The Case: Project MUSE Empire-building Group Ltd - initial 12-month financial forecast for start-up business plan

The Project MUSE Group Ltd is now entering the final stages of preparation before the launch of their venture. Much market testing has been done and results have been overwhelmingly favourable. Suppliers and creditors have been secured. A staffing contract has been signed with a local HR supply firm that will advertise and screen for suitable candidates to fill future staffing needs. Distribution, transportation and logistics have been procured and all details of timing, volume, and price have been agreed upon.

While MUSE is highly anticipating their initial project launch; they have also begun to set their sights on expansion into neighbouring Thailand in the next 18 months. While language, culture and regulations different, the untapped demand makes the obstacles acceptable.

Production and distribution arrangements

The venture is a mobile phone case manufacturing business, which will initially produce only a single phone case. The case will be transported across Vietnam via a distributor. To minimize costs and establish clear costing guidelines, MUSE's inventory and production details includes:

• Ending inventory required will equal 25% of the next month's sales as a precaution against stock-outs.
• There is only one type of raw material used in production. Space-aged plastic (SAP) is a very compact material that is purchased in powered form at a cost of $0.45 per kilogram. SAP supplier is somewhat unpredictable thus MUSE finds its necessary to maintain an inventory balance equal of to 100% of the following month's production needs.
• 2 kilograms of SAP is required to make a single mobile phone case. Indirect materials cost $0.20 per unit. Environmental fee per unit is $0.15. Plant maintenance is $0.30 per unit. Other manufacturing costs are $0.05 per unit.
• Employees are paid on a per unit basis. Their total pay each month is, therefore, dependent on production volumes and averages $9.00 per hour.
• Each unit spends 20 minutes in production.
• MUSE has negotiated with the supplier a 30-day supplier credit arrangement for payment of the monthly shipment. No early payment discount.
• As MUSE is situated within 100 kilometres of its raw material supplier, delivery (when available) has a lead-time of only hours.

The supplier has committed to this purchase schedule.

Forecast sales volume for the first year of operation

MUSE's market research indicates that they can realistically forecast initial monthly sales volume of 1000 items, through electronic retailers throughout the country. Sales arrangements have already been negotiated. The distributor will charge a fee of 12% of all sales value and will assume responsibility for any commissions due to retailers

MUSE forecasts, somewhat conservatively, that sales for the month 2 and month 3 will be 1000 items in each month. No sales in first month of operations

Market research also indicates that the product is likely to be well received by the target group, so MUSE forecasts that in Quarter 2 a 2.5% volume increase is realistic. They again conservatively plan Quarter 3 will see a 8% increase. In Quarter 4 a 15% increase in forecasted. After the first year, market saturation is expected thus a constant growth of 3% is expected. Forecast figures are cumulative. Round sales figures up/down to the nearest unit (no fractional units).

The initial per unit selling price will be $15, and this will not change in the first year.

The distributor insist that they be given the below credit terms to pay for the stock that they will sell for MUSE through their many stores and outlets. Since this is industry practice, MUSE has had acquiesce to this request. Nevertheless, research based on the payment experience of other distributors follows a pattern as follows:

• 1^st month after sale 70%;
• 2^nd month after sale 25%;
• 3^rd month after sale 5%

Capital assets required

MUSE estimates that initial requirement for capital assets will be:

Computer and printer $5,000

• Estimated life: 2 years
• Depreciate straight line
• Nil salvage value

Motor vehicle $25,000

• Estimated life:4 years,
• Depreciate straight line
• Nil residual

iPad $ 500

• Estimated life one year
• Write-off in year 1

Other expenses

When considering the direct & indirect overhead, direct & indirect labour, direct & indirect material costs, the total production cost of the mobile phone case is $7 each.

Other costs that MUSE estimates will be necessary are:

• Production equipment rental $10000 per month
• Motor Vehicle running costs $300 per month
• Phone, data and internet costs $200 per month
• Other office overheads $500 per month
• Part-time sales person salary $1200 per month (full cost)

MUSE plans to pay cash for all of these items, including paying the part-time salary monthly as it is incurred. Taxes on profits are paid one month in arrears at 30%. No tax shelters from losses.

Funding their start-up

MUSE has set up a company to run their venture.

There are three shareholders; each will contribute the same amount of equity by taking up the same number of shares.

They estimate that the total funds they need must be sufficient to allow MUSE to purchase the capital assets, and provide a cash buffer for start-up of 3 months' of the estimated cash operating expenses is equal to Quarter 1's total cash outflow.

Small business venture capital funding is difficult to raise in 2016, so the three shareholders agree that equity will be 60% of the required funds, and the balance will be debt funded by a private investor. The interest on debt will be at 7% annual rate, but the investor has agreed that interest can be paid in full on the final day of the year. The loan is for 1.5 years, with principle to be paid at the end of that time.

Required:

1. Complete a detailed master budget for MUSE for the first twelve months. Your master budget must contain all necessary schedules, and be completed by month (except for the Balance Sheet, which is required once only, at the end of the full year.

2. At the completion of your master budget, review the cash budget, and comment on the feasibility of the plan based solely on the information about planned future cash flows. Based on your review, are there any assumptions that you would recommend changing, and if so, what impact would they have on the plan and the cash situation.

3. When you are of the opinion that the master budget is complete, and feasible, use your budget to derive:

• The Income Statement for the first full year (i.e. one for twelve months, not monthly)
• The Balance Sheet at the end of year 1
• The Statement of Cash Flows for the first full year (i.e. one for twelve months, not monthly)

4. Calculate the Breakeven Point in units of sales, and also in dollars. Calculate the Margin of Safety in units and also in dollars at year end. What level of sales would be needed in year 2 to achieve breakeven, and then a target profit before tax of $6000 for the year.

5. Calculate a limited number of ratios:

• Summarise the working capital situation and its management (is this consistent with your original assumptions when you produced your master budget?)
• Calculate ROA, ROE and gearing and comment on your observations.
• Calculate the profitability ratio, and gross profit margin and comment on your observations.
• What changes, if any, in your operations and/or funding situation would you recommend for year 2?