Scenario

The cement industry in South Africa is currently undergoing mixed sentiments by

various economic and financial specialists. From an economic perspective, this industry

should grow, especially in view of the growing property markets. There are several

initiatives surrounding new housing and shopping complexes across the country, which

is ensuring a growing market for building cement and related products. There are also

opportunities to develop cement production facilities in African countries such as

Ethiopia, Zimbabwe, Botswana and Rwanda. From a financial perspective, there seems

to be a growing (bullish) trend in cement shares; however, this market might be

influenced by cheap importers of cement from other countries such as Pakistan.

Notwithstanding, it seems that this market will show a steady increase in the future,

providing local and foreign investment opportunities. Due to these potential views of the

cement market, there might be ample work opportunities, including for small and

medium enterprises (SMEs).

In this regard, Mr Baloyi decided to investigate an SME to provide ready mixed cement

to builders. He is aware that all SMEs are subject to specific risk exposures. As such, it

is essential to determine if such an investment would be worth the risk. As a risk

specialist, he approached you to analyse the following business and make

recommendations.

The business involves the use of cement mixing trucks to provide ready mixed cement

to builders for building purposes. To start such a business, it is imperative to get a

licence from the appropriate government department and be a registered supplier of this

product and service. Due to the price of these cement-mixing trucks, it will be an

expensive business to start. The cost of one truck is R1.5m, and usually, two trucks are

required to start such a business. It is also imperative to confirm a customer base to

ensure that there is a market for the business. This would mean a detailed marketing

campaign to advertise the business and to establish a customer base. The cost for such

a campaign will amount to R500 000 and after that R50 000 per annum (This will only

come into effect the second year after establishing the business). Furthermore, it is

crucial that the business must have skilled employees. Firstly, skilled to ensure that the

mixed cement consists of the correct volume of sand, stone, cement and water.

Secondly, the drivers of the trucks must be trained and have a special license to drive

these trucks and thirdly have the skill to operate the mechanics of the truck's mixing

machines. Training is thus, essential to ensure a successful business. The average

training cost per employee will be R65 000, which will include the required license fees.

In order to operate two cement trucks, the following staff members are required with an

annual compensation package:

2 x truck drivers R470 000 per driver

2 x machine operators R350 000 per operator

2 x Cement mixing specialists R225 000 per specialist

1 x Administration officer R300 000

To employ the above staff members, it is required that the total annual compensation

must be available upfront in order to protect the employees for at least a year should the

business fail.

The trucks require a maintenance service after 20 000 km. A normal service costs

approximately R8 500 and the average distance per month for a truck is about 10 000

km. To ensure that the trucks operate at their full capacity, these maintenance services are crucial. Should a truck break down, it will cause a major problem for Mr Baloyi in the

sense that he will incur penalties for not delivering cement on specified times.

One truck can provide three loads of cement per day which will ensure a net income of

R16 000 (after the cement, sand and water costs). Mr Baloyi envisaged that he would

provide cement for only 20 days per month, which will allow him time for the

maintenance of the trucks on a monthly basis. The building industry closes during the

months of December and January each year, meaning that there are only ten months

available for business.

A potential problem that Mr Baloyi will face is the availability of cement which could be

influenced by strikes at the cement factories. As such, Mr Baloyi must make provision

for these incidents should they occur. Another potential threat to this business is the

exposure to road accidents involving the trucks. Since the trucks form the basis of this

enterprise, Mr Baloyi must be insured against accidents. This is also essential to cover

any third party claims against the business such as the non-delivery of cement as per

agreed times as well as claims from other accident victims. Potential monthly insurance

premiums are:

R5 500.00 per month (12 x months) per truck (including third party costs) for

accidents.

R2 500.00 per month (12 months) to insure against claims for non-delivery.

The availability of skilled and trained drivers on these cement trucks are scarce in South

Africa and should one of the drivers fall ill, or want to go on leave. Mr Baloyi will have a

serious problem to achieve his business objectives. Furthermore, the availability of

diesel could be a problem if the country experiences a shortage. This is a high

possibility which could also negatively influence the business. The safety of the trucks

also requires attention, and they must be parked in a safe environment when they are

not in use. In this instance, Mr Baloyi will have to rent buildings with adequate parking

facilities and office space. These rental costs (including water and electricity) for a

suitable building is R20 000 per month. Security is also vital to safeguard the

equipment, which will cost R6 500 per month (including a 24-hour security guard) and

rapid response from ABS Security. It is also imperative to ensure that there is a process

to clean the trucks when not in use to ensure the longevity thereof. In addition, the

trucks must be monitored in terms of its fuel usage; the oil services and the kilometres

travelled to ensure that the trucks are serviced when it is due. It is therefore imperative

that those above be technologically supported. A system for the business will cost

R50 000 and R2 000 per month.

Due to the fact that the trucks make use of the public roads, it is eminent that the drivers

are exposed to traffic fines resulting in possible legal action against the business. This

should also be adequately addressed during the business strategy.

Mr Baloyi envisaged that to make the business worth his while, he must, at a minimum,

receive a monthly income, before tax, of R90 000. The total tax implications for the

business can be calculated at 28% on the gross income per annum. To ensure the

continuity and the growth of the business, a minimum annual amount of R1 000 000

must be invested. Should this target not be achieved, the business will not grow and go

bankrupt after five years (this is also the lifetime of the trucks and must be replaced

after five years).

To start the business, Mr Baloyi is prepared to invest R5 000 000 into the business for

ten years at 5% interest per year. The monthly amount for this loan is R67 870.

Question 1

Calculate the income (including the original loan) and expenditure for the first year to

determine if the business, from a financial perspective, is worth the risk for Mr Baloyi.