OKMA 6013

ACCOUNTING FOR MANAGERS

GROUP ASSIGNMENT
“CAFÉS MONTE BLANCO:
BUILDING A PROFIT PLAN”

SUBMITTED TO:
PROF. DR. WAN NORDIN B WAN HUSSIN

PREPARED BY:
NAME MATRIC NO
NG LINDA 821935
MORINE JOHNSON 822116
MOHD KHAIRI B SERBANI 822415
AMIR FARID B ABD RAHMAN 821209

SUBMITTED ON
17 December 2017
1. INTRODUCTION

Cafes Monte Bianco is a premium coffee manufacturing and distributor company located
in Milan. Monte Bianco coffee products are marketed throughout Europe and have a
reputation as the best coffee in continental Europe. The company Cafes Monte Bianco was
founded in the early part of the century by Mario Salvetti having previously worked on a
coffee plantation in South America and eventually returned to Italy to open a coffee
factory. Monte Bianco Coffee quickly became famous in Milan because of its taste and
quality. This effort was passed on to the Salvetti family, and eventually inherited by Mario
Salvetti's grandson Giacomo Salvetti.
Giacomo intend to surpass his grandfather's success and intend to grow his business
successfully. Over the past five years, he has expanded capacity by building sophisticated
and expensive facilities. During 2000, the company's performance showed excellent
results. One of the reasons for this success is the production of private brands for two
supermarkets in Italy. Actually, some retailers have contacted Giacomo with a request to
supply coffee to be distributed with their own private brand label. However, the company
has a trade-off problem between production capacity for private brand and premium
coffee. The total production capacity for 2000 is 350,000 kg per month. With the new
expansion completed in December 2000, there is an additional capacity of 150,000 kg.
The cost for this expansion is 6 billion lire with expected life of 15 years.
Gaicomo and company management discussed how to decide allocate manufacturing
capacity. Management views are split into two, with one side supporting the full transition
to private brand production and the other supporting premium coffee production. Parties
who share private brand strategy argue that this market segment is more stable. With a
price of 8,800 liras, full production capacity can be guaranteed. In addition, if the
company only produces the private brand, fixed cost can be reduced by 781 million liras.
Manufacturing plan is also easier because private brand coffee can be stored on inventory,
while premium coffee cannot be stored in inventory due to quality problems. Other costs
can also be saved, such as selling cost can be saved 65%, R&D cost can save 75 %, and
administrative cost can be saved 50 %. However, there are disadvantages of this private
brand strategy. Private brand buyers will pay their debts longer (90 days compared to the
usual 30-days policy). This will cause the company to be in full credit line limit position
(25 billion liras) at the end of the year due to fewer summer orders. Giacomo underwent a
dilemma and required a clear and comprehensive picture of the consequences of this
private brand strategy.

2. DISCUSSION
Profit planning is required in 2001 so that key management can determine the strategy that
will be implemented by the company whether to sell new product i.e. Private brand coffee
or stay focused on its presence product i.e. Premium coffee. Profit planning used by the
manager to assess their business and operate the planning, making trade-off options,
establish performance and accountability objectives, and evaluate how business
performance can meet expectations. The profit planning structure are including stages as
following:

a. PROFIT WHEEL

Estimate The Level of Sales

In this stage Cafes Monte Bianco has set up sales estimation as below:

When compared to the level of previous year's product sales (consisting of private
brand coffee and premium coffee), which reached 56,112,408,000 liras, then the sales
rate in 2001 which rely solely on private brand coffee products decreased by 5.9 %
because this product only able to generate a sales revenue of 52,800,000,000 liras.

Forecast Operating Expenses

Operating expenses within the Café Monte Bianco are divided into two i.e. Cost of
Goods Sold (COGS) and non-production costs. The following shows the components
of operating expenses in 2000 and 2001 if the company produces 100% of new
products.
Based on the above calculation table, it can be concluded as below:
 If the company produces 100% private brand coffee product only, the COGS will
increase by 29% (if compared to year 2000). Other operational costs (including
Marketing, R&D, Selling, Administrative, and interest) will decrease by 58%
while total operational expenses will decrease by 3%;
 COGS increase is also due to the additional monthly fixed cost of depreciating
new machine investments to increase production capacity by 400,000,000 liras per
year; and
 The decrease in other operational expenses is due to 100% savings on marketing
expense expenses, 75% on R&D expenses, 65% on selling expense, and 50%
administrative expenditure (as per Carla, director of strategic planning directive).

Calculate Expected Profit

To find the expected economic value to be generated by the company, management

needs to estimate Earnings Before Interest and Taxes (EBIT). Detailed of the
calculation is shown in the following table:
If the company produces 100% private brand coffee, its gross margin will decrease
from 22,878,541,000 liras in 2000 to 9,882,000,000 liras. Meanwhile, EBIT will
decrease from 7,067,721,000 liras to 5,422,818 liras in year 2001.

The Investment Price in New Assets

To finalize profit planning, managers should be able to see the level of investment
required in the new asset included in working capital i.e. inventories and accounts
receivable. The predicted sales level will be determined by the level of assets available
during sale generating. To determine the estimated asset levels available in generating
sales, the company needs to out with profit planning support which is the asset
investment plan. Asset investment plans can be made on operating assets and long-
term assets. This investment is calculated by net present value (NPV) method.
New Assets for capacity additions to new products were not implementing in
2001, the plan had been implemented in the year 2000. NPV assets can be calculated
by reducing the additional value of new assets invested with the present value of cash
inflows generated by these assets. Assuming that the investment has been done in the
previous year, it is certain that the NPV of the investment is positive. The positive
NPV result indicates that the new investment is feasible to run.
Close The Profit Wheel and Test Key Assumptions

Some key assumptions the resulting feedback on the profit planning that has been
done is not linear then management must restart from the beginning and check
whether the variables in the planner of reinforcement have been in accordance with the
strategy company and attractive from the economic view. In this case, profit planning
is still linear and illustrates a positive result. It can be displayed in the profit plan table
or projected income statement below: -

Based on the above table, although showing a positive result (still giving profit), but
when compared with the previous year financial variables, it is seen that the choice of
executing the strategy of transfer of 100% to private brand coffee that is considered.
This happens because when viewed from the side of profitability, then the old strategy
(selling premium products coffee and private brand coffee products together) provides
a higher level of profitability than the new strategy (only focuses on brand coffee
brand only) comparison as follows:
  old strategy profitability = 1,945,633,000 or equal as 3.47% of sales level.
 new strategy profitability = 958,691,000 or equal as l.82% from the sales level.
Thus, the company experienced a profit gain of 986,941,000 liras or 5.73% when
switch to strategy 100% sells product private brand coffee.

b. CASH WHEEL

Estimate Net Cash Flows From Company Operations

To estimate net cash flows from operations can use income before taxes, taxes,
depreciation, and amortization (EBITDA). Based on 2001 sales projection data, the
net cash flows from the company's operations can be calculated as follows (in
thousand liras).
Cash from operating activities
Profit after tax 958,691
Tax payment 639,128
lnterest payment 3,825,000
Add: Depreciation & other non cash
2,993,700
expenses
EBITDA 8,416,519
Changes in working capital
Decrease in account receivable 553,036
Decrease in inventory 4,056,363
Decrease in account payable (487,331)
4,122,068
12,538,58
Cash flow from operating activities
7

The calculation in the above table is obtained by using several assumptions as follows:
i. There is no inventory of either raw materials or finished goods in the warehouse
as shown in the case exhibits 5;
ii. The amount of receivable accounts is determined based on the percentage of A/R
on the previous year's sales of 16.7% sales of the current year;
iii. The entire payable account of 2000 was settled in 2001 and the company was not
indebted in 2001; and
iv. Depreciation expense for fixed asset is same as previous year added with new
asset depreciation expense of 400,000,000 liras.

Based on the above assumptions and calculations, an EBITDA of 8,416,519,000 liras

was obtained by adding back non-cash or non-operating expenses elements, such as
taxes, interest and depreciation payments to income after tax. Furthermore, using
EBITDA calculations and total changes in working capital, net cash flows from
operating activities amounted to 12,538,587,000 liras.

Estimate Cash Needs to Finance Growth From Operational Assets

Earnings before interest, taxes, depreciation, and amortization (EBITDA) are rough
measurements because it does not care about the necessary changes in working capital
in business operations. So the cash requirement to fund growth in operating assets is
estimated using cash flow from operating activities. In 2001, it was estimated that the
Cafes Monte Bianco Company did not invest, as new asset investment of
6,000,000,000 was done in 2000 to increase production capacity to 500,000 kg/month
or 6,000,000 kg/year. So that cash flow from investment activity in the year 2001 is 0
liras.

Price the Acquisition and Divestiture of Long-Term Assets

Giving pricing on long-term purchases and disposals of assets is with the flow cash
from operations minus investments in new assets. Different strategies and the initiative
will require different levels of investment and cash. In no case found information
about the release or purchase of long-term assets company. Thus all cash flows from
such operating or investment activities is not reduced because there is no addition or
subtraction for purchase or the release of long-term assets.

Estimate Financing Needs and Interest Payments

Cash flow analysis is often an indication of funding and payment needs interest to
support the proposed profit planning. Managers must be able to choose between
available resources from external funding (equity, term debt) short, long-term debt, or
a combination of the three) and select the source funding that matches the financial
risk with existing business risk.
In the case of Cafes Monte Bianco, funding activities are only made for
payment of taxes and interest payable (assuming: the amount of interest paid is equal
to year before). Meanwhile, using indirect method of activity method short-term loans
made by the company to cover the cash-strapped effect Day's Sales Outstanding
(DSO) is sometimes 90 days worth of zero. If it is withdrawn into the period 1 year
(not monthly), then the cash flow is not visible anymore. This is because loans made
earlier in the year may already be paid at the end of the year. Thus, cash flow for
funding activity can be calculated as follows:

Cash from financing activities

Pay back debt 0
Additional borrowing required 0
Tax payment (639,128)
(3,825,000
lnterest Payment )

After all the steps in making the Cash Wheel are executed, with entering the previous
year's cash value and cash flows that occurred in 2001, then it can generated an intact
cash plan for the year 2000. The cash plan can be seen in the table following:
 Cash Plan 2001, prepared using EBITDA
(In thousands of Italian Liras)

Cash at the beginning of year 1,121,450

Cash from operation activities
Profit after tax 958,691
Tax payment 639,128
lnterest payrnent 3,825,000
Add: depre. & other non cash expenses 2,993,700
EBITDA 8,416,519

Changes in working capital

Decrease in account receivable 553,036
Decrease in inventory 4,056,363
Decrease in account payable (487,331)
4,122,068
Cash flow from operating activities 12,538,587

Cash from investment activities

lnvestment in new assets 0

Cash from financing activities

Pay back debt 0
Additional borrowing required 0
Tax payment (639,128)
lnterest payment (3,825,000)
(4,464,128)
Total cash flow 8,074,459
Cash at the end of year 9,195,909

From the above calculation, it can be seen that if using the strategy 100% selling
private brand coffee products in 2001 then the company will get net cash flow of
8,074,459,000 liras. The value looks great, but it should be noted that in 2001 there
was no large investment activity and spent huge amounts of money as it did in 2000.
c. ROE WHEEL

The investors of the company will oversee the return of their investments well. This is
because share prices and dividend pay-outs depend on the company's ability to
generate profits from their investments. One of the tools used to measure the return on
investment of investors is Return on Investment (ROI). While the manager uses
internal measurements to estimate the return on investment of the investor capital i.e.
Return on Equity (ROE).
To calculate accounting variables in ROE wheel such as ROE, ROCE, Working
Capital Turn Over, or Fixed Asset Turn Over required data from company financial
statements, especially Balance Sheet and Income Statement. Since the balance sheet
for 2001 does not yet exist, based on the assumptions and calculations we make in
Profit Wheel and Cash Wheel we can present Balance Sheet for 2000 and 2001 as
follows (next page):

After our financial data-report shows the next step is to calculate the accounting
variables used in ROE Wheel. Calculation on the variables are as follows:
From the table above can be seen that all variables indicate that the old strategy in the
year 2000 such as selling private brand coffee products and premium brand coffee
together are more profitable and attractive in the eyes of investors than the new
strategy i.e. just selling private brand coffee only. This happens because the old
strategy gives ROE, ROCE, Working Capital Turn Over, or Fixed Asset Turn Over
which is higher than the new strategy.
3. CONCLUSION

Based on the above discussion we would like to conclude as following:

a. In accordance with the above profit planning based on the analysis of each stage of
Profit Wheel, Cash Wheel, and ROE Wheel shows that the change strategy of
marketing premium coffee and private brand coffee products are simultaneously
turned out more profitable. This can happen because the company has the power on
premium coffee that has been known by the market;
b. Expansion into new products in full (100%) turned out to cause losses because the
margin / unit of new products are very small. Even if the production capacity is not
used maximize, only about 1,500,000 kg, and then the company will loss because the
production cost is greater than revenue. The company must increase the production
capacity maximum level (6,000,000 kg / year) in order to gain maximum profits. This
increase is sufficient to cover company’s funds. If the company does not have
sufficient funds to expand its production capacity, then the interest expense will be
incurred for additional funding of expansion. These costs will further lower the
company's profit;
c. If choosing a new strategy, the company will be short of working capital due to
account receivable collection of private brand coffee product is 90 days or 60 days
which are longer than premium coffee product. The Company has the potential to
experience cash flow deficit and require and addition of new loans which will effect
increase in the payment of interest rate;
d. Company’s inventory turnover is increasing due to the stock system since new
products do not have to be sold like premium coffee applying just in time principle.
The addition of automatic inventory balances requires an increase in working capital
so that corporate funding also needs to be supported; and
e. The management should still maintain premium coffee products because premium
coffee is a high margin producer for the company while the private brand coffee
product is only a complement to product differentiation strategy and does not become
the core competence and profitable for the company.
As overall, we would recommend to Giacomo Salvetti of Cafes Monte Bianco to continue
with their current strategy of mixing premium coffee and private brand coffee. Cafes Monte
Bianco could pick up three more private label retailers to make up the shortfall in demand for
their premium brand offerings.