Bauman's Frozen Custard expects to raise $70,000 in long-term debt with $25,000 from the owners. A short term loan of $5,000 will be used to maintain a level of cash necessary to maintain expected inventory levels and to buy additional inventory should sales be higher than expected. The long-term debt will be paid back over the next ten years. No other immediate financing needs are expected.
With sales increasing from $66,000 the first year to over $113,000 by year three, Bauman's Custard will begin to turn a net profit early in year two, and increase net worth in years two and three after initial decreases.
One important assumption is the initial sales projections. We made this estimate by taking an assumed hourly average observed at a local ice cream shop. We then drastically cut the number to reflect seasonality, our unknown brand name, and reduced foot traffic. These estimates are extremely conservative, and we expect actual sales to surpass them almost immediately.
We assumed the borrowing rate at 4.08% for the short term and 5.20% for the long term and an increase of 1.00% per year for the next two years in the interest rate due to a recovering economy. We also assumed initial investment in equipment and fixtures at $69,800.
The break-even analysis shows that Bauman's Frozen Custard has sufficient sales strength to remain viable. Our break-even point is $7,058 per month. We estimate our average sales price at $2.50, which is an approximate sale price for a medium-size dessert at our retail outlet. This translates in the break-even unit sales of 2,823 per month. Our sales forecast for the first year calls for an average of 2,228 units per month. This was calculated by total yearly sales ($66,840), divided by 12 months, divided by average sale price per customer ($2.50). However, in the second year we expect to sell, on average, 435 more units a month than our break even point. This will allow Bauman's Frozen Custard and Italian Ice to increase the net worth of the business after our initial year of operations.
Over the first year we expect to incur a loss of $16,753. This will largely be due to the losses during the start up months and recurring payroll and other expenses. Over the next year we expect to see a more stable and sustainable profit level of $3,337, and in the third year we expect our profits to grow to $6,396. This is based on our estimation that sales will grow by 46% over the second year. This occurs because of the increase in brand awareness of the company, our continuous advertising campaign, and 8% annual industry growth over all.
Bauman's Frozen Custard and Italian Ice expects to manage cash flow over the first year with the assistance of retained earnings and cash reserves from our short-term loan of $5,000.This financing is required to assist in covering unforseen expenses and help us through seasonal fluctuations in customers. We expect to finance our long-term assets with a $70,000 long-term loan, on which we expect to make monthly payments over the next ten years. During 2005-06, we will incur a loss in cash flow as long as our expenses exceed our revenues.
We estimate that our business will be cash flow positive in our second and third year. We expect second year cash flow to be approximately $646, and $4,162 our third year.
As stated earlier, the owners emphasize long-term growth in the business value over short-term returns. Our projected balance sheet shows a decrease in net worth over the first year to $3,185 from $19,938 at startup. However, starting from the second year, our net worth steadily increases to $6,522 and by the end of the third year we expect the value of the firm to increase to $12,919. With the present financial projections we will be careful in keeping costs to a minimum without making sacrifices to product quality. It will not be necessary for Bauman's Frozen Custard and Italian Ice to purchase more assets, because our machinery has at least a twenty (20) year life span and will have production capacity that exceeds our needs.
Our gross margin is significantly above the industry average (Frozen Custard Industry SIC 2024.0201). We believe this is because a large part of this industry involves manufacturers who produce large quantities using economies of scale. As a scoop shop, Bauman's Frozen Custard and Italian Ice can command a higher price per gallon than wholesale manufacturers, but more costs are incurred in terms of man hours and marketing expenses.