William had commenced in business with capital provided by his mother. The financial statements for the period from 1 April 2009 have been submitted to you as shown below.

(a) Expenses that change with sales; 

(b) Expenses that do not change with sales. 

In an effort to persuade his mother to lend him a further amount, William points out that:

1. The sales in the year ended March 2011 were 40% more than that in the previous year and he estimates that his sales in the year to March 2012 would probably be around £150,000.

2. The net loss in the second year results from the increase in fixed costs because of renting more commodious premises big enough to allow for the anticipated expansion in sales.

3. A cash injection is urgently needed to maintain the business at the intended scale. Currently the business is unable to comply with the suppliers’ term of one month’s credit and the inventory levels are inadequate to meet customer demand.

4. The bank overdraft has not been negotiated.

The mother’s concern, however, is that William is capable of earning around £7,000 per year if he finds employment and she herself could earn 8% per year on her savings.

Required: Your advice is sought by William’s mother.

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Statement of income year ended 31 March 2010 Sales Cost of sales Gross profit Overheads: Variablea Fixedb Net profit (loss) £ 2011 £ 70,000 98,000 (42,000) (63,000) 28,000 35,000 (14,000) (24,500) (8,400) (11,200) 5,600 (700) Statements of financial position as at 31 March 2009 Non-current assets Current assets: Inventory Trade receivables Bank balance Current liabilities: Trade payables Bank overdraft Capital employed £ 49,000 3,500 9,100 (2,100) 59,500 2010 £ 49,000 7,500 9,700 2,400 (3,500) 65,100 2011 £ 56,000 4,000 16,800 (9,600) (2,800) 64,400