Professional Athletic Equipment
Professional Athletic Equipment, Inc. desires to finance growth through a combination of equity/debt investment and internally generated cash flow. Because of the cost of initial tooling and inventory and marketing costs of establishing a market presence, the business will be financed primarily by investment in the early stages and is expected to burn cash. The target of break-even in year one will only apply if one stops at selling initial inventory and stops marketing or does not engage in additional production. Obviously, any of those courses would hinder growth. Thus, it is expected that additional investment will be required.
The most important indicator in our case is inventory turnover. We have to make sure that turnover stays above 5 on all production subsequent to test marketing, or we will be clogged with inventory.
Collection days are very important. We do not want to let our average collection days to get above 45 under any circumstances. This could cause a serious problem with cash flow, because working capital will be tight. Fortunately, most sales in test marketing will be direct via credit card. Thus, business at this stage will be basically for cash. Retail distribution entails 30 to 60 day billing cycles. Every effort will be made to collect on time and to offer billing term discounts. Major retailers are notoriously slow in payments. Even when sales are for cash, this plan assumes 45 day payments on all sales in order to be conservative on cash flow demands.
We must maintain gross margins of 70% and hold marketing costs to 30% of sales in all direct sales channels.
In retail channels gross margins based on wholesale pricing must be 40% and marketing costs held to 15% of sales. Volumes must be significant to support these numbers. An accurate forecast of retail sales potential can only be made after significant product acceptance by consumers. Estimates for year three retail sales contained in this plan should be considered as such. Subsequent plan revisions will have a higher degree of accuracy.
7.1 Break-even Analysis
The break-even analysis shows that Professional Athletic Equipment, Inc. has a good balance of fixed costs and sufficient sales strength to remain healthy. Our break-even point is close to 1430 units per month, while our sales forecast for the next year calls for 750 units per month on average.
Some costs included in the plan may be trimmed if necessary. Thus, there is room to cut the gap to break-even in year two with interim plan revision on the cost side, particularly by limiting ad and promotion expense and some fixed expense. The break even number of 1430 units a month is an extremely conservative break-even number since it assumes full marketing and media expenditures as called for by the plan. These expenses are treated as “fixed” when in fact they are “variable”. Thus, break even is based on full expenditures.
The initial production run will be 3200 units or approximately one third of the first year’s projected sales. This will preserve operating capital and incoming sales revenue will permit the company to function with some cash flow reserve during the first year. A close to break-even performance in year one on a new consumer product would be outstanding.
Since production gear up is short once molds are in place, additional production runs can be done on short notice. For the purpose of this first plan we have used a “zero inventory” model. That is, after the production run initially, we produce to need, which is driven by sales. Generally direct or mail order sales can ship within 30 days and often collect via credit card up front. Subsequent plans will include inventory balance on an on-going basis which will yield more accurate cash flow numbers in year two and three.
7.2 Important Assumptions
The financial plan depends on important assumptions, most of which are shown in the following table. They key underlying assumptions are:
- We assume a slow-growth economy, without major recession.
- We assume of course that there are no unforeseen changes in technology to make products immediately obsolete.
- We assume access to equity capital and financing sufficient to maintain our financial plan as shown in the tables.
|Year 1||Year 2||Year 3|
|Current Interest Rate||10.00%||10.00%||10.00%|
|Long-term Interest Rate||10.00%||10.00%||10.00%|
7.3 Key Financial Indicators
- The most important indicator in our case is inventory turnover. We have to make sure that turnover stays above 5, or we are clogged with inventory.
- Collection days is very important. We do not want to let our average collection days get above 45 under any circumstances. This could cause a serious problem with cash flow, because our working capital situation is chronically tight.
- We must maintain gross margins of 45 percent at the least, and hold marketing costs to no more than 20% of sales.
7.4 Projected Profit and Loss
All expenses estimated in this initial plan are considered to be accurate but not firm. Flexibility is assumed as the plan progresses through execution. Also, the assumption here is that we only raise $250,000 in initial capital. If we actually raise $500,000 it may or may not alter the sales forecast and increase advertising and promotion activity, but it will serve as a buffer of cash reserve.
The plan now projects a moderate loss in 1997, the first year of sales. This will be considered very acceptable when considered against the need to spend to introduce a new product. In fact, it is achievable only since we are pursuing low-cost channels of distribution in the test. Our over-all objective here remains only to prove salability and test various channels and promotional strategies, not to make an instant profit.
Year two assumes new sales into retail with a corresponding reduction in margin on the sales into that channel. Volumes increase as do ad and promo expenditures. Only one or two small retail chain or independent stores (assuming multiple locations) would be required to generate the sales volume sought provided the product has proven to be acceptable to consumers. We are thus forecasting a roll-over to profitability in 1998 with a strong bottom line. These are realistic targets.
If this is achieved, it would be a good time for management to look at a major financing, other acquisitions, and an aggressive national expansion of the “Body Armor.”
|Pro Forma Profit and Loss|
|Year 1||Year 2||Year 3|
|Direct Cost of Sales||$0||$63,520||$1,191,000|
|Lost Margin on Retail units||$0||$0||$992,500|
|Total Cost of Sales||$0||$63,520||$2,183,500|
|Gross Margin %||0.00%||73.81%||45.99%|
|Total Operating Expenses||$48,699||$293,630||$1,169,430|
|Profit Before Interest and Taxes||($48,699)||($114,600)||$689,570|
7.5 Projected Cash Flow
Cash flow in year two, 1997, needs a closer look on a month-to-month basis. Since this will be entirely a function of actual sales vs. inventory turns it will be addressed in detail in subsequent plan revisions. At this juncture, the “produce as needed” philosophy of management still is the operative mode. Subsequent revisions of this plan in years two and three will switch to a full inventory, payables, and receivables model. The following chart represents the use of cash from initial investment in 1996.
|Pro Forma Cash Flow|
|Year 1||Year 2||Year 3|
|Cash from Operations|
|Subtotal Cash from Operations||$0||$242,550||$4,042,500|
|Additional Cash Received|
|Sales Tax, VAT, HST/GST Received||$0||$0||$0|
|New Current Borrowing||$0||$20,000||$0|
|New Other Liabilities (interest-free)||$0||$0||$0|
|New Long-term Liabilities||$0||$0||$0|
|Sales of Other Current Assets||$0||$0||$0|
|Sales of Long-term Assets||$0||$0||$0|
|New Investment Received||$250,000||$0||$0|
|Subtotal Cash Received||$250,000||$262,550||$4,042,500|
|Expenditures||Year 1||Year 2||Year 3|
|Expenditures from Operations|
|Subtotal Spent on Operations||$67,529||$316,802||$3,107,919|
|Additional Cash Spent|
|Sales Tax, VAT, HST/GST Paid Out||$0||$0||$0|
|Principal Repayment of Current Borrowing||$0||$0||$10,900|
|Other Liabilities Principal Repayment||$0||$0||$0|
|Long-term Liabilities Principal Repayment||$0||$0||$0|
|Purchase Other Current Assets||$0||$0||$0|
|Purchase Long-term Assets||$65,000||$0||$0|
|Subtotal Cash Spent||$132,529||$316,802||$3,118,819|
|Net Cash Flow||$117,471||($54,252)||$923,681|
7.6 Projected Balance Sheet
Preliminary Balance Sheet is estimated.
|Pro Forma Balance Sheet|
|Year 1||Year 2||Year 3|
|Other Current Assets||$0||$0||$0|
|Total Current Assets||$142,908||$63,219||$986,900|
|Total Long-term Assets||$63,500||$57,500||$51,500|
|Liabilities and Capital||Year 1||Year 2||Year 3|
|Other Current Liabilities||$0||$0||$0|
|Subtotal Current Liabilities||$5,107||$35,018||$264,584|
|Total Liabilities and Capital||$206,408||$120,719||$1,038,400|
7.7 Business Ratios
Business ratio estimates are preliminary, and the Industry Profile is based on Standard Industry Code #3949, Sporting and Athletic Goods.
|Year 1||Year 2||Year 3||Industry Profile|
|Percent of Total Assets|
|Other Current Assets||0.00%||0.00%||0.00%||26.30%|
|Total Current Assets||69.24%||52.37%||95.04%||75.10%|
|Percent of Sales|
|Selling, General & Administrative Expenses||0.00%||121.47%||28.96%||23.50%|
|Profit Before Interest and Taxes||0.00%||-47.25%||17.06%||2.70%|
|Total Debt to Total Assets||2.47%||29.01%||25.48%||49.70%|
|Pre-tax Return on Net Worth||-24.19%||-134.89%||88.92%||5.40%|
|Pre-tax Return on Assets||-23.59%||-95.76%||66.27%||10.70%|
|Additional Ratios||Year 1||Year 2||Year 3|
|Net Profit Margin||0.00%||-47.66%||17.02%||n.a|
|Return on Equity||-24.19%||-134.89%||88.92%||n.a|
|Accounts Payable Turnover||10.70||12.17||12.17||n.a|
|Total Asset Turnover||0.00||2.01||3.89||n.a|
|Debt to Net Worth||0.03||0.41||0.34||n.a|
|Current Liab. to Liab.||1.00||1.00||1.00||n.a|
|Net Working Capital||$137,801||$28,201||$722,316||n.a|
|Assets to Sales||n.a.||0.50||0.26||n.a|
|Current Debt/Total Assets||2%||29%||25%||n.a|