Profitability is the “making of gain in business activity for the benefit of the owners of the business.”
It is vital to my business as it allow my business to keep running.
This is because by making a profit:
> Means my business is of interest to people and so by making a profit it is prevented from closing down.
> Where I have borrowed money, for example, for the set up of my business, I will take a loan from the bank, by making a profit I am then able to pay off that money.
> In the future, if I am looking to expand my business I am able to as I have enough, or even extra funds to use. This shows that ‘passion4fashion’ is doing well and its performance is improving.
> I can be rewarded for the risks that I have taken in order to run the business.
Profitability is a vital part in my business as I have to ensure the list above is carried out, once I have made a profit, e.g. pay bank loans back. As the owner of ‘passion4fashion’ I would like to ensure all the hard work I put into the business will be paid off, I believe that the profit is my reward for my entrepreneurial activities. Failure to gain profit leads to an unsuccessful business. By making a profit and by that profit gradually increasing let me know that my business is improving over time. However, as ‘passion4fashion’ is a new business I cannot expect a profit immediately. Even though I will not gain a profit immediately, I will still need some sort of finance in order for my business to survive in the short run therefore I will have to have a sufficient amount of liquid resources. This is because liquid resources can be turned into cash within 12months. This will allow me to pay off immediate bill and wages etc.
Liquidity is a term that refers to ‘the ability with which assets can be converted into cash.’
As I may not be making a profit within the first twelve months, I will need a way in which my business to survive. I believe it is possible to survive without making a profit within the first year as I can use the cash from liquid sources. These include cash in hand and money I have put either in a savings account or have as savings.
Hence, liquidity is so important as if ‘passion4fashion’ has a liquidity shortage, then it means there is no available cash. Cash is needed to pay for immediate bills, for example; wages, electricity bills, etc. without these bills being paid it is impossible for me to continue with my business.
If ‘passion4fashion’ did have a liquidity issue, I could sell off any raw materials and fixed assets that are unnecessary for running my business. This would allow me to make cash on them for a quick source of money. Also, I could retrieve any debts that I am owed in order to gain more money; however, as I am opening a new business it is unlikely that I have debtors already. This action will only take action if there is a severe liquidity problem within my business.
In general, the productivity and liquidity is crucial because I will need to monitor the financial position that my business is in. If I cannot make a profit, I will most definitely need liquid sources that are easily available.
Assets, Liabilities, Expenses & Revenues
An asset is property owned and used by the business. The assets I have will consist of:
> Current Assets: current assets are those that are available as cash and other assets that could be converted into cash within a year. Current assets will be use up in production and include stock and cash.
The stock; for my business the main stock is T-shirts; this will include a range of colours and sizes, and creative-flex (this is the printing ink) there will also be a range of colours of creative-flex. I will re-order the two main stocks on a monthly basis.
> Fixed Assets: an asset to a business that is central to its operation and not traded. My fixed assets are what I will buy to be used over a long period of time; this includes the premises I will be running the business in, and the printing press machine.
A liability is the money that is owed, all debts and financial obligations. There are 2 types of liability:
> Long term liabilities- “An investor’s legal responsibility for no greater proportion of a company’s debt than is represented by the value of the financial stake in the business.” These are finances that are not due to be paid back for atleast 12 months. An example is money that is to be repaid in bank loans.
> Current liabilities- these are finances that are due to be cleared before the end of the financial year. This includes payment to suppliers, overdrafts, short term loans, and annual taxes.
Revenue: the revenue is the income that comes into the business, due to the sale of products or services. So the revenue for “passion4fashion” is the total income that I get from selling the personalised T-shirts.
Expenses: these are overheads of the business. It is all money spent for business purposes. For my business this will include; broadband internet, mobile phone contract, printing press machine, T-shirts, printing ink, premises, stationery, computer, etc. (all expenses named in cash flow forecast)
Profit and Loss Account
My profit and loss account will show calculations of the net profit or loss made within my business. This account includes the income that has been received and the expenditures on resources that will be used within the next 12 months.
Overall, this contains information about costs and profits, also revenue that I will record over the year.
The main details of a profit and loss account consist of
This is the revenue that I will generate from my business. The turnover minus the cost of sales will show my gross profit.
Cost of Sales:
The cost of sales is the expenditure that needs to be reached in order to produce goods.
This is figure is found by cost of sales – turnover. Gross profit is the profit that my business will make before any expenses have been taken away.
These are also known as overheads. The expenses are not associated with production.
This is the total amount of profit that is left over.
The Profit and loss account that I have created displays that for the initial year of trading that I have made a net profit of ï¿½29,388. As, I am a new business it is not expected to make a profit for the first year. However, if I keep to the budget and if business continues in the way I have forecasted, then ‘Passion4Fashion’ should make the high profit I have predicted. I wish to maintain, and exceed this profit in years to come and therefore that means not making a loss. This means I will need to increase sales, I could also decrease the cost of my expenses, however as I am not making a loss I do not need take extreme actions.
Profit and Loss Account
For end of initial year:
Cost of Sales
Advertisement and website
Underneath is the profit and loss account for ‘passion4fashion:
My balance sheet will show the assets and liabilities for ‘Passion4Fashion’ at one time. The balance sheet below shows the assets and liabilities of my company within a year.
Balance Sheet for
Cash in Bank
Cash in hand
Net Current Assets
Long term Liabilities
NET ASSETS FINANCED BY
Add Net profit
Cash flow forecast
The cash flow forecast is a vital aspect in the planning process when setting my business up. Overall, my cash flow forecast will show the amount of money coming into the business and going out of the business a year. However, it is separated and presented in months.
The advantage of producing a cash flow forecast is to help me control and maintain my cash. By predicting in which months I will have more money I am then able to take risks or expand my business. Also I need to ensure ‘passion4fashion’ remain liquid meaning there is enough money coming into the business so I am able to repay debts and bills.
By creating a cash flow forecast and thinking about the future of the company I can plan ahead, enabling me to estimate future costs and revenues. Also, by creating a cash flow forecast I not only see when I have more money coming in, but also I can see when I have little money coming in aswell, this allows me to prepare or save for those times. By having a estimate of what the future of my business will be like I can save well before time in order for my business to remain liquid or else my business will fail.
As I have previously explained, when setting up my business I will need to borrow money, this will be a loan borrowed from the bank. However, as that money is needed to be paid back I will have to prove to the loaners that the business I plan on starting up will be successful and will be able to pay back the loan. By producing a cash flow forecast I have enabled myself to present to the business how their money is going to be spent, and paid back. Also, a cash flow forecast is an effortful task and therefore it shows the bank managers that I am determined to make this business reach its maximum potential.
I have researched many banks in order to find the best loan for my business. I have found that Lloyds TSB offer the best loan, and I will requesting a loan of two thousand pounds. As the owner I feel it is also my duty to take a risk and put in four thousand pounds of my savings into the business. I believe in myself that I can make the business work and achieve the aims and objectives set. However, it is my job to persuade the Lloyds TSB that I am worthy of the loan. So in order to do so I have put together my cash flow forecast to allow the bankers to see that my business plans are practical and attainable. Also, if I knew from looking at the cash flow forecast that my business would fail I would be very hesitant to put in four thousand pounds worth of savings. At the end of the business year I can then compare my cash flow forecast with the actual cash flow. This allows me to see where it is I have over spent, or even not spent enough. But most importantly, it allows me to make any adjustments for the following year. So my cash flow forecast for each year gradually becomes more and more realistic and is closer to the actual cash flow.
I have used a spreadsheet to present my cash flow forecast, I have presented how much money I have estimated to flow in and out of my business during the first year. On a monthly basis I have calculated that my business make sales worth ï¿½1900 for the first three months. I plan to sell 120 T-shirts a month, at the average price of ï¿½15.83. I have only calculated an average price as the price may vary depending on the type of T-shirt the customer requires, e.g. larger logos will have an additional charge.
I have increase my estimated sales figure after three months as during the 1st three months I plan to heavily advertise my business in the local newspaper, and become a recognised brand. The advertising will come into effect after three months. And so by the time of April and May I will have a larger market share.
I have estimated that my busiest months of the year will be June and July. I have again increased my estimated sales figure to ï¿½4600, I hope for this increase as the weather will be getting hotter and therefore people are more likely to buy and wear T-shirts. Also, during the summer, I have researched that people, mostly students, go on holiday. As they go in large groups they buy personalised T-shirts stating where they are going, and their name or the name of their group. For example;
During those two months I plan to sell 290 T-shirts per month (rounded up to nearest 10) this will increase my revenue by ï¿½1250, with sales rising from ï¿½3,350 in May to ï¿½4,600 in June.
However, during the months of August and September I have realistically decreased sales to be the same as April and May, this is because the weather will be getting colder and therefore people will not buying or wearing as many T-shirts. I have also estimated that the sales drop after September until December, this is because the weather is going to be extremely cold and it is highly unlikely that T-shirts will be worn. However, I expect to still get sales during these months as October, November, and December are months of which people do Christmas shopping, and with the aid of advertising a personalised T-shirt maybe the perfect Christmas present.
In total the cash flow forecast shows me that I am expecting a total of ï¿½34,000 in sales during the first year of trading.
As a business I will have expected costs that the business will need to meet. These include the materials used to make my T-shirts; this is known as my direct costs. For the first three months I will have ï¿½245 for stock and ï¿½265 for materials (T-shirts). As I plan to sell more after the first three months this means I will have to spend more on materials and stock, so raising the total of both from ï¿½510, to a total of ï¿½760 in April and May. The direct costs will keep rising until August, and the decrease again in October through until December.
The premises I have decide to use is my Uncle’s stationery shop. I have discussed the matter with him. He agreed to give me a spacious (enough to make and sell my T-shirts) part of his shop if I pay him rent of ï¿½50 a month, this is because it is an unused space and he feels he has no gain from using this space, so the extra ï¿½50 a month can do his company some good aswell. Also, by advertising my company they will enter his shop in order to purchase a T-shirt, and customers may decide to pick up some stationery on there way in or out. However, I agreed that after the first year, after sales increase, I will also increase the rent I pay.
I have also included fuel costs which I have estimated to be ï¿½30 a month, this is because I will only be driving to and from work, and occasionally I may have to either go to the bank or pick up supplies. But on the whole I will not be travelling much. Also, I have decided that on large orders, if they are unable to pick up the T-shirts I ill be willing to drop them off. This will only be within a 10 miles radius of my shop.
My car tax is ï¿½125 a year, and I have received a quote from AA for my car insurance which is totalled to ï¿½600 a year. This is because I learnt to drive from AA driving school, and as a result I get discount off my car insurance. I have included this in my cash flow forecast as 12 monthly instalments. My mobile phone service is ï¿½120 a year, on O2 as I feel they give the best deal for the lowest amount of money.
The net cash flow is the sales minus the expenditure. If sales are more than expenditure than the net flow will be positive, however, if expenditure is more than sales then net flow will be negative. Looking at my cash flow forecast I have a positive net flow, this is because my total sales are more than my total expenditures. I have a net flow of ï¿½16,649. As T-shirt sales increase so does the net flow, this is shown as by looking at my cash flow forecast I can see that during the months of June and July (boxes G48 and H48 in cash flow forecast) my net flow increases by ï¿½225 compared to that which it was in May.
The opening balance is the amount of money my business will have at the start of each month.
My cash flow forecast shows that the opening balance in January is ï¿½0. This is because I have not sold any T-shirts yet. As my business prolongs and I am gradually selling more T-shirts my opening balance will increase every month, this is because sales will be higher than expenditure.
My closing balance shows the amount of money that is left at the end of the month.
The closing balance for one month equals the same as the opening balance for the month after, and is calculated by adding the net flow to the opening balance.
The closing balance for January is ï¿½5,997 this is reasonably high for the first month.
After January the closing balance keeps increasing, however it increases more after June and July than any other months.
Normally businesses either have liquidity issues as they do not have a positive cash flow. They may decide to take out extended loans, and in the future if I my business does have liquidity problems I will have to do this. However, for the first year according to my cash flow forecast my business will not have a negative cash flow. This is because my expenses are low in comparison to my payments. By showing the bankers this, it is a persuading factor in order for them to give me a loan.
A budget is a major part for financial planning; it is used to see how much money is available for future and present use. In order to keep my finances in order and in effect I will have to produce a budget every month.
The main functions of having a budget are;
> Planning: by having a budget I can plan for the future incase problems occur and I fall short of money.
> Directing: by budgeting the money I get I can put some of it towards motivating my employees, so they work harder in order to achieve their goals and targets set. Also, I can see exactly where the money is going, and this will mean that no one else can spend the money unnecessarily, including myself.
A budget is useful as it gives me an indication of where I can spend and save money. This is extremely vital as it can prevent the assimilation of debts. The budget can help with the successfulness of my business; this is because I can see where it is necessary to spend my money in order for it to go further. I can also prioritise what I need to buy ahead of time; again, this will enable my business to go further and for me to avoid debts as they will be my first priority.
There are different types of budgets; some of them are listed below;
> Production Budget- this type of budget is used to plan levels of production.
This will show the amount of units for each product that will need to be made in order to reflect the revenue plans shown in the sales budget.
> Sales Budget- this is the budget I am likely to use, I feel this is the most important type of budgeting as it effects other types of budgeting, as you can see from above (affects production budgeting). This is caused as if the amount of sales increases during the year, the amount of production will also need to be increased (as demand goes up, supply has to follow). By using this type of budgeting I can gain a clearer insight on where my money is going.
Variance analysis is a budget that can be carried out for both revenue and costs. Below is a list of the four types of variance analysis:
1. Sales Variance; this is the difference between budgeted sales revenue and actual revenue. For example if a new competitor comes into the market, that would decrease my sales, and as it was unexpected it would make a large difference when comparing predicted revenue to actual revenue.
2. Materials variance; this is the difference between predicted cost of materials and actual cost of materials. For example, if the price in cotton (the T-shirt material) rose unexpectedly yet rapidly I would have to increase the selling price of my T-shirts. Thus as the increased price in cotton was not expected, it would have a great effect when comparing my predicted cost of materials to the actual cost of materials. Also, the increase or decrease in inflation will have an occurring difference in the price of the materials I buy.
3. Fixed Overhead Variance; this is the difference between the predicted fixed overhead and the actual overhead. An example relating to ‘passion4fashion’ would be if the rent increases within the first year, this would not be planned as I have agreed for the rent to increase after a year. And so with the unexpected circumstance there will be a different between predicted and actual price of fixed overheads.
Variance analysis will allow me to view the overall performance of my business as I can see where and why variance has occurred.
The point where my business will break even is when the total revenue from sales is exactly the same as producing the T-shirts. The level of output where total costs and total revenue are the same is known as the ‘break even output’. The formula I will use to assess whether or not I have broken even is;
The fixed costs are those that remain the same for the business throughout the year for example, my premises, and machinery. Also, the repayments I make to the bank will remain the same during the year so that can also be counted as a fixed cost.
The contribution for my business would be the cost of producing the T-shirt subtracted by the sale of the T-shirt.
The fixed cost for my business equals, and the contribution equals ï¿½15.83-ï¿½4.25, this gives me a total contribution of ï¿½11.58.
Break even can help me monitor the performance of ‘passion4fashion’. I am able to do this as if I receive a profit more than I expected I can see that my targets have been met and exceeded. Also, if I target my business to break even in June and it does so in October than I can see that I need to improve my business strategies in order for my business to be successful.
I will use the calculation shown above to figure out how long it will take in order for my business to make a net profit. By using the research I have conducted which tells me how many T-shirts I are demanded a week, for example 40 T-shirts in demand for every week on an annual basis, I will sell 2080 T-shirts a year. Break even comes into this as I can see how many T-shirts I have to sell in order to break even and how long it will take me to sell that many T-shirts. If I am able to break even within the first year I can then calculate my net profit after breaking even, with this information I can then start expanding on ideas for my business and strive to achieve new aims and objectives.
By using my market research to calculate how long it will take in order for my business to break even, I can then adjust it accordingly. For example, if I end up selling more than I planned I will be sure break-even quicker. However, if I end up selling less than I intended than I will have to recalculate my break even time.
My break even figure may even change, for example, if a new scenario occurs where perhaps a new competitor enters the market, I may have to lower prices. This means that I will have to sell more T-shirts in order to break even. To keep revenue the same if I decrease the price I will have to either promote my business more, or look around for a cheaper supplier!
My break even figure can also help me when I have the money to pay out in order for my business to remain liquid.