 $6,124 $12,861
unit selling price 7 7 10 5 5 7
Units for Break Even 7,349 7,349 14,699 11,759 14,699 22,048
Monthly Units required for Break Even 612 612 1,225 980 1,225 1,837
Daily Unit for Break Even 20 20 41 33 41 61

So as can be seen the new friends café had to sell 20 units of Big cappuccino/latte per day , 41 units of big burgers , 33 units of medium Cappuccinos , 41 units of medium latte and 61 units of medium sized burgers to break even. Considering the numbers this is quite reasonable and with various schemes that the management is going to unveil in time, the same can be realized comfortably.

8. Calculate and evaluate the Operating Leverage and Safety Margin and their Explanations of risk for the business.

Calculation of Operating leverage

Operating leverage is a measurement of the company’s Fixed costs as a portion of the total costs of the firm in a particular year. The café would have a higher operating leverage if it has a large amount of fixed costs and thus increase the risks of operations and vice versa.

Operating leverage = contribution / operating income = $546,660 / $317,460 = 1.72

The operating leverage is quite low for the café. This means a change of fixed cost would not have much impact on the operating margins. And thus the risk of the business is quite lower. If at this level the sales of the business increase by 1% then the operating profit would increase by just 1.72% (Dyson, 2007).

Calculation of Safety Margin

The safety margin of the café is assessed as given below:

Safety margin = Actual sales in $ - BEP $ = $1,314,000 - $536,503 = $ 777,497

Safety margin in % of revenue = $ 777,497 / $1,314,000 = .6575 = 59.17%.

So the safety margin for the new friend café is 59.17% for the first operating year and the same can be taken as a safe margin. Which effectively means the firm’s management might be able to withstand a drop in demand by 59% of the estimations made and still not make loss. So from profitability perspective the estimations are quite good (Belverd E. Needles, 2012).

9. Critical Evaluation of the best ways that your business can increase its profitability.

The new Friends café is a business which is looking forward to cashing on the expansion of the central business district and increased footfall in the area. The business proposed is well placed to capture a good share of the market and make for a decent profitable venture. As can be seen form the above discussion the business is well timed to make an impact in the mind of the consumers who come to the area on a daily basis for official business and the thousands of employees who also comes to the area for their jobs etc. they are on the lookout for a good place where they can enjoy a good meal and satiate their hunger. They need a good ambience and good quality food and coffee with their family, friends etc. New Friends café is exactly such a place which is not only strategically located but also covers the capacity to pay as well very nicely (Atrill, 2013).

The services are designed in a manner so that once the order is placed the same would be delivered to the customer in exactly less than 5 minutes even at the peak time which means customer can rely on us for a timely lunch and evening snack when they get time form their busy day job. The café recognizes their speeding pattern and has devised a method to enroll as many customers as possible in a monthly membership card in which if a customer’s spends more than $150 in a month they would be given 3% discount on their very subsequent visit and the same would definitely help the café gather as many members as possible. Those customers who places orders worth $120 or more in a single order would be given a flat 10% discount. This is aimed at the visitors who are travelers to the area (Atkinson, 2012).

The market study reveals that there would be enough demand if the product and service quality are good. However, in the coming months the New Friends café recognizes the need for introducing new menus and that too at a reduced price than competition.

  1. Introduce the new products which are offered at present by existing players at least 20% lower price.
  2. Increase the manpower of the café in coming months to increase level of services and that is aimed at reducing the time of servicing.

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