Husk Power System’s portable power source is a new line of product that is meant to increase revenues for the company. As discussed in the previous section of the report, the initial market research had identified a gap both in the local and international markets that can be filled with this innovative product. In this section, the focus is to conduct a financial assessment and resource planning. As Mayes (2017) observes, when planning to introduce a new product to the market, one of the most important factors that a company must consider is cost analysis and resource planning.
The total cost of producing a unit product should be determined to help the management to set a fair price that would assure it attractive profits. The financial assessment helps the management to determine the viability of the initiative. This section of the paper focuses on the resources needed, conducts a comprehensive analysis of the total cost, and estimates the expected returns before calculating the expected profit. The top management unit can use the information to determine if the new product will be sustainable as part of its products portfolio.
Resources Needed
The portable power source is a revolutionary item that has gone through all the stages of new product development and the only remaining step is to produce it in mass for commercialization. At this stage, the company needs specific resources that will enable it to have successful production and commercialization of the portable power source. The resources needed are classified into three groups below.
Equipment and Materials
One of the most important resources that a firm needs to make the launch successful includes materials and machines needed for the production of the portable energy source. Husk Power System has to develop a processing facility specifically for the manufacturing of the item. It will need to purchase and install large production machines meant to develop different components of the power generator. Consumables such as aluminum, iron, rubber, and steel meant for the production of different components of the generator must be made available in large quantities and at regular intervals.
Energy source is another important factor that the management has to consider in resource planning. Having a regular energy source at a reasonable price can help in ensuring that the unit cost of the product is maintained at reasonable levels. It is important to note that even though energy can be internally sourced, its cost should be outlined alongside other costs to have an accurate calculation of the price of the product (Williams & Dobelman, 2018). The cost of each of these materials and equipment are discussed in the section below.
Staff
The production of the portable power source will require a new set of staff, separate from those who have been working in the renewable energy production department. The management will have to hire design and production engineers, machine operators, sales and marketing officers, quality assessment workers, additional finance officers, cleaners, and other workers who may be required to perform different functions. The cost of hiring these additional employees must be factored in when determining the unit cost of production.
Promotional Platforms
Husk Power System’s portable power source is a new product that is not yet available in the market. Instead of using gasoline as other portable power generators, it is relies on rice husks. The revolutionary power source is not known at home and in the international market. The majority of the targeted customers do not have an idea about its existence and how it should be operated. It will require the management to use various platforms to create awareness about the product.
According to Wahlen et al. (2018), social media platforms have gained massive acceptance as means of reaching out a wide audience within a short period. The marketing department of this company will need to use Facebook, YouTube, Instagram, Twitter, and any other social media platform that is locally popular to promote the product to the targeted audience.
Schroeder et al. (2019) observe that despite the growing popularity of social media platforms as means of promoting an item, mass media are still crucial outlets of advertising in the current market. The marketing unit will need to balance between mass and social media platforms when promoting its products.
Cost
When conducting a financial assessment, the primary goal is to always determine the total cost of producing a unit product, determine the revenue from that individual product, then determine the profit that it generates, assuming all factors remain unchanged. In this section, the focus is to outline the cost of every item that is needed for the production of the portable power source and making it available in the market.
Estimating Approach and Confidence Level of Estimates
One of the most important factors that a financial analyst needs to define is the approach that will be used in estimating the cost of various items and processes involved in making a product available to customers. The accuracy of the estimation approach is critical in determining the confidence level (Asish, 2019).
The management of this company is keen on having an accurate estimation to determine whether this new project will earn it the expected return. Give that the product is new to the company, the management cannot rely on historical records. As such, the most appropriate estimating approach would be an expert judgment. This approach involves inviting an expert who will define every process of production and materials needed.
Once a detailed explanation of the entire process is provided, the team will then need to get the exact market value for every item needed, including the cost of labor and any other relevant item. The approach leaves little room for error and is often expected to have a confidence level of 98%. The management can rely on the approach and the confidence level to make critical investment decisions (Duțescu, 2019). When using this method, the financial analysts will need to go beyond general classifications of costs to determine specifics as discussed below.
Product Manufacturing Cost
One of the first areas of focus in this financial analysis should be the cost of using raw materials to make a finished product (Wahlen et al., 2018). The section focused on determining the cost of labor involved in the production of this portable energy source. In this case, costs are estimated on a monthly basis. The following are the specific items whose costs were determined as part of the product manufacturing process:
- Equipment cost (The estimated cost of the depreciation of the production equipment per month based on its usage)
- Labor cost (Monthly salary and wages of permanent and casual workers who are involved in the production department of the company)
- Energy cost (Estimated cost of the energy that the company uses on a monthly basis to produce the portable power source)
- Software cost (Cost of installing the software that the portable energy source uses to operate)
- Hardware cost (including mechanical components, non-electricity control components, electric signal components, IC components, the IC itself, semiconductors, the digital display, and battery)
- Logistics (the cost of transporting materials to the company)
- Warehousing (the cost of storage of raw materials)
Cost to Complete Service
The second category of costs is that which is used to complete the service and make the product available for sale. Once the manufacturing department has completed the entire process of making a portable energy source, this department will take over. Activities involved include packaging of the product, transporting the packages from the production plant to the market, storing them in different stores in the market, and the labor involved in these processes. The following are the costs that have to be taken into consideration:
- Packaging cost (including the cost of branding the product)
- Transporting products to the market
- Warehousing (storage of finished products)
- Labor cost (employees involved in the intermediate activities after manufacturing and just before the products are handed over to the sales team)
Cost Associated with Supporting Operations
The third category has the cost associated with supporting operations. Once the finished products are handed over to sales and marketing team, they have to ensure that customers have access to them at the right time and in preferred locations. Primary activities at this stage include the promotion of the brand and its products in the targeted market, sales activities, cost of paying those who are involved in the marketing department, and relevant government levies. The list below summarizes costs under this category.
- Promotion of the brand and products
- Sales activities
- Labor cost
- Government fees
Table 1 below provides a summary of all the costs discussed above. It is important to note that the company currently has the capacity to produce 500 units of the portable energy source every month. As such, the estimates are for the production of 500 pieces of the product. It is necessary to note that the number of units produced within 30 days may change as the demand increases and the firm expands its production capacity. At such a time, the calculations may change. However, at this time, the estimates below will guide the financial analysis of this company.
Fixed Cost of Operation
The three categories discussed above are all part of variable costs that the firm will incur in the production of the 500 units of the portable power source. As the name suggests, these costs may vary depending on the rate of production that the company may embrace in response to the changes in sales. It is equally important to outline the fixed costs that will have to be incurred. Fixed costs may not easily change unless there is a major expansion or reduction in the size of the company. The following are the fixed costs that have to be factored in when calculating the cost of operation:
- Cost of rent
- Payment of insurance premiums
- Loan repayments
Table 1 below provides a comprehensive analysis of all costs involved in making 500 units of the portable energy source available in the market. The main assumption at this stage was that the company takes one month to complete the production of these units and to make them available for sale.
Table 1: Cost Estimates.
Table 2: Total Cost in the First 3 Years of Operation.
The primary assumption was that the production capacity and production cost remain unchanged within the period.
Estimated Revenue from Sales
When the total cost of production has been established, the next step in the financial analysis is to determine the revenue generated from the sale of products. A company may have different sources of funds such as investments made by the business owners, grants that may come from environmental organizations to support its production of renewable energy, or bank loans meant to support expansion. In this case, the focus is to determine revenues that specifically arise from the operations of the company.
These revenues are directly linked to the costs discussed above. The proposed price is $ 95, which is relatively low compared with those available in the market but is using gasoline, which is more expensive to operate, instead of rice husks.
Sales revenue = units sold x sales price per unit = 500 x 95 = $ 47,500
The following are the assumptions made when calculating the estimated revenue from the sale of the portable power source:
- All the 500 units are sold soon after arriving in the market
- Inflation cost is not factored in the calculation
- The price is acceptable among the targeted customers
- There are no major hidden forces in the market within that duration that can significantly disrupt the normal operations of the company.
- The above factors do not change within the first 3 years
Cost-Benefit Analysis
Cost-benefit analysis provides critical information to the management about the relevance of making a specific investment. Husk Power System’s portable energy source is a new product that is yet to be tested in the market. According to Lessambo (2018), it is possible for a firm to introduce a new product that is unable to yield profits in the market. Sometimes the marginal profit that it offers is unable to meet the actual cost of production in the long run.
In such cases, the management is expected to discontinue its production when the profitability fails to meet expectations. A cost-benefit analysis helps in determining the value of investing in a given new project.
Calculating Profit
One of the most common ways of conducting a cost-benefit analysis is to calculate the profit that a company would earn from the sales of a given product. In a rational business environment, it is often expected that the unit cost of producing a product will be less than the price at which it is sold in the market. The profit margin is often defined by the difference between the cost of production and the product price. When the price is significantly higher than the cost, then the company will make impressive profits. However, when the margin is small, then the profit will be equally small. The following if the profit that the company will make from the sale of its products based on the above statistics.
- The cost of bringing 500 units to the market = $ 32, 456
- The cost of 1 unit will be (32,456)/500 = $ 64.912
Profit = Revenue from the sales of the unit (price) – the total cost of producing and availing the product in the market
= $ 95- $ 64.912
= $ 30.088
The calculation above shows the unit profit for every portable energy source that Husk Power System makes available in the market. Given that the assumption was that the company will be making sales of all the 500 units produced within a month, it is necessary to determine the total profit that it will be making within the period.
The major assumption at this stage is that all the items are sold at the proposed price. It is also assumed that no major market events will occur, making it necessary for the management to take longer than expected to sell the product. When the time is extended, various additional costs may set in, such as cost of labor, warehousing, insurance, and energy cost.
Total profit = (Profit from a unit product) x (the number of products sold) = $ 30.088 x 500 = $ 15,044
The calculations above show that if Husks Power System is capable of producing 500 units of portable energy source at the cost proposed above and the marketing unit can sell the products at the suggested price, it will make a profit of $ 15,044. The profitability can be scaled up if the company can increase its production and measures can be put in place to enhance sales. One of the ways of enhancing sales is to explore the national market.
Currently, the company’s operations primarily target the rural eastern part of the country. However, this product is suitable for everyone who lives in rural settings. It can also be used in outdoor urban settings as long as one can have access to a regular supply of rice husks. The management can also consider exploring international markets, especially the Chinese and Indonesian markets. The huge population in these two foreign markets and the fact that they also have a significant number of their populace living in rural settings make them an attractive market.
Their closeness to the parent country also means that it will not be costly to transport the product to the market. Just like in India, these two countries are known to produce rice in large quantities, which means that fuel that the portable power source uses (rice husks) will be available in large quantities.
Break-Even Calculation and Chart
One of the most important aspects of a cost-benefit analysis is the calculation of break-even analysis. Young et al. (2018) define this metric as the point at which a company has recovered all its cost of production and is just about to make profits. At this point, the company will neither be making profits nor losses. Beyond the break-even point, the firm will start enjoying the profit.
The management of Husks Power System will need to determine this break-even point because it will help in assessing the worth of the project in terms of its capacity to generate returns within a specific desired period. Using fixed costs, variable costs, and revenue, one can calculate the break-even point for the investment that the company will be making to produce the portable energy source. The following is the formula for calculating this metric:
Break-even point = (Total cost) / (Contribution per unit)
Where
- Contribution per unit = (Selling price per unit – variable cost per unit) = profit per unit product
- Total cost = (Fixed cost + variable cost is as was calculated in the section above)
∴ Break-even point = 32,456/30.088 = 1,078.70 units
It means that the company will need to sell 1,078.7 units of the portable power source to be at the break-even point. This will be the stage where the firm shall have recovered all its fixed and variable costs. Any sale below that number will result in a loss, and any extra unit sales above this number will start earning this company profits, ceteris paribus (assuming all other factors remain constant). The information can be presented graphically in the chart shown in figure 1 below.
Using the information above, it is possible to calculate when the company will start making profits as shown below.
- If HPS takes 1 month to produce 500 units of the portable power source
- How long will it take to produce 1,078.70?
It will be: (1078.7/500) x 1 = 2.16 months
It means that it will only take 2.16 months for the company to break even. It is a reasonably short period, which makes it an attractive investment.
Summary
The financial analysis above has provided critical information that the management can use to determine if it is worth investing in this project. Husks Power System has already made a successful entry into the business of producing renewable energy using rice husks for rural dwellers on the eastern part of India who are not yet connected to the national grid. The introduction of this new portable energy source was meant to create a new revenue source as the company seeks to cement its position as a leading producer of renewable energy in the global market. The financial analysis strongly supports the idea of introducing the new product.
It shows that the company will be making attractive profits once it starts its operations. Husks Power System will recover investments that it has made in this project after 2.16 months. It means that in the subsequent years, the earnings that it will be making will be pure profits after subtracting the cost of operation. It means that this project is worth the investment that the firm plans to make because it is sustainable.
References
Asish, B. K. (2019). Corporate financial reporting and analysis (2nd ed.). PHI Learning Pvt. Ltd.
Duțescu, A. (2019). Financial accounting: An IFRS perspective in Romania. Palgrave Macmillan.
Lessambo, F. I. (2018). Financial statements: Analysis and reporting. Palgrave Macmillan.
Mayes, T. R. (2017). Financial analysis with Microsoft Excel. Cengage Learning.
Schroeder, R. G., Clark, M. W., &Cathey, J. M. (2019). Financial accounting theory and analysis: Text and cases. John Wiley & Sons.
Wahlen, J. M., Baginski, S. P., &Bradshow, M. T. (2018). Financial reporting, financial statement analysis, and valuation: A strategic perspective. Cengage.
Williams, E., &Dobelman, J. A. (2018). Quantitative financial analytics: The path to investment profits. World Scientific Publishing Company.
Young, S. D., Cohen, J., & Bens, D. A. (2018). Corporate financial reporting and analysis. Wiley.