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Introduction
The client, Isaac, is planning to start a new venture that will import German chocolate into Canada and sell it. The firm AlpenChoc, which specialises in handmade artisanal chocolates, is prepared to sell him seven-year exclusive distribution rights in the country.
As such, he can leverage this advantage to establish a presence in the nation, find a customer base, and begin making a profit. Since Isaac has retired recently, he has the time and motivation to developing and expanding the business, both of which are critical to success. However, there is a concern regarding the potential of failure and the loss of the investment. The purpose of this report is to evaluate the projects prospects, determine how likely it is to succeed and grow and provide a series of recommendations for the various aspects of the business.
Assumption and Estimate Summary
The first assumption that is required is that of the conversion rate between Canadian dollars and Euros. Understanding it is critical to any business that operates internationally and especially valuable to importers such as the proposed venture. This report will use the average value for the last year as reported by the Bank of Canada (2020a), where one euro is equivalent to approximately 1.48 Canadian dollars. The rate is subject to substantial and unpredictable fluctuation, which is why using a single data point is dangerous. The average is still likely to be generally inaccurate, but it can approximate the future to an adequate degree, assuming both economies remain stable. The business will plan based on this assumption, as it would be imprudent to rely on the strong growth of either currency in the foreseeable future.
The inflation rate is another critical assumption, mainly because the report will be using discounted cash flow analysis. Money depreciates over time, reducing the businesss profitability if its prices remain the same. Once again, it is possible to refer to the Bank of Canada (2020b), which shows an inflation rate of approximately 2.2% over the last year (using the median metric). The same considerations about stability apply as in the previous case, but inflation is easier to control because it is mostly limited to Canadas internal economy. Moreover, according to Di Bartolomeo and Saltari (2017), most countries target an inflation rate between two and four per cent, and Canada fits into this interval. As such, with a stable economic situation, the nations growth is likely to continue at the same rate as before, making the 2.2% estimate mostly safe.
It is also necessary to make some assumptions about the miscellaneous costs of running the business. Some aspects of the company, such as refrigeration, will require the usage of electricity. However, the amount is likely negligible when compared with the overall size of the business. As it is challenging to estimate it accurately given the lack of information, it will be omitted from the report. The assets will be subject to depreciation (Weygandt, Kimmel and Kieso 2019), but due to their overall low cost and a lack of information, this factor will be omitted, as well.
The cost of maintaining the website is easier to determine, as Pricing & supported domain endings (2020) sets the annual price for a.ca website at $120, or CAD 161.06 as of the time of writing (Bank of Canada 2020c). As long as the business uses a reliable domain, there should be little need for maintenance. Also, the company will spend $1000 per month on advertising via various channels as a baseline estimate.
Discounted cash flow is appropriate in this case because, according to Hitchner (2017), it is best applied when short-term and long-term growth is likely to be different, and the company has not stabilised yet. While much of the analysis will focus on the short term, where inflation is unlikely to be highly influential, a more extended perspective is also warranted. However, it is still essential to factor in every possible element when making a potentially risky decision.
Barringer (2016) notes that a comprehensive evaluation of dangers is critical for ensuring that the project is reliable enough to merit an investment. Every start-up is associated with the threat of early failure and loss of money before they can begin operating successfully. By improving peoples understanding of the potential issues, the business can outline the impact of potential crises and the amount of starting capital required to address them.
The payment method used by the business warrants additional consideration due to the complexities that it brings. The transaction company will hold customers money until the month ends and transfer it in bulk two weeks after that. As a result, every month, all of the companys sales during it will be filed as accounts receivable. Prendergast (2020) recommends that they are included in the sales for the period in the profit and loss statement.
The sensitivity analysis projections will use the same approach and treat customer payments as instant cash infusions. However, the paper will use the direct method for the cash flows statement, which means that accounts receivable will only be filed once the payment to the company is complete (Klammer 2017). The balance sheet has a dedicated section for accounts receivable, so the consideration does not apply there. The shipping time from Lindau to Toronto is also irrelevant because the company will buy the product in advance to compensate.
Break-Even Analysis
To conduct the break-even analysis, one has first to determine the fixed costs of operating the venture. Lee, Lee and Lee (2016) describe the general purpose of the break-even analysis as determining when the businesss revenues equal its costs. Some of the latter, known as variable costs, depends on the number of goods sold, while others remain constant, or fixed, irrespective of the firms activity. In this case, the prices of purchasing chocolate from AlpenChoc, shipping it to Toronto and delivering it to buyers will constitute variable costs.
Employee salaries, rent, and other miscellaneous expenses such as advertising and domain maintenance will constitute the fixed costs. As a side note, this analysis will not factor in the contract with Jade, which will generate profits due to its 33.82 CAD variable cost per box and its CAD 45 price. This contract is not permanent, and in the long term, it would be prudent to assume that the business will have to survive and make profits without it.
The companys employees will receive CAD 3,000 per month, and the rent will be CAD 3,500. The business will also spend CAD 1,000 every month on advertising and CAD 10 on domain maintenance. Overall, the fixed costs come up to approximately CAD 8,510 per month. The variable costs include the CAD 106.56 purchase price per kilogram of chocolate and the CAD 20.72 price of delivering it to Toronto. There is also the CAD 6.00 shipping cost for delivering orders to customers and the handling fee of CAD 1.92, bringing the total variable cost to CAD 135.20.
As such, the contribution margin for each kilogram of chocolate sold should be approximately CAD 24.80. To compensate for the fixed expenses, the business will have to sell 343.15 kilograms of chocolate every month. The market study suggests that it can hit this figure and break even within the first year, further exceeding it by a factor of approximately two later on.
In the projections below, the business will not necessarily break even when it hits this mark. The reason is that it stocks supplies for a month ahead and will buy a higher amount of chocolate than it sells every month. As a result, while it technically makes a profit selling of the stock that was delivered last month, it spends more than its total revenue buying a higher amount of supplies. Once sales are high enough to offset the effect or stabilise at a set level, the company will begin making a profit. The former will typically only happen toward the end of the first year, while the latter always occurs at the beginning of Year 2 in the projection. As such, the business will lose money consistently throughout the first year on paper, even though its value will increase substantially.
Profit and Loss Statement
Table 1: Profit and Loss Statement for the Company.
Balance Sheet
The balance sheet below represents the companys projected state at the end of the first year of operations.
Table 2: Balance Sheet for the Company.
Monthly Cash Flow
Table 3: Monthly Cash Flow for the First Year.
Annual Cash Flow
Table 4: Annual Cash Flow for Years 2 through 7.
Starting Capital Analysis
The business will stock supplies for a month ahead, necessitating an initial purchase and delivery of 75 kilograms of the chocolate for a total cost of approximately CAD 9,546. This figure is based on the market study, and he can stock more for situations where demand is higher than expected. To store them, Isaac will need to purchase the refrigerator and pay the deposit for the room, which amount to a total of CAD 26,000. The wrapping machine will cost CAD 2,200, and the website will incur an additional expense of CAD 8,500. Additionally, Isaac has spent CAD 5,000 on the market study, but this money does not factor in the final figure of CAD 46,246. All of these costs will have to be paid to conduct the essential setup before the company can begin operating.
As can be seen in the cash flow statement, the report assumes the starting balance of the business to be CAD 250,000. With this figure, it does not go into negative numbers before it can begin making money, and there is also a substantial safety margin in case of unexpected events. It is best to have it to avoid early bankruptcy before the company can break even (Vinturella 2017). If Isaac wishes, he can lower that figure and either rely on a lack of financial difficulties or invest additional money to rescue the business later. However, this report will assert a starting amount of approximately CAD 300,000 in addition to the licensing fee that the company will pay to AlpenChoc. That amount will be discussed below in more detail, with specific recommendations attached.
Sensitivity Analysis
Several factors can affect the companys operations, potentially improving it or making it worse. According to Viguri and López (2019), it is prudent to conduct a sensitivity analysis to determine how changes in these parameters can affect the businesss performance. Exchange rates and inflation have been mentioned as potential issues above, but they are unlikely to fluctuate significantly. As such, there is little to no practical reason to analyse them as potential risk factors.
However, customer demand is a significant variable because of the price elasticity of chocolate (Buch-Andersen et al. 2019). AlpenChoc chocolates are likely in the premium category, which can substantially reduce demand, according to Wise and Feld (2017). On the other hand, the chocolates popularity may also exceed the projections of the market study. As such, two analysis cases of demand 25% below and above expectations will be featured in the following analysis.
Table 5: Financial Projection in the Case of 25% Lower Sales.
Projection for Low Demand
As can be seen from this projection, while the businesss performance will be substantially worse than in the case of the demand matching expectations, it will remain profitable from the second year onward. The reason is that the sales are still higher than would be necessary for the business to break even. With that said, it will take the company considerably longer to break even than in the case of average demand, which reduces its attractiveness and feasibility. Saxton, Saxton and Cloran (2019) recommend offering discounts and looking for wholesale channels to improve sales. The business will operate and make a profit, but it is a worse investment in this case.