Estimating Business Profitability and Working Results
Profitability Projections (Estimates of Working Results)
The estimates of working results may be prepared along the following lines:
Cost of Production
This represents the cost of materials, labour, utilities, and factory overheads as calculated earlier.
Total Administrative Expenses
This consists of:
- Administrative salaries
- Remuneration to directors
- Professional fees
- Light, postage, telegrams, and telephones, and office supplies (stationery, printing, etc.)
- Insurance and taxes on office property
- Miscellaneous items
Total Sales Expenses
The expenses included under this head are:
- Commission payable to dealers
- Packing and forwarding charges
- Salary of sales staff (which may be increased at 5 percent per annum)
- Sales promotion and advertising expenses
- Other miscellaneous expenses
Selling expenses depend mainly on the nature of the industry and the kind of competitive conditions that prevail.
Royalty and Know-How Payable
Royalty and know-how payable annually may be shown here. The royalty rate is usually 2–5 percent of sales. Further, royalty is often payable for a limited number of years, say 5 to 10 years.
Total Cost of Production
This is simply the sum of cost of production, total administrative expenses, total sales expenses, and royalty and know-how payable.
Expected Sales
The figures of expected sales are drawn from the estimates of sales and production.
Gross Profit Before Interest
This represents the difference between expected sales and total cost of production.
Total Financial Expenses
Financial expenses consist of interest on term loans, interest on bank borrowings, and commitment charges. Of course, these primarily include interest on term loans and interest on bank borrowings.
Depreciation
This is an important item, particularly for capital-intensive projects. In figuring out the depreciation charge, the following points should be borne in mind:
Other Income
This represents income arising from transactions not part of the normal operations of the firm. Examples of such transactions are: sale of machinery, disposal of scrap, etc.
Write-Off of Preliminary Expenses
Preliminary expenses up to 2.5 percent of the cost of project or capital employed, whichever is higher, can be amortized in ten equal annual installments.
Profit / Loss Before Taxation
This is equal to: operating profit + other income – write-off of preliminary expenses.
Provision for Taxation
To figure out the tax burden, a sound understanding of the Income Tax Act – a complicated legislation – and relevant case laws is required. While calculating the taxable income, a variety of incentives and concessions have to be taken into account. Once the taxable income, as per the Income Tax Act, is calculated, the tax burden can be figured out fairly easily by applying the appropriate tax rates.
Profit After Taxation
This is simply profit / loss before taxation minus provision for taxation. A part of profit after tax is usually paid out as dividend: dividend on preference capital and dividend on equity capital.
Retained Profit
The difference between profit after tax and dividend payment is referred to as retained profit. It is also called ploughed back earnings.
Net Cash Accrual
The net cash accrual from operations is equal to: retained profit + depreciation + write-off of preliminary expenses + other non-cash charges.