Case study - Operations, finance and influences
Operations, finance and influences on business (answering using PINCC)
Nice Ice is a manufacturer of premium ice cream based in the West Midlands. Harvey and Hayden founded the business two years ago, and quickly established a reputation in the local area. They promote the fact that their ice cream is produced using locally-sourced organic ingredients as a way to make their products stand out from the well-known brand names.
Harvey and Hayden currently run their business as a partnership. They are keen to expand and move to bigger premises as they feel that this would enable them to increase production levels and get their ice cream into more shops. The nature of the product means that they are unable to hold large quantities of stock for large periods.
They charge £4.75 for a 500ml tub of their ice cream. They know that the variable cost of producing each tub is £0.75 and that their fixed costs are £50,000 per year. Last year they managed to make and sell 15,000 tubs.
Over the next couple of years, Harvey and Hayden would like to develop a new range of flavours, but know that this would increase costs for the business. The business does have some retained profit, and the cash flow forecast for the next 12 months is showing that there are several months of the year where cash outflows are going to be lower than cash inflows.
Example answers
One way of analysing a case study is PINCC: product, industry, customers and competitors.
In the above case study, we can see that:
- the product is premium, locally-sourced organic ice cream
- the industry is the frozen food industry
- the customers are most people who like ice cream
- the competitors are other big brand ice cream manufacturers.
Question
Calculate Nice Ice’s break- even level of output
A (low mark - zero marks): The break-even point would be at £59,375.
A (high mark - 3):
Break-even point = fixed costs/(price – variable costs)
Break-even point = £50,000/(£4.75-£0.75)
Break-even point = £50,000/£4.00
Break-even point = 12,500 units
Question
Recommend whether Nice Ice should use retained profit or a share issue to develop their new flavours
A (low mark - likely to be 4): Using retained profits would be quicker than issuing shares so the new flavours could be developed sooner. This could increase sales, and lead to even higher profits. It would mean that they cannot have the profits themselves. Issuing shares would involve sharing ownership of the business with those who invested in the shares, and will mean that they will have to share the profits with more people. As such, they should use retained profit to develop their new flavours.
A (high mark - 9): Retained profits are those profits kept in the business, and have not been taken out by Harvey and Hayden. Using retained profits does mean that the business is not borrowing the money to develop their new flavours, but also means that the money is not earning interest for them.
A share issue would involve the business becoming a private limited company, and selling shares to investors in order to raise the money for the new flavours. This would mean that Harvey and Hayden would not be the only owners of the business, and would have to share any future profits.
Launching new products is always a risk, and it would be advisable to launch new flavours gradually over a period of time, rather than launch lots of them at once. I would therefore recommend that they use retained profits to finance the development of the new flavours because their cash flow forecast indicates that they will not need the retained profit they have over the next 12 months. In addition, if they want to move to bigger premises in the future then that might be the best time to use a share issue because the funds will be needed in a lump sum.
