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Calculation of Accounting Break Even Point

Executive Summary of DuraBikes

The report summarizes the effects of pandemic and the marketing plan that has been suggested by DuraBike to increase its sales. The pandemic has affected the business and the sales of the company have been reduced. In this report, a marketing campaign effects will be studied by NPV, Cost of capital, and Payback method. NPV has been considered as one of the best method as it provides the present value of future cash flows for the company. In these unsettled times, treasury bonds are the investments that are safer to invest as they provide appropriate and confirmed returns while share prices fluctuate and the return from them are also not guaranteed. Thus, overall the plan of the campaign was appropriate and selected as it is bringing good results for the company.

Table of contents

Introduction.

Change in Payment period.

Break-even point.

Payback period, NPV and the weighted average cost of capital

Treasury bonds and stock market.

Required Changes in business.

Limitations.

Conclusion.

References.

Introduction to DuraBikes

A bike manufacturing company named DuraBike carries its operation in New York. In the present year, due to a spread of pandemic COVID-19 company's revenue and market share has declined significantly. This happened because there was the loss of income as due to pandemic businesses have come to stand still and many employees have been laid off. People are trying to save as much as they can because there is no surety of how long this pandemic will continue. For the company, it was required to create a marketing plan to cover the sales. The marketing team has suggested a campaign for the next 10 years and various changes have been created in the plan. The period of the payment has been increased from 30 to 60 days while it has been estimated that the sales of the company will be around 21900 bikes per year. Also, the cash flows for the next 10 years has been given. In this report by using the NPV method on the cash flow, the present cash flows will be analyzed and then the decisions will be made whether or not the project is to be adopted. The report will be aimed at providing the various cost and also the weighted average cost of cost will be found. Also, the limitations of the plan will be described in the report.

Change in Payment Period

Trade credit is an important source of working capital. It defines the cash inflows and outflows period for the company. It is referred to as 'payment delay' that has been provided by the company to its creditor or the delay of payment that has been received by the company from its suppliers. This is done for the purchase of raw materials from the suppliers or the product being sold to the creditors. This is a chain through which the company maintains its payment cycle. The receivables period is lesser than the period of payment. In this manner, trade credit is one of the major sources of finance for the companies as no business runs solely on a cash basis (Pakdel & Ashrafi, 2019). The main factor that affects the trade credit is the reputation, goodwill, or the credit history of the company. Profitability is also an important factor that is considered while providing trade credits or receiving the credits.

In the present situation of the pandemic, Dura Bikes have decided to increase their receivables period from 30 days to 60 days and according to the payment period will be moved. But, in the environment that is prevailing certain drawbacks are attached to the financial conditions:

  • In present times the business is failing due to which the risk of bad debts has been increased. Since the company is planning to increase its payments period, it increases the chances of bad debts for the company. The business in the economy has slowed down due to which there are very likely chances of failure in the payments that in turn will affect the profits for the company (Shah, 2016).
  • An increase in the gap of the cash flow will create a mismatch as there is no assurance of payment.
  • It will also increase the cost of the creditors as for the working capital, they then have to find other sources that in turn will charge interest on them.

Deferral period calculation:

The company has an inventory conversion period of 25 days while the receivable period was 30 days before and now it has turned down to 60 days. This will bring a change in the operating cycle from 55 days to 85 days and the cash conversion cycle will move from 25 days to 55 days. So the required change in the pay period to accommodate the change will be 30 days. This can be obtained through subtracting the after some time of the operating cycle and cash conversion cycle. 30 days change will absorb the receivables change period. Following shows the calculation for the above:

 

Before

After

Inventory conversion period

25

 

Account receivable collection period

30

60

Account payable deferral period

60

90

     

Operating cycle

55

85

Cash conversion cycle

25

55

Required change in working capital financing

 

30 days.

Break-Even Point

Break-even point refers to the point where the company achieves that amount of sales where its fixed cost is covered (Bathkovskiy et al., 2017). This is the last point till where the company keeps its operation running. Certain costs that helps in analyzing or achieving the break-even point of the business are

  • Analyzing the variable cost: These are the cost that is not fixed and changes as per the quantity or the purchasing method. The various example of variable cost includes electricity, raw material cost, etc.
  • Fixed cost assessment: Fixed costs represent the expenses that are incurred in the activity of business and do not change by the change as per the quantity. These are the expenses that the company has to bear over some time.
  • Selling price: Selling price is one major component in analyzing the break-even point. It is the price that is determined in a manner so that company covers all its costs.
  • Analyzing the sales volume: The break-even point changes as per the change in the volume of sales. It affects the price per unit. 

Analyses of break-even point of Dura Bikes

The company has forecasted sales of 21900 bikes per year. The selling price is 620 per bike while the variable cost is at 300. There are two types of break-even point Accounting break-even point in which depreciation expenses will be included wile cash break-even point won't include the depreciation cost is fixed cost (Kampf, Majercak & Svagr, 2016). The formula for the above are as follows

Calculation of break-even points:

Fixed cost (F)

5600000

Selling price (P)

620

Variable cost (V)

300

Accounting break-even point

17500

Cash break-even point

12500

Thus, after selling 17500 bikes Durabikes will reach its break-even point of accounting, while after selling 12500 bikes the cash break-even point will be achieved. The forecasted sales are at 21900 bikes, this depicts that the company will be making profits by achieving targeted sales.

Payback Period, NPV and Weighted Average Cost of Capital

Weighted average

Weighted average cost of capital depicts the cost of business where every category of capital like equity, long term debt, etc. are weighted equally. The increase in WACC happens because of an increase in the beta and the rate of returns that are received on equity. The increase in the WACC depicts that the risk for the business has increased and the valuation has been declined for the company (Frank & Shen, 2016). The formula for calculating WACC is as follows:

Where:

Kd= Cost of debt

T= Corporate tax

Wd= Weight of debt in overall capital

Ke= Cost of equity

We= Weight of equity in overall capital

WACC calculation for Dura Bikes:

Cost of equity=

Cost of equity (KE)

0.144

Cost of debt (KD)

0.08

Weight on equity (WE)

0.8

Weight on debt (WD)

0.2

Tax rate (T)

30%

Weighted average cost of capital (WACC)

0.12352

Thus, the weighted average cost of capital for the marketing campaign of the company is at .12 or 12.35%.

Payback period

Payback period defines the number of years in which invested capital can be obtained back by the company. It is one of the methods of capital budgeting for the company. It defines how many years the capital will be received back (Gorshkov et al., 2018). The longer the period of payback, the chances of taking that project will be less. It helps in determining the best project that is profitable to be adopted. In this method, the investment is divided by the cash flow of the company annually.

Calculations of the Payback period:

Total investment

4000000

Returns each year

2585600

     

Payback period

1.54703

Net Present Value

Net Present value refers to the series of cash flows on whom the discounting factor has been applied. This helps in calculating the sum of all the cash flows for the company. The value of cash flows is dependent on the interval of time between the first cash flow that has been received to the last cash flow of the company. The basic fundamental of the Net Present Value is the Tiem value of money that studies the effect on cash inflows.

Calculations of Net Present Value

Time

0

1

2

3

4

Cash flows (CF)

CF0 (negative)

CF1

CF2

CF3

CF4

Amount

-4000000

2585600

2585600

2585600

2585600

Sum of NPV

7795502.583

2301339

2048329

1823135

1622700

 

5

6

7

8

9

10

CF5

CF6

CF7

CF8

CF9

CF10

2585600

2585600

2585600

2585600

2585600

2585600

1444300

1285513

1144184

1018392

906429.6

806776.5

 

Returns through campaign

3795502.583

The returns that are received from NPV are positive and are higher. The returns show that the company should accept the project as it is bringing in more profits than the investment over the period and is beneficial for the company.

Benefits of the NPV

  • NPV method is based on the realistic approach of Time value. A dollar earned today will have more value than the dollar earned after today.
  • This method includes the risk in its value calculation. The cash flows are uncertain and the events are unpredictable so the cash value keeps on declining over the period. This method inculcates the value of changes in the money (Santoso, Bahaweres & Alaydrus, 2016).
  • It is a method that is adopted at large and also used in the profitability index for the company. It provides an appropriate value of outcomes for the cash flow of the company.

Treasury Bonds and Stock Market

The stock market is the investment that has the riskiest investment form. They are the ones that provide the maximum return to the investor. The problem with the stock market is that there is no surety of returns on them. There is no liability for the company even if they are generating good returns to provide it to the investors. While on the other hand, Treasury bonds provide security and also have various other benefits attached to it. They are the securest form of investment and are backed by the government (He, Krishnamurthy & Milbradt, 2016). Since the pandemic has disturbed the market, there is no surety of returns on the stock market. The prices are getting affected and moving on the lower side. In the present scenario, treasury bonds are the best solution for investment as the money is secured in them

Pros of investing in Treasury bonds:

  • There are no fees for maintenance on the bonds of the treasury.
  • They are secured investment.
  • The money is placed to the government so the chances of losing the money are very rare.
  • One of the major benefits of investing in the T bonds is that there are tax exemption on the money that is being invested in them.
  • Also, the interest is received every 6 months on the investment.
  • These are the safest form of investment in the present times as they provide surety of returns to the business. Thus, T-bonds should be chosen by DuraBikes for investment.

Required Changes in Business

The marketing plan that has been created by Durabikes is very appropriate, yet there are certain loopholes in the process. The ongoing crisis is not considered and also the below-mentioned factors have been neglected in the business plan:

  • Performance factor and gap: There is no measurement to analyze the gap that is prevailing in the performance of the company. Employees performance, whether the targets have been achieved or not etc. are not considered. No measuring scale has been set to make the changes if required in the performance. This should be included.
  • Factor of crisis: Crisis can prevail anytime. The campaign has depicted a very flowery picture of the sales. It is very hard to achieve the targeted sales in the crisis of any time considering the present crisis of the world. So in case of contingency or crisis, the company should have an exit plan.
  • Technological factor: The pandemic is affecting the world and business in a very negative manner. So the required changes in technology should be considered by the company to improve sales. Changes in infrastructure for improvement should also be considered
  • Factor of opportunity: Opportunities that are prevailing in the present situation should be considered before making a decision. DuraBike should have a different marketing practice to attract more customers. Every detail of opportunity should be considered.

Limitations of DuraBikes

The pandemic has become one of the major challenges for the world. Even after taking various measures, there is no reduction in the cases. It has been spread throughout the world and no country has been left. Also, there is no availability of medication for the disease. The growth of the business cannot be predicted as there is no specific control over the disease.

Strategies and planning regarding sales of Durabikes do not provide any surety. There are very likely chances that the business is not able to achieve its target. And the present situation limits the planning department of the company. So, creating bigger strategies and predicting sales do not guarantee the results for the company. At present rather than achieving the sales target company should focus on the strategies to survive in the situation as there are huge losses that will be faced if the pandemic continues for a longer period.

Conclusion on DuraBikes Accounting Analysis

Durabikes' extension of credit from 30 days to 60 days requires a backup for the company as a payment cycle has to be adjusted according to that. The payment cycle should reach 90 days to cove the extension of credit that is being provided to the creditors. These changes will help in accommodating the difference between both periods. According to the case study the sales forecasted from the marketing campaign in 21900 bikes per year but the break-even point of accounting will be achieved at 17500 bikes after which the company will start making profits. The NPV of the campaign shows positive results that means the company can opt for the project. T-bonds are the securest form of investment for the company as they provide guaranteed returns. The limitations in the plans are because of the performance gap, technological gap, etc. The plan should consider the crisis factor in it. In the present times, it is very hard to depict the sales for the company as there is no guarantee. Although this plan can be carried forward with as there are chances that if the company achieves the required sales than profits will pour in huge numbers.

References for DuraBikes Accounting Analysis

Batkovskiy, A. M., Semenova, E. G., Trofimets, E. N., Trofimets, V. Y., & Fomina, A. V. (2017). Statistical simulation of the break-even point in the margin analysis of the company. Journal of Applied Economic Sciences, Romania: European Research Centre of Managerial Studies in Business Administration12(2), 558.

Frank, M. Z., & Shen, T. (2016). Investment and the weighted average cost of capital. Journal of Financial Economics119(2), 300-315.

Gorshkov, A. S., Vatin, N. I., Rymkevich, P. P., & Kydrevich, O. O. (2018). Payback period of investments in energy saving. Magazine of Civil Engineering, (2).

He, Z., Krishnamurthy, A., & Milbradt, K. (2016). What makes the US government bonds safe assets?. American Economic Review106(5), 519-23.

Kampf, R., Majerčák, P., & Švagr, P. (2016). Application of break-even point analysis. NAŠE MORE: znanstveno-stručni časopis za more i pomorstvo63(3 Special Issue), 126-128.

Pakdel, M., & Ashrafi, M. (2019). Relationship between Working Capital Management and the Performance of Firm in Different Business Cycles. Dutch Journal of Finance and Management3(1).

Santoso, N. B., Bahaweres, R. B., & Alaydrus, M. (2016, October). Cost-benefits, NPV, IRR, and QoS analysis of the dynamic telecytology system in Indonesia. In 2016 1st International Conference on Biomedical Engineering (IBIOMED) (pp. 1-6).

Shah, N. (2016). Impact of Working capital management on firms profitability in different business cycles: evidence from Pakistan. Journal of Finance & Economics Research1(1), 58-70.

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Accounting and Finance Assignment Help

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