Coffee Shack Financial Performance and Investment Appraisal

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Academic Year 2023/24

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Term Jan 2023 - May 2024

Module Leader

Name: Altaf Khoso

Email: A.Khoso@uel.ac.uk

Room: DL4.01

Student Hours: Monday 11-1200hrs

Tuesday 11-1300hrs

Further can be requested or Online

Co- Module Leader

Name: Syed Naqavi

Email: S.Naqavi2@uel.ac.uk

Room: DL4.01

Student Hours: TBD

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Executive Summary

Managing finance is an important function in fulfilling the financial requirements of the

business and tracking performance to make informed decisions. A report regarding revenue

and spending variance is presented to reflect the difference in actual and budgeted value. The

report examined the financial performance of Coffee Shack to analyse the gross and net profit

margins. A CVP analysis has been presented to evaluate the cost structure of the business and

identify the optimum production level. The comparison of Proposal 1 and Proposal 2 of Coffee

Shack with the implication of NPV, ARR, IRR, and PBP analyse the suitability of Proposal 1

which provides high returns and develops profitability. The sustainable profitability develops

the financial performance of Coffee Shack to ensure long-term operation. Further, the use of

debt securities and equity financing is considered a suitable source of finance. Overall making

viable investment decisions and functioning operations helps to achieve long-term growth for

the business.

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Table of Contents

1. Introduction............................................................................................................................ 4

2. Revenue and spending variance.............................................................................................4

2.1 Preparation of a spending variance of Coffee Shack for January 2024...........................4

2.2 Possible reasons behind variances....................................................................................5

2.2 Objectives of Budgeting and its Benefits for Coffee Shack.............................................5

3. Evaluation of the income statement of Coffee Shack............................................................5

3.1 Computation of contribution and importance of Break-even sales..................................5

3.1.1 Contribution calculation............................................................................................5

3.1.2 Relevance of break-even sale....................................................................................5

3.2 Calculation of profitability ratios.....................................................................................6

3.3 Evaluation of the viability of the proposal due to the changes in sales and direct materials

................................................................................................................................................6

3.4 Explanation of results and benefits of Cost volume profit (CVP) analysis.....................7

4. Investment appraisal techniques.............................................................................................7

4.1 Merits of each Investment Appraisal Technique..............................................................7

4.1.1 Net Present Value (NPV)..........................................................................................7

4.1.2 Accounting Rate of Return (ARR)............................................................................7

4.1.3 Internal Rate of Return (IRR)....................................................................................8

4.1.4 Payback Period (PBP)............................................................................................... 8

4.2 Recommendation for the management of Coffee Shack based on the above techniques 8

5. Advising on profitability and sustainability and sources of finance......................................9

5.1 Explanation of terms........................................................................................................9

5.1.1 Profitability................................................................................................................9

5.1.2 Financial Sustainability............................................................................................. 9

5.2 Suggestion for potential sources of finance...................................................................10

5.3 Advice on measures for the attainment of sustainability by Coffee Shack....................10

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6. Conclusion............................................................................................................................11

References................................................................................................................................ 12

Bibliography.............................................................................................................................14

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1. Introduction

Evaluation of financial statements provides meaningful insights about the overall performance

of a business. The purpose of this report is to evaluate the performance of Coffee Shack,

through different profitability ratios. A budget and spending variance report is made to compare

the actual and the forecasted financial values over a specific year. Different investment

appraisal techniques such as NPV, PBB, IRR and ARR have been used to determine the long-

term profitability of two proposals in the context of the expansion of 10 potential business sites.

The overall report deals with financial and non-financial aspects such as profitability and

sustainability of the business in a comprehensive manner.

2. Revenue and spending variance

2.1 Preparation of a spending variance of Coffee Shack for January 2024

Table 1: Revenue and Spending variance

The revenue and spending variance report of Coffee Shack is provided to reflect the ability of

the firm in terms of forecasting potential income and expenses. Table 1 above shows a

comprehensive overview of the budgeted and actual figures of revenue and operating expenses

which may be beneficial for the business to improve decision-making and control costs.

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2.2 Possible reasons behind variances

A significant increment of 13.50% is observed within the actual and budgeted revenue of

Coffee Shack in 2024. The key reason for this increase can be attributed to the rising high foot

traffic because most of the coffee chains are located on high streets and shopping centres.

Additionally, the enhancement in raw materials depends on the rising ingredient price. For

instance, in the last two years, the Coffee Price in the UK rose by 26% because the food outlets

experienced the highest inflation (Ungoed-Thomas, 2022). Apart from this, wages and salaries,

utilities and repair and maintenance reflect a hike due to increased staff members, energy

consumption and equipment breakdown respectively.

2.2 Objectives of Budgeting and its Benefits for Coffee Shack

Budgeting is useful for planning and setting financial goals for an organisation by outlining

anticipated income and expenses (Schmidt, 2023). A robust budgetary plan may be beneficial

for Coffee Shack in terms of achieving financial stability while ensuring the requirement of

adequate cash flow. Additionally, a budgetary plan identifies potential financial and non-

financial risks for an organisation (Nilsson et al., 2022). For instance, Coffee Shack may utilise

its budgeting plan to evaluate the potential risks associated with its investment in potential

business expansion in 10 additional sites.

3. Evaluation of the income statement of Coffee Shack

3.1 Computation of contribution and importance of Break-even sales

3.1.1 Contribution calculation

Table 2: Computation of Contribution

3.1.2 Relevance of break-even sale

Break-even sales determine the amount in which a product is to be sold in terms of covering

the overall cost of production (Sintha, 2020). In this case, determining the break-even sale for

Coffee Shack is crucial to determine the allocation of different overheads within the

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manufacturing process. This would be beneficial for the company to utilise the optimum level

of resources in terms of generating profit.

3.2 Calculation of profitability ratios

Table 3: Profitability Ratios

Figure 1: Profitability ratios of Coffee Shack

The net profit ratio of Coffee Shack indicates that the company has efficiently managed its

operational expenses and generated profit at the end of the year [Refer to Figure 1].

Additionally, the GPM is significantly higher for Coffee Shack indicating the generation of a

substantial portion of sales after considering the direct cost of production [Refer to table 3].

Overall, the profitability of the business shows a sound position and potential growth in future.

3.3

Evaluation of the viability of the proposal due to the changes in sales and direct

materials

The proposal has been evaluated based on the assumption that 35% of 70,000 for direct

materials is considered focused on meal deals. However, the proposal is not viable for Coffee

Shack because it would not generate a profit at the end of the year hence, it needs to be rejected.

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3.4 Explanation of results and benefits of Cost volume profit (CVP) analysis

Table 4: CVP analysis

According to the CVP analysis, Coffee Shack needs to sell 3 units to cover the overall fixed

costs and a MOS of 1 indicates that if the sale of the business declines, then it can lead to a

loss [Refer to Table 4]. CVP analysis can be beneficial for an organisation to set realistic

financial targets and budgets (Lulaj and Iseni, 2018). Coffee Shack has managed to identify its

cost structure through this approach including its optimum level of production level.

4. Investment appraisal techniques

4.1 Merits of each Investment Appraisal Technique

4.1.1 Net Present Value (NPV)

Net Present Value (NPV) is the most viable technique of investment appraisal that analyses the

difference between present value cash inflows and outflows over a specific period. Further, this

technique is beneficial to ascertain the profitability of the potential project while considering

the time value of money approach to estimate the present value of future cash flows (Wieloch,

2019). Therefore, this technique is significant for Coffee Shack to analyse the suitability of the

proposal.

4.1.2 Accounting Rate of Return (ARR)

Accounting Rate of Return (ARR) measures the expected return from the initial investment

value to undertake viable capital budgeting decisions. Additionally, ARR helps identify the

average profit from the potential investment and compares multiple projects to select the most

appropriate one based on high returns (Mollah, Rouf and Rana, 2021). In this way, to compare

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proposals 1 and 2 of Coffee Shack, ARR provides a better understanding of the high-return

investment. Thus, the high rate of return maximises the profitability of investment decisions

and improves financial position.

4.1.3 Internal Rate of Return (IRR)

Internal Rate of Return (IRR) is the technique used to estimate the rate of return from

investment decisions. The merit of IRR is to compare different projects based on the return and

compare it to the NPV method as an indicator of efficiency (Mellichamp, 2017). In this way,

Coffee Shack has received the benefit of analysing the potential cash flows generated by the

investment and measuring its credibility. Hence, this technique is viable for making profitable

investment decisions for the business to predict the return capacity of the potential project.

4.1.4 Payback Period (PBP)

Payback Period (PBP) is the method that estimates the length of time involved to cover the

investment value of the project and analyse the risk associated with the project. The benefit of

PBP is to predict the time frame for assessing risk and return generation capacity while

covering the cost of investment (Silva et al., 2019). Thus, Coffee Shack measures the period

involved to cover the initial value of the proposal through PBP for measuring risk and return

factors to make informed decisions.

4.2 Recommendation for the management of Coffee Shack based on the above

techniques

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Table 5: Calculation of NPV, ARR, IRR, and PBP

Table 5 indicates the high NPV and ARR of Proposal 1 of Coffee Shack although the value of

IRR is similar to Proposal 2 and PBP is higher. High NPV ensures improved profitability from

the investment value to maximise the returns and develop cash flows (Zhang, 2022). In this

way, to consider the time value of money concept in NPV analyse its suitability to undertake

viable investment decisions also high ARR develop the profitability. Thus, Proposal 1 is

suitable for the business to provide high NPV and ARR of £10,891.74 and 28.43% respectively

although Proposal 2 involves £9,997.52 and 27.30% respectively. Overall, the high returns

indicate the efficiency of proposal 1 of Coffee Shack to grow the business.

5. Advising on profitability and sustainability and sources of finance

5.1 Explanation of terms

5.1.1 Profitability

Profitability refers to the measure which focuses on the profit-earning capacity of an enterprise

through its operational activities. Arai and Hirota (2023), described profitability as a well-

known tool for the evaluation performance of a company via return on sales, equity and assets.

Thus, it is an important metric for the assessment of the operational effectiveness of businesses

by revenue-generating capability.

5.1.2 Financial Sustainability

Financial sustainability for corporate entities incorporates the activities for conducting

businesses with a focus on earning profits to meet all expenses and generate profit. This

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approach prioritises association with sufficient capital returns to overcome risks of insolvency

with condition-based investment strategies (Gleißner, Günther and Walkshäusl, 2022). Hence,

sustainability allows companies to enjoy monetary stability with efficient cost management

and risk management outlook.

5.2 Suggestion for potential sources of finance

The major sources of finance for Coffee Shack to fund the selected proposal include equity

financing and debt securities. Equity financing is a beneficial source as it avoids the payment

of interest allowing businesses to reinvest cash flows for corporate growth (CFI, 2024). Thus,

this source is appropriate for the enterprise due to the absence of repayment obligations

increasing the strength of its capital structure. Lestari and Indarto (2021), addressed that debt

securities offer a cheap source of finance as they reduce interest costs and improve operational

performance through optimum issuances. Hence, debt securities are

useful for Coffee Shack to

raise funds at a low cost increasing the potential profitability of Proposal 1 with an IRR of 10%.

Therefore, equity financing and debt securities have been considered appropriate for the

company to avoid repayment obligations and high costs.

5.3 Advice on measures for the attainment of sustainability by Coffee Shack

The corporate sustainability theory concentrates on the development of a holistic business

model with enhanced efforts on environmental, social and governance activities for increased

financial stability with sustainability (Kantabutra and Ketprapakorn, 2020). Figure 2 reflects

the importance of sustainability vision and values for the achievement of corporate

sustainability performance. Therefore, it is advised that Coffee Shack focus on establishing

sustainability goals, energy conservation and stakeholder engagement to strengthen its

sustainability approach. The other advised measures revolve around the hosting of

sustainability workshops, using biodegradable materials and prioritising recycling.

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Figure 2: Components of Corporate Sustainability Theory

(Source: Kantabutra and Ketprapakorn, 2020)

6. Conclusion

Based on the above evaluation it has been found that budgeting offers benefits of effective

planning, risk monitoring and goal establishment for Coffee Shack. The break-even sale is also

found to be beneficial for the utilisation of the optimum level of resources in an enterprise.

Considering the investment appraisal techniques Proposal 1 is considered the most profitable

for Coffee Shack with the highest NPV. It is recommended that the company increase

stakeholder engagement, establish sustainability goals and use biodegradable materials for the

attainment of sustainability.

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References

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https://corporatefinanceinstitute.com/resources/valuation/equity-financing/

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Gleißner, W., Günther, T. and Walkshäusl, C. (2022) ‘Financial sustainability: measurement

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https://doi.org/10.1007/s11573-022-01081-0. (Accessed: 29 April 2024).

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