Question

Simple as Pie Break-Even Analysis

Rob and Joan Russell started baking pies from their home eight years ago. Their business idea was simple: There were no top-quality pies sold commercially in their mid-sized New England town. They produced no plan, no budget, and gave no thought to how much capital this venture would require. Their pies were indeed great and with little effort they built a customer base of individuals and restaurants that wanted the best and were willing to pay $12-15 per pie. Rob and Joan rented a kitchen from a catering firm that they could use during the caterer’s off hours. With the new facility they could bake 100 pies per day. Their revenue was soon running at a pace of $500,000 per year with monthly sales of 3,000 pies at an average price of $14.

The success they were enjoying and the encouragement they received from customers and friends made them think of expanding their distribution regionally, creating a brand name, and adding other products. But these expansions required taking on significant new expenses. It was time to make a haphazard venture into an expansive venture with a bankable business plan.

With revenues of $500,000 per year and renting the kitchen from the caterer, they had profits of about $200,000 per year (they paid themselves no salaries.) The Variable Costs per pie were $4, and their Fixed Costs including staff, kitchen rental, and two delivery vehicles were approximately $160,000 per year. BEP=$160,000/10=16,000; current volume is 36,000.

Over a few months Rob and Joan developed the outline of a business plan:

• There was a closed restaurant that they could buy and equip as a commercial bakery. The parking lot could accommodate delivery trucks and employees’ vehicles. The total cost of buying and equipping this new facility was $1 million.

·      A bank agreed to lend them $500,000 at 7% per annum and the owner of the building offered to give them a second mortgage for the other $500,000 at 10% per annum. The total yearly interest cost would be $85,000 with principal payments of $50,000 begin- ning in the third year.

·      The new location would allow them to triple production and keep Variable Costs at the same $4 per pie.

·      The fixed costs after the move to the new facility would increase to $700,000 per year not including interest or principle payments, covering advertising, a full-time salesperson, and the operation of the bakery. Rob or Joan would still not be salaried.

Questions

1.    How should an entrepreneur make the decision about how much debt and how much equity to use in the mix of financing? What are the plusses and minuses of each form of financing?

2.    It is very common for entrepreneurs to underestimate the amount of financing their ventures will need. Why do think this is so?

3.    What is a break-even analysis and why is so important?

4.    What methods are available to obtain average financial comparisons for new and start-up ventures? Why might this be important in your business plan?

Answer 1

1Ans: For every entrepreneur it is very difficult to decide where to invest and where not to, it is a quite common aspect but entrepreneurs are smart enough so they will find their way to taste their success. Debt – They can opt good banks which provide best loan services and equity is all about the liabilities and assets which they have so they have to keep half a side and use half in-order to be on safer side and almost by investing half of the equities they can take less debt as well.

Plusses and minuses of Debt financing:

Plusses:

·          Helps to maintain ownership

·          Less pay of taxes

·          Immediate flow of cash

Minuses:

·          High interest rates

·          Reduces cash liquidity

·          No guarantee of approvals and payments

Plusses and minuses of Equity financing:

Plusses:

·          No credit concern

·          Gain partners

·          Less burden

Minuses:

·          High risk

·          Flow of money will be blocked

·          Takes time to re-build the assets and liabilities

2Ans: Sometimes, Underestimation may help and may not. It completely depends upon the situations. We can’t justify that entrepreneurs commonly deny that. Finance is like a heart for any company and every aspect will revolve around it, so eventually every venture will be described on the basis of the priority.

Tips before financing a venture:
- Decide your company’s short-term and long-term goals
- Invest in creative projects
- Take risk which can be bearable by the company at initial stage
- Evaluate the opportunities

3Ans: Break - even analysis completely helps accountants, it categorizes variable cost and fixed cost which ultimately deals with the production. It helps to determine the profits or losses for the company.

Importance of Break - even analysis:

·Helps in building a pricing strategy

·Classifies the safety margin

·Derives a cost control

·Creates a profit - loss ratio

·Sets targets for the company

4Ans: There are various methods available for financing for new start-ups and financing is the major aspect in attaining good success in business.

Bank loan and 401 K are the best available methods to process ahead with the best financing aspects.

Importance:

1. Career growth

2. Can learn Time management

3. Will Handle risk

4. quick decision-making process