Jan de Bofarull, Cristina Canela, Enric Jaulent,

Cost Accounting Report Ferran Jurado & Gemma Rascón

Illes 18

1.INTRODUCTION

The main aim of the following report is to formulate

the hypothesis of Illes18 investing in a new asset
and analyse in detail how this investment would
affect the profitability of the company.

In the first place, the report will include a brief

description of the firm together with a the
characteristics of the asset they want to invest in.
Secondly, its cost structure will be examined using
the knowledge acquired during the Cost Accounting
course and the profitability of the asset’s
investment will be covered through an incremental
analysis.

Moreover, the report will also contain a study which

determines the best way to finance the project, a
market analysis done from a survey to see the
consumer’s behaviour towards the announcement
of this new service and a marketing proposal of the
way the company should introduce it in the market.

2.ILLES 18 AND CRYOLIPOLYSIS

Illes 18 is an aesthetic medicine center located in

Vila-Seca, close to Tarragona. It started in 2008 and
since then it is looking to be the pioneer in
treatments and services by offering a complete
process to its clients. It is run just by the owner,
Rosa Besa, who is a diplomate nurse with master’s
degrees in nutrition, naturopathic medicine, and

Dónde estamos
aesthetic medicine.

YA 1
Nowadays, it has a diversified portfolio of services, such as facial treatments, body sculpt treatments, diet, laser
depilation, naturopathy, and cosmetic products.However, we will focus on the body sculpt treatments that take
part in the sector in which the new machine will operate.

Table 1. ILLES 18 portfolio structure.

Lately the company has considered introducing a new pack that contains the new machine and which will be much
more efficient in people with concentrated fat. The new pack will be formed by cryolipolysis (the new asset),
thermo-stimulation and pressotherapy.

Cryolipolysis is a non-surgical fat removal procedure in which therapists place a suction cup on a client’s skin and
gradually extracts body heat until the subcutaneous fat is frozen. During the procedure, the applicator delivers
controlled cooling conditions that have been proven to target and eliminate fat cells in specific areas of the body.
When fat cells are exposed to precise cooling, they trigger a process of natural removal that gradually reduces the
thickness of the fat layer. In simpler words, it turns fat cells into liquid which can then be naturally drained by the
body's own natural filtration system.

Table 2. Cryolipolysis photo

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3.ANALYSIS OF THE COST STRUCTURE OF THE COMPANY

Before doing any analysis, company’s

3.1 COST CLASSIFICATION costs were classified in the following
table into Direct Costs (those which can
be directly traced to the products),
Indirect Costs (not directly accounted to
the cost object), Product Costs (incurred
in the process of producing a product),
Period costs (not directly related to
production), Fixed Costs (do not depend
on the quantity produced), Variable Costs
(depend on the quantity produced) and
Semi-Variable Costs (which contains one
part fixed and another variable).

From the table in the left we can see the

breakdown of all fixed costs of the
company, the breakdown of the variable
costs of the machine and then, the
variable costs of the part of product
selling and also the costs of the services
part of the company.

However, because the costs of the

Table 3. Cost Classification.
services come from some labs but the
purchases could be for different types of
services (facial, body sculpt, and so on)
we just work just separating the firm
between products or services (as they do
because of accounting reasons).

3.2. VARIABLE COSTING AND EXPECTED INCOME STATEMENT

To analyse the cost structure of Illes18, the variable costing method has been used as it is the one that helps us
the most in order to determine a decision over the investment. This is because fixed costs will arise in any
situation, whether the investment is done or not. However, variable costs will be the ones changing depending on
the decision.

On the other hand, full costing is very useful in order to determine the price of a product or service. However, in
this case the price of the service has been already determined by the demand curve because the company could
work as a competitive monopoly, since the firm is differentiated from their competitors. So, as the price will not be
determined by the marginal cost, but by demand factors, full costing is not that necessary for the company.

Moreover, it is important to state that Illes 18 is quite special in terms of labor costs. The firm has no labor costs
as the company is fully-owned by Rosa and she is the only worker, so she hasn’t a wage as such, but she gets the
revenues of the firm. Consequently, there are no indirect costs due to the labor wages.
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Furthermore, it must be mentioned that because of the relationship between the services and products of the
company, an assumption was made that the increase of customers due to the machine will affect all sectors. In
other words, Illes 18 has the purpose to give a full treatment to their clients and then if the company gets some
new customers thanks to the publicity received due to the acquisition of cryolipolysis, revenues (and profits) of
other services and products will increase too. This is because the clients that make this treatment, usually are
also doing diet and other treatments which can be done as well in Illes 18.

According to this assumption, the company's revenues and variable costs are expected to increase by 20%
thanks to this new acquisition. So, using this method we compute the income statement (the actual one, and
the one with the expected revenues). And the result is the following:

Table 4. Actual Income Statement Table 5. Expected Income Statement

As it can be seen, there is a high increment of the profitability of the firm thanks to the purchase of the
machine. This is because the variable costs are multiplied at the same time as the revenues, so this creates an
extra profit because of the difference between both. But the profits grow by more than 20% (they increment by
50% with respect to the actual profits) and this happens due to the fact that fixed costs remain constant (even
though there is an increase in the depreciation part because of the machine).

Although, the first year the firm incurs an extra cost of marketing. In this, the expected revenues were not
changed, but the fact that marketing activities are being introduced, makes the probability that our predictions
become real to increase. So, even if the profit is reduced, the risk of not matching the expected revenues is
reduced. It is important to show where the gross margin is coming from. It is to say, which part comes from the
products and which from the services.

Table 6. Percentage of Products and Services in the gross margin.

From table 5, we can see that the core business of the firm is mainly based on the selling of products.
However, as said before, it is an extra added value having treatments inside the firm and, despite that, it is
also profitable to offer those treatments and invest in them.

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 3.3. INCREMENTAL ANALYSIS AND THE NET VALUE OF THE PROJECT

It is important to mention that even if the company has higher expected profits, it doesn’t mean that the
project is worth it. To check this, an incremental analysis was done in which the capital inflows, capital outflows
and the cost of capital derived were taken into account. The length of the project is expected to be until 2032,
so this is why the cash flows were computed until that year.

A 10% cost of capital was assumed as the mean of these types of business, taking into account the years, the
profitability and the variance of the profits of the firm over years.

Here the main interest is focused on the difference between the actual and expected results with the
investment on the machine. To do so, the 20% increase in revenues and variable cost and also the
depreciation of the machine must be added. Let’s see it in the table below:

Table 8. Net present value of the project with debt

Table 7. Net Present Value of the project without debt

The NPV of the project in 2022 will be 94.807,21€, which is quite high and the margin until it is unprofitable is
very large. So the conclusion is that the machine will be profitable in terms of cash flows as well.

Furthermore, we are also interested in which way of financing is the best in this case, so the next table will take
into account that the machine is financed with debt at 4% interest, which is expected to approximately be the
interest rate for the debt. It is important to have in mind that it is financed for 10 years (as depreciation, so the
interest expenses must be computed with the compound interest). See new Table 7. It can be seen that the new
NPV is 95.022,99€ which is slightly higher than without financing (just 0,22% higher). So, according to the financing
patterns of the firm which is fully-equity based, the recommendations are that the company should pay the machine
through the company’s equity as the risk is lower than financing.

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3.4 BREAK EVEN AND MARGIN OF SAFETY

In order to analyse how this new investment will affect the profits of Illes 18, the break-even point and the Margin
of Safety of the project were also considered. This analysis will ease the decision-making, and it will inform about
how hard it’ll be to recover the fixed investment. The following contains the information about the Cryolipolysis
machine and the company’s expectations on the rentability of the investment:

Table 9. Basic data on the cryolipolisis machine

The unitary variable costs came from the 7€ that costs the plates needed for each treatment, and the firm is
paying 0,06€ kw/h and the treatment lasts for 1 hour, and there are no other variable costs. So, the variable costs
for each treatment are 7,06€.Thanks to the previous information, the Break-Even Point (B-E) was computed:

Thus, the firm will need to treat 46* customers to recover the fixed initial investment of the cryolipolysis machine.
As the expected treatment sales of Illes 18 is 240 treatments, it is clearly seen that this investment will be easily
recovered.

To express the facility of recovery, the Margin of Safety (MS) should be computed. This will show in absolute, and
percentual, terms, how much sales would have to reduce in order to make the investment unprofitable.
Therefore:

So, the treatment sales would have to drop 81.19% for the firm not to recover the fixed costs. Clearly, the Margin
of Safety is really high, 194 treatments, hence, the conclusion is that it won’t be hard for Illes 18 to recover the
fixed costs.
This analysis was the break-even point in the case Illes 18 did independent treatments of the machine.
Nonetheless, the Cryolipolysis machine treatment is included as a pack offer with two other complementary
treatments, the Bodyter machine treatment and the pressotherapy treatment. The following table contains
information regarding the three treatments:

Table 10. Data needed to compute the Mixed break-even point

The Break-Even point and the Margin of Safety are going to be different now that the pack is taken into account.
Considering the different percentages on the contribution to the treatment, it is easy to calculate the Weighted
Average Contribution Margin:
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Therefore, according to the calculations made on the pack, the real break-even point for this investment will
be 84 treatments, and sales will have to reduce 65.08% to fall to break-even sales. So, even though the
breakeven point has increased, and the margin of safety decreased, compared to the previous calculation, the
conclusions are that the fixed costs of the investment won’t be hard to recover for Illes 18.

Now, let’s consider that Illes 18 expects a profit of, at least, 26,190.72 €. The sales needed to get to this profit
will be:

In this case, 619 treatments will be needed to obtain the targeted level of profits. Considering that the
company expects to do 240 treatments, it is unrealistic to believe that the company could get to this point.

3.5. OPERATING LEVERAGE ANALYSIS

As known, operating leverage measures to which degree the project can increase operating income by
increasing its revenue. This analysis is important to know at which degree the company will notice if the
investment fails or succeeds. Therefore, the operating leverage analysis can give information to determine if
the company can increase its operating income substantially, increasing its revenue:

Looking at the calculation above, every euro of operating profit is generated by 1.64 euros of Illes 18’s
contribution margin. Hence, through trivial operations and if the contribution margin of the firm is
considered, approximately 60% of its contribution margin will be operating profit after the taxes and the
other costs and expenses.

This percentage is pretty high, therefore the firm has a relatively high control of its profits through its sales.
Meaning that it can increase significantly its revenues by increasing sales, since right now the non-variable
non-product costs represent 40% of the company’s contribution margin. Hence, increasing sales, they can
reduce this percentage and increase revenues even more.

Now let’s take into account that the treatment is included and sold as a pack with two other treatments. The
Operating Leverage will change, and be:

When the pack is considered, the operating leverage decreases substantially, therefore, with the pack the firm
increases the degree at which sales contribute to operating profit. Now, the firm will be more efficient than
before, and the non-variable non-product costs will be relatively lower, as the profit now represents
approximately 87% of the contribution margin.
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4.MARKETING ANALYSIS

Besides numbers and calculations backing up the investment we still can’t conclude that the investment is
going to be successful. Even if we expect a certain amount of sales for these treatments, the uncertainty, the
lack of information about it, or the fear from new things could make our new acquisition, not only fail the
investment but also be abstained from other treatments.

To be completely sure about our cryolipolysis machine investment we need to consider:

-The acceptance of the new machine by our actual customers.
-The interest to catch potential customers because of the new machine.

To know how the market might react to this new machine and its functionality we made a survey to more than
20 people close to Illes 18.

The survey had 6 questions including some segmentation as gender or age gap. What we saw in the survey is
that 87% of the people surveyed did not know about cryolipolysis. However, after a little introduction about
the machine, 95,7% of them would use it. We also asked for the price and as we can see we will not need to
use any penetration price strategy nor any other as the public of the survey described the price as correct and
even more than 65% were willing to pay even more than the actual price established. Thanks to the survey we
know that our marketing campaign needs to address the uncertainty and ignorance of all the information
about the machine.

Then, to address actual customers we have two groups we are interested in: the ones who already know about
the machine and all its benefits, and the ones who don’t.
Told by Illes 18, we know that they have an informal way to communicate with customers about new
purchases or any piece of information they want to communicate. Even word-of-mouth is one of the most
effective ways to communicate to your closer audience, you still lose some interesting groups, people who you
have not interacted with, people who have not been in touch since a certain amount of time or people who
you might think are not interested in what you are offering. That is the reason why we propose to Illes 18 to
make a second marketing campaign to also introduce to other groups not targeted currently from Illes 18.

Marketing launch campaign:

This marketing campaign has as objective the following: reach a bigger audience from what Illes 18 could do
with their traditional communication tools and inform about the new acquisition and its benefits for audiences
who are not familiar with it. Not to boost sales or increase our numbers but to reach a bigger audience, we
want to get leads.

We will assess the effectiveness of the campaign by the results of the sales. Knowing that we expect
approximately 240 treatments in a year we will take that number to judge the results. The launch marketing
campaign will have a duration of 3 months since the machine actually starts to operate.

Segmentation:

For this campaign we have selected a special segmentation group we want to address to develop and make
the respective marketing actions.

Demographic: We will not make any discrimination on gender, and we will target adult people

Geographic: Living or doing activities near to Vila-seca..

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Psychographic preferences: We have two groups: People with health eating related problems, eating disorders,
or obesity problems. And people with insecurities about their bodies or people concerned in improving their
health. People wanting to get fit or in a better shape.

Behavioral preferences: People who are loyal consumers and like to be very well attended and well treated.
People who like proximity and a good consumer experience.

Actions:

Showroom: We suggest to Illes 18 to invite actual and old clients to a free-visit to get to know and have the
possibility to know all the information and benefits from this new treatment and machine. If they eventually
don’t do the treatment, the visit will not be charged.

Visual Merchant: Flyers, posters, and show-cards all over the Illes 18 center. We suggest also that benefiting
from this new acquisition, Illes 18 could do some posters out-the-center. Taking advantage of this innovative
and new machine to catch new customers.

Social Network campaign: Regarding the out-of-center strategies we suggest Illes 18 to boost the new machine
from their social networks via Instagram posts and introducing to actual clients (the ones who currently follow
Illes 18 on social networks, have the option to know and understand the machine).

Facebook Ads: As well as a good network campaign, we can also use Facebook Ads to promote not only the
machine but the center itself taking advantage (as told before) from the new machine.

Cost budget estimation:

*The budget of Illes 18 for promoting and marketing strategies will depend on their actual revenues from the
machine. Knowing that we expect 240 sales to a unitary price of 98€ and the Break-even point is at 46 treatments,
we suggest a variable cost of 10% of the Margin of Safety made by the machine. That would be 19,4 treatments
(20 treatments) which means that our cost budget estimation for the marketing campaigns cannot surpass
approximately 1.901,20€.

In order to get rounded numbers we will take into account 2.000,00€ in case we have any improvisation or
unexpected event. In this price we are including all the material costs, the printing of the: flyers, posters, and
show-cards; Facebook ads, designing of all the materials (posts of social networks, flyers, show-cards, and
posters), distribution of the out-center posters, and the visit-free discounts.

Table 11. Survey results about knowledge of the machine Table 12. Survey results about people's willingness to
pay

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5. CONCLUSIONS

According to the analysis done, the machine should be very profitable. The fact that the different services
and products have a strong relationship between them, increases the profitability of the machine. Even if
the cryolipolysis might be profitable by itself in just one year, the fact that the purchase will increment the
sales in other parts of Illes 18 make its profitability even higher.

Moreover, it can be seen that the breakeven point should be covered in less than a year according to the
forecasts made, with a high margin of safety. For this reason the risk of the new machine is not too high
and despite this, remains very profitable. Just what an investor wants in their investments!

About the financing method, the results of the NPV show that it is more profitable to finance it with debt.
However, as we said before in the report, as the difference between the two results is not very high and
taking into account the patterns of financing of the firm (full-equity firm), it is better to buy it with equity (as
the firm has the resources). In addition, to make this recommendation, the risk of the project increasing
with the indebtedness is also taken into account, and as the analysis was done with forecasted results,
those could change and therefore, the NPV of the project may change with the possibility of even having
lower NPV if Illes 18 decides to finance it with debt.

Finally, even though it has been proved the profitability of the acquisition from a financial and cost
perspective, it could be interesting that the firm launched the marketing campaign mentioned to increase
not only the sales of the service the machine offers but also giving tools to Illes 18 to reach the expected
values. Knowing this huge margin of safety the firm has, a 10% expenditure to try to ensure the investment
is worth the try.

6.REFERENCES

https://bseaesthetics.co.za/product/bsefreeze-cryolipolysis-machine

We have used the tools explained in class about Marketing and Finance

We got all the data from the company through the owner Rosa Besa