The Café's Cash Flow Crunch
Mia owns a small café that has been operating for two years. She is preparing her business plan for the next year. Her accountant provided the following projections: monthly sales revenue is expected to be $40,000; cost of goods sold is 40% of sales; fixed costs (rent, utilities, wages) are $18,000 per month; and variable operating expenses (marketing, supplies) are 5% of sales. Mia also plans to purchase a new espresso machine for $12,000 in July, which will be depreciated over 5 years. She has a cash balance of $10,000 at the start of the year. Mia wants to know if she can afford the machine without borrowing, and what her monthly profit will be.
1. Calculate Mia's expected monthly profit before depreciation and the monthly cash flow after the machine purchase in July. Based on these calculations, advise Mia on whether she can afford the machine without borrowing, assuming no other cash inflows or outflows.
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First, calculate monthly profit before depreciation: Sales revenue = $40,000. Cost of goods sold = 40% of $40,000 = $16,000. Variable operating expenses = 5% of $40,000 = $2,000. Fixed costs = $18,000. Total costs = $16,000 + $2,000 + $18,000 = $36,000. Profit before depreciation = $40,000 - $36,000 = $4,000 per month. Depreciation of the machine = $12,000 / 5 years = $2,400 per year, or $200 per month. So profit after depreciation = $3,800 per month.
Next, cash flow: For months without the machine purchase, cash flow = profit before depreciation = $4,000 per month (assuming depreciation is non-cash). In July, cash outflow for the machine is $12,000. So July cash flow = $4,000 - $12,000 = -$8,000. Starting cash balance is $10,000. By June, cash balance = $10,000 + 6*$4,000 = $34,000 (assuming January to June). In July, cash balance = $34,000 - $8,000 = $26,000. After July, monthly cash flow returns to $4,000. So the lowest cash balance is $26,000, which is positive. Therefore, Mia can afford the machine without borrowing, as she has sufficient cash reserves. However, she should consider if there are any other cash outflows or timing issues.
2. Explain how the depreciation of the espresso machine affects Mia's cash flow and profit, and discuss whether depreciation should be considered when deciding whether to purchase the machine.
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Depreciation is an accounting expense that allocates the cost of the machine over its useful life. It reduces profit each month by $200 but does not involve any cash outflow after the initial purchase. Therefore, depreciation affects profit but not cash flow (except in the month of purchase when the full cost is paid). When deciding whether to purchase the machine, Mia should consider the initial cash outflow of $12,000 and the impact on cash flow, as well as the expected benefits such as increased sales or efficiency. Depreciation itself is not a cash cost, so it should not be the primary factor in the decision; instead, the focus should be on the machine's ability to generate additional revenue or cost savings that outweigh the purchase cost. Additionally, Mia should consider the opportunity cost of tying up $12,000 in the machine versus other uses. In this case, the calculations show she can afford it without borrowing, but she should still evaluate the return on investment.