SM520 Managerial Accounting

The Case Study

Last summer, Billie viewed the forthcoming graduation from her business studies course with some
apprehension – the graduate job market did not appear to offer too many opportunities! Then she received
an outline of a business proposition from her French cousin Jeanne, with whom she shared maternal
grandparents.

Jeanne felt that there was a very promising opportunity to establish a business in the environs of the historic
Chateau de Vincennes. The Chateau has recently been restored and is likely to become a leading tourist
attraction and events venue. As part of this process, the chateau owners plan to lease a commercial property
adjacent to the entrance to the chateau. Jeanne thought that this could be used to establish a traditional
café/gift shop, focusing on quality craft products and including a small coffee bar at the rear of the premises.
She suggested forming a partnership with Billie and tendering for a lease to operate a business.

Trading is planned to commence on the 1st January 2019. The cousins could fund the business with the €5,000
each that they had received on passing their degrees from a trust fund created by their grandparents. In
addition, they think they can secure a small bank loan.

The tender decision criteria include the conditions that; a) potential operators must have satisfactory
financial backing and b) must present a viable business plan. In the event of more than one operator meeting
the criteria satisfactorily, the contract will be awarded to the operator who offers the highest sustainable bid
price for the lease.

Based on preliminary surveys and studies, the chateau owners expect the visitor numbers for 2019 to be
450,000 with a best/worse case range of plus / minus 10%. Visitor numbers are forecast to vary seasonally
and also to be affected by the staging of events – especially the New year firework tableau, the international
jazz festival in July / August and the historical pageant in October. Taking this into consideration, the monthly
attendance, as a percentage of annual visitor numbers, is expected to breakdown along the following lines:-

Jan 10% Feb 5 % Mar 5% Apr 10% May 10% Jun 12%
Jul 15% Aug 15% Sep 10% Oct 6% Nov 1% Dec 1%

It is important to note that only 10% of the total visitors to the chateau are likely to visit the Gift Shop and
Café.

After viewing the premises and having considered the above, the two cousins have decided to form a
partnership and explore the possibility of running a business (tentatively called ‘The Chateau Shop’). They
have pulled together the following information upon which to base a business forecast and make a decision.

 On the advice of a local estate agent they will make an initial bid of €20,000 for a ten year lease on
the premises. The necessary redecorations and refurbishments are expected to cost €8,000 (this
includes all new fixtures and fittings and a conventional cooker and a microwave oven). Work will be
completed so that trading can start on the 1st January 2019 and the total sum will have to be paid
by the end of January. (The fixtures and fittings, cooker and microwave are expected to last about
four years and should be depreciated accordingly. Provision should also be made to amortise the
lease over its lifetime.)
 Sales volume forecasts for both the gift shop and the refreshment facilities are to be based on the
expected number of visitors to the Château as shown above. Jeanne’s aunt, who operates a similar
business in Lyons, has informed Billie and Jeanne that in her experience they can expect visitors to
spend on average €7, and that this is likely to be broken down on an 70/30 split between the Café
and Gift shop. (So average spend will be €4.90/€2.10 respectively)

 Electricity is expected to amount to €6,800 per annum. Usage will be billed quarterly up to the end
of March, June, September and December, and payments are expected to be made in arrears in the
following month. For planning purposes, the annual charge may be spread evenly across the four
quarters.

 Staffing – Staff costs are expected to vary in relation to the volume of sales. Staff will be paid on an
hourly basis with no retainer. For financial planning purposes, Billie and Jeanne suggest that the cost
of staff including payroll taxes, should be estimated to amount to 25% of total sales in the Café and
10% of the total value of sales in the gift shop.

 Rent will be € 30,000 per annum and is payable in equal monthly instalments in advance. Instalments
for January and February will be paid on the on the first day of January, the instalment for March will
be paid on the first day of February, and April will be paid in March, and so on.

 Cost of sales is estimated to be 40% (for food and beverage) in the Café and 65% in the gift shop.
Suppliers are expected to allow 30 days credit – that is goods have to be paid for by the end of the
calendar month following the month in which they are delivered (i.e. in arrears).

 It is planned to build up stock evenly during the first two months of trading to a value of €2,000 and
then to maintain stock at this level throughout the year. For financial planning purposes it can
therefore be assumed that purchases each month will be equivalent to the cost value of the stock
consumption for that month, except for January and February when an additional €1,000 will be
purchased each month.

 Both partners are expected to work in the business on a full-time basis and to share the profits
equally. For planning purposes, provision should be made for each partner to draw €1,800 in cash
from the business every month. These monthly drawings will be set against each partner’s share of
the profit.

 Apart from the partners’ investment, a bank loan of €10,000 is estimated to be required to fund the
start-up of the business. The assumption is that the loan will be based on a five-year agreement with
interest calculated annually on a simple charge of 10% per annum and that the Bank will collect
repayments of principle and interest charges through equal monthly instalments via Direct Debit.

 Billie and Jeanne also estimate that the business will need to arrange a bank overdraft facility of up
to €7,000. They are aware that because of seasonal variations in the potential number of customers
and the fixed nature of many of the expense payments, there may be months in which the cash
receipts from sales will not cover the cash going out on payments and that there may be temporary
cash-flow shortfalls. (See note about overdrafts in the box at the end).

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The Assignment

Billie and Jeanne have asked your group to use the above proposals and projections to forecast financial data
for the business and to give your views on the following questions:

Liquidity:
1. Will the proposal as it stands, generate sufficient liquidity to operate the business within the limits of the
proposed overdraft facility?
2. Given that the bid price could be the deciding factor in obtaining the lease, is there scope, either in the
proposal as it stands or through feasible alterations, to revise the initial bid to make it more acceptable?

Sensitivity:
3. What would be the effect on the businesses’ cash flow and liquidity, its estimated breakeven volume,
and the forecast profit for the first year, if the ‘worst case’ were to occur in terms of projected visitor
numbers?

Profitability and return:

4. Will expected profits be a sufficient reward for the partners for risking their capital and using their own
labour to run the business?

Groups

This is a group assignment and requires the comprehensive use of a spreadsheet. You should join with
colleagues to form a group of three or four. Groups should be created on Student central (please see separate
instructions) no later than 11:00am on Thursday 11 October 2018.

The grade awarded will be apportioned to each member in accordance with the Statement of Contribution
form completed by the group. It is essential that you are involved in every stage of the assignment. Where
there is reason to doubt this, a viva will be arranged, where all group members will be expected to be able
to operate and to explain how the spreadsheet has been designed and used and be able to answer
questions on the report.

Your tasks:

1. Using an excel spreadsheet, construct a Cash Flow Forecast and a projected Income Statement for the
proposed business for the year ending 31 December 2019 and a Balance Sheet as at that date.
[The spreadsheet must be capable of carrying out ‘what if’ analysis. As a guide, you may use the File:
Pro-forma 1-220.xls. that will be posted in week 3 in the Assessment section on the module site on
Student Central. The file will contain a partially completed spreadsheet containing some data from the
case study, but which requires completion. Alternately, you may design your own spreadsheet from
scratch – but it must be capable of being used to support the next task).

2. Write a REPORT addressed to Billie and Jeanne that answers the questions raised by them under the
headings of Liquidity; Sensitivity; and Profitability and return. Your answers must be supported by the
extensive use of data generated through analysing the effects of key variables used in the construction
of your spreadsheet, by data drawn from other relevant business sources and by analysis and discussion
of your findings and their implications.

The report should be no less than 2,500 words and no more than 3,000 words in total, (excluding the
bibliography and any appendices containing calculations). A copy of the Income Statement and Balance
Sheet produced in your spreadsheet must be attached to the report. These financial statements are not part
of the word count.

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Task Two - Assessment criteria

 Spreadsheet design: efficiency, organisation and Integration of data. (15%)

 Application of spreadsheet generated data to answering the questions within the essay. (20%)

 Understanding and application of key accounting concepts and techniques in the construction and
interpretation of accounting data and the report. (30%)

 Depth of analysis and explanation in the report. (25%)

 Coherence and quality of report including presentation of data, recommendations and referencing
where appropriate. (10%)

The completed group assignment must be submitted through Student Central groups assessment point, no
later than 11:00am on Friday 14th December 2018 consisting of:-

 a electronic file containing your spreadsheet file, as prepared for task one and capable of generating
the data referred to in your report;

 a report (including the financial statements) and bearing the name of all group members;

 and a statement of contribution signed by all group members.

Note about overdrafts - It is common in business to cover such cash shortfalls with a bank overdraft facility
whereby the bank permits the business to pay out more than it has in its bank account, should the need for
this arise. It is advisable to arrange such facilities in advance, as banks make a charge for them (a fact that
has surprised Billie, who was used to her ‘free’ student overdraft)! The overdraft charge is calculated based
on how much of the facility is used to cover cash shortfalls at the end of any calendar month, and the
prevailing bank interest rates1. When the financial business plan is being prepared, assumptions about the
cost of using the overdraft facility will need to be made on the basis of the forecast cash flow and possible
future interest rates.

1 Please use an interest rate based on current mainstream consumer banks (aka High Street), make a reference to the source
for the rate chosen.

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