Financial analysis fundamentals and methods

Financial Analysis

Marco Polo

Statement of Income

Revenue

Cost of Goods Sold

Gross Profit

Marketing Expenses

Distribution

Overheads

Interest Exp

Total Expenses

Net Income

The first year of trading was rough, in that the company lost money. While on the surface this poor performance, it should be noted that the cost of goods sold is somewhat inflated because the expenses of putting together each guide were not amortized. Thus, they are fully applied to this year, even though the sales of these books will be extended beyond this year. The sales were only for three months of this year, meaning that for at least the next two years there were be revenues without these costs associated with building ten guidebooks from scratch.

If we were to extrapolate what the profit/loss will look like next year, it should show that there is a revenue stream from sales, and while there will still be marketing, distribution and overhead costs, those will be the only costs. A breakeven analysis will be conducted and although a modified breakeven taking into account semi-fixed expenses would be preferable for this scenario (Powers, 1987), the data we have only allows for a simplistic breakeven. If last year's fixed costs are assumed to be next year's fixed costs, the breakeven is calculated as follows:

Fixed Costs / Revenue per book (Peavler, 2014)

52600 / 6-3.1 = 18138

6 per book, the breakeven point for Marco Polo in year two will be 18138 copies (not factoring in higher distribution costs for more books sold). This is about two months' worth of sales. The financial performance therefore, while it looks bad for year 1, is actually very good and the company should turn a tidy profit in its second year. It is assumed that those profits will be plowed back into expanding the product line, because reinvesting retained earnings is correlated with sustainable growth (Ashford, Hall and Ashford, 2012) and the next section notes some of the areas where future investment will be required.

2.

Marco Polo needs to take a number of other factors into account. The first is that it will need more titles, so will need to reinvest profits from year 2 into building out the product line. If it is assumed that the first ten titles were the best ideas, the next ten might not sell as well. This is speculation, but reasonable that there might be a point of diminishing returns and the company needs to think about that.

Also, the existing books will probably sell at a rate of stable demand for a year or so, but will then start to decline as they become out of date. In the Internet age, an out of date guidebook cannot compete, so funds need to be set aside to update these titles. These costs are not as high as the initial writing cost, but they do need to be accounted for.

The second factor that Marco Polo needs to take into account is that the proprietor will eventually need to eat, move out of his mum's flat and might want a pint every now and again, and will need to draw a salary to do those things. A salary will need to be factored into the budget for the coming year. If the company is going to be profitable, the taxman will come knocking, so a provision for taxes will need to be set up as well. This includes the various provisions under IAS 12, which "describes recognition and measurement of deferred taxes using a temporary difference approach, similar to the method of FAS109" (Bernard, 2008).