Impacts On The Profit And Loss Statement

Impacts to the Profit and Loss Statement

Tim’s Coffee Shoppe is evaluating the potential financial impacts of increased business volume due to new large businesses moving into the neighboring area. To assist in this assessment, it is necessary to analyze how various line items on the pro forma income statement will change, considering the expected rise in sales volume. This paper discusses each line item—both income and expenses—and provides justification for whether each will increase, decrease, or remain unchanged. Additionally, it will address the overall impact on total expenses and net profit, based on reasonable assumptions grounded in the expected increase in sales and business activity.

Analysis of Income and Expense Line Items

Income Earned

With new businesses establishing offices near Tim’s Coffee Shoppe, the primary driver of increased income will be the rise in customer volume. As more employees and visitors patronize the coffee shop, total sales revenue is projected to increase significantly. The volume of customers directly correlates with higher sales of coffee, snacks, and other items, thereby escalating overall income. Based on this scenario, we assume that Income Earned will increase proportionally with customer volume. For example, if foot traffic doubles, sales income could potentially increase by a similar margin, provided that prices per unit remain stable. This assumption hinges on the expectation that business hours and customer preferences remain consistent, and the shop can accommodate more customers without compromising service quality.

Expenses

Salaries

An increase in customer volume typically necessitates additional staffing to handle heightened demand, especially during peak hours. Therefore, Salaries are likely to increase as the shop may hire more employees or allocate overtime to current staff. This will incur higher payroll expenses. However, the extent of increase depends on whether the existing staff can be scaled up with minimal additional hires or if new employees are essential. Given the anticipated business growth, it is reasonable to assume Salaries will increase but potentially not in direct proportion to sales—some elasticity exists due to efficiencies and better scheduling.

Rent

The rent expense for typical small businesses remains constant regardless of sales volume unless lease agreements include escalator clauses or if an expansion into a larger space is considered. Given the scenario, rent will likely stay the same unless Tim decides to move or lease additional space to accommodate increased demand. For the purpose of this analysis, rent is assumed to remain unchanged.

Depreciation

Depreciation on fixed assets such as equipment or furniture usually remains constant unless the shop invests in new assets or upgrades existing ones. Since this scenario does not specify asset expansion, Depreciation is assumed to stay the same.

Supplies

An increase in sales volume naturally leads to higher consumption of supplies such as coffee beans, cups, napkins, and food items. Consequently, Supplies expenses are expected to rise proportionally with increased sales. For instance, more cups and ingredients will be used as more customers are served, leading to higher variable costs.

Lease (on refrigerator)

If the refrigerator lease is a fixed monthly expense, it will remain unchanged regardless of sales volume unless additional refrigerated units are leased or purchased to support increased inventory needs. As no such expansion is indicated, lease costs are assumed to stay constant.

Tax

Taxes are primarily calculated based on taxable income, which depends on the net income after deducting expenses. Since both income and expenses increase with higher sales, taxes will likely increase, but this depends on the effective tax rate. As net income is expected to grow, the shop’s tax liability should proportionally increase.

Interest on Loans

If Tim’s Coffee Shoppe has existing loans with fixed interest rates, the interest expense remains unchanged unless the shop takes on additional debt to fund expansion. Assuming no new borrowing occurs, interest expenses will stay constant.

Insurance

Business insurance premiums are often fixed or based on the value of insured assets and the level of coverage. Unless the shop expands assets or coverage, insurance costs will stay the same. However, if the increased workload necessitates higher coverage, premiums might increase marginally; absent that, insurance costs are assumed stable.

Overall Impact on Expenses and Profit

Based on the above analysis, total expenses are expected to increase. The major variable expense—supplies—will rise in direct proportion to increased sales volume. Salaries may also increase due to the need for more staff or overtime pay. Fixed expenses such as rent, depreciation, lease, interest, and insurance are assumed to stay constant unless additional investments or lease modifications occur. Overall, the total expense increase will primarily depend on how significantly sales and associated variable costs grow relative to fixed costs.

Impact on Net Profit

Given the assumption that income will increase substantially due to higher customer volume, net profit is also projected to grow. While expenses will rise, the proportional increase in gross revenue is expected to outpace the rise in variable and fixed costs, especially since many fixed costs remain unchanged. For example, if revenue doubles due to increased sales, and variable expenses increase at a similar rate, the profit margin may improve if the shop can manage costs efficiently. Furthermore, economies of scale or operational efficiencies may further enhance profit margins. It’s important to recognize that the net effect hinges on the shop’s ability to fully capitalize on increased demand without disproportionately increasing expenses. Overall, the net profit should increase, assuming sales volume rises at a rate that surpasses the increase in total expenses.

Conclusion

In summary, the anticipated influx of new businesses into the area is expected to significantly boost Tim’s Coffee Shoppe’s income. Most variable expenses, including salaries and supplies, will increase proportionally with sales volume. Fixed expenses like rent, depreciation, lease, interest, and insurance are likely to remain steady unless additional actions are taken. As a result, total expenses will rise, but the overall effect should be an increase in net profit due to the higher gross income. Effective management of increased costs and operational efficiencies will be vital for maximizing profitability in this growth phase.

References

• Brigham, E. F., & Houston, J. F. (2019). Fundamentals of Financial Management (15th ed.). Cengage Learning.
• Gibson, C. H. (2020). Financial Reporting & Analysis (13th ed.). South-Western College Publishing.
• Higgins, R. C. (2018). Analysis for Financial Management (11th ed.). McGraw-Hill Education.
• Khan, M. Y., & Jain, P. K. (2018). Financial Management: Text, Problems and Cases (5th ed.). McGraw-Hill Education.
• Investopedia. (2023). Financial Statements Explained. Retrieved from https://www.investopedia.com/terms/f/financialstatements.asp
• Orphee, W. E. (2018). Small Business Financial Management. Routledge.
• Ross, S. A., Westerfield, R. W., & Jaffe, J. (2019). Corporate Finance (12th ed.). McGraw-Hill Education.
• Wild, J. J., Subramanyam, K. R., & Halsey, R. F. (2019). Financial Statement Analysis (12th ed.). McGraw-Hill Education.
• Young, R., & Brigham, E. F. (2020). Fundamentals of Financial Management (15th ed.). Cengage Learning.
• Supplemental online videos and tutorials on financial statements. Retrieved from reputable finance education platforms such as Khan Academy or Coursera.