You have been approached by your friend, jessica, who is thinking about opening
ID: 2595210 • Letter: Y
Question
You have been approached by your friend, jessica, who is thinking about opening a toy store in the High Street.
Jessica’s mother, Margaret, is willing to invest £20,000 in the business in return for a share of the profits of the business. However, Jessica believes she will also require a business overdraft from her bank and has a meeting next week with the bank manager to discuss this.
The bank manager has requested that Jessica produces a written business plan for discussion at the meeting. Jessica is aware that you are studying finance as part of your degree and would like your help.
At a recent networking event, Jessica met two other shopkeepers in the High Street who have each provided her with their latest income statement to give her an idea of costs that she might incur (see Income statements below)
Bargain Foods
Income statement for the year ended 31 December 2014 and 31 December 2015
2015
2014
Revenues
770,000
808,000
Cost of sales
(555,000)
(550,000)
Gross profit
215,000
258,000
Wages
(144,000)
(139,000)
Rent
(32,000)
(30,000)
Light and heat
(9,500)
(9,750)
Insurance
(4,000)
(3,750)
Advertising
(500)
(500)
Other costs
(4,000)
(2,000)
Operating profit
21,000
73,000
AJ Jewellers
Income statement for the year ended 31 December 2014 and 31 December 2015
2015
2014
Revenues
138,000
122,000
Cost of sales
(48,000)
(35,000)
Gross profit
90,000
87,000
Wages
(25,000)
(20,000)
Rent
(5,000)
(5,000)
Light and heat
(2,000)
(1,750)
Insurance
(1,000)
(750)
Advertising
(4,000)
(6,000)
Other costs
(500)
(500)
Operating profit
52,500
53,000
AJ Jewellers is jewellery store which operates from a shop which is a similar physical size to Jessica’s. The shop opens five days a week.
Bargain Foods is a supermarket operating from a much larger premise. This shop is open seven days a week.
Jessica expects her weekly turnover to be £1,000 in the first six months of trading, increasing to £1,500 in the second six months of trading. She expects her gross profit margin to be 45%. Her shop will open five days a week.
Jessica’s initial cash expenditure will include: £10,000 on inventory, £5,000 on shop equipment and £2,500 on advertising. She will also pay a deposit of £2,500 to her landlord which will be refundable after her first year of trading.
Using your forecast (see previous question) and the historic financial performance of AJ Jewellers and Bargain Foods, advise Margaret on whether she should invest in Jessica’s business. Your answer should include a number of relevant financial ratios.
2015
2014
Revenues
770,000
808,000
Cost of sales
(555,000)
(550,000)
Gross profit
215,000
258,000
Wages
(144,000)
(139,000)
Rent
(32,000)
(30,000)
Light and heat
(9,500)
(9,750)
Insurance
(4,000)
(3,750)
Advertising
(500)
(500)
Other costs
(4,000)
(2,000)
Operating profit
21,000
73,000
Explanation / Answer
First of all let’s prepare estimated income statement for Jessica’ business. It is also given that AJ Jewellers is jewellery store which operates from a shop which is a similar physical size to Jessica’s.
Thus Income statement will be prepared on the basis of income statement of AJ Jewellers;
Estimated Income Statement
Revenue
$60000
Cost of sale
($33000)
Gross profit
$27000
Wages
($25000)
Rent
($5000)
Light and heat
($2000)
Insurance
($2500)
Other costs
($500)
Operating profit (Loss)
($8000)
Estimated revenue for Jessica will be calculated as follow;
[($1000 * 4 * 6) = $24000] + [($1500 * 4 * 6)] = $60000
Now let’s see that gross profit is very impressive that is 45% but apart from this it is also clear that there will be net operating loss of $8000. So it is clear that Margaret should not invest in Jessica’s business.
It is also given that total investment will be ($10000 + $5000 + $2500 + $2500) = $20000
Because it is clear that all expenditures will be estimated for Jessica on the basis of financial statement of AJ Jewellers.
Estimated Income Statement
Revenue
$60000
Cost of sale
($33000)
Gross profit
$27000
Wages
($25000)
Rent
($5000)
Light and heat
($2000)
Insurance
($2500)
Other costs
($500)
Operating profit (Loss)
($8000)
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