Case Analysis
Case Analysis
Case Analysis
• The concept can be easily copied. For example KFC introduced “rotisserie gold” and
became world’s largest Rotisserie gold chain.
• Controls given to large regional developer which to some extent leads to loss of
control over internal working and efficiency. There is acute inherent risk of losing
control of the business operations as a result of its focus on rapid growth.
• The much vaunted focus on growth could lead to reduced quality of operations,
increased food wastage, and lower profitability of franchise operations.
• The growth strategy also puts a heavy strain on cash management, since funds are
required for growth.
• Revenues are recognized for franchise fees and development fees when the store
opens.
• Revenues from royalties are recognized when the store generates sales
• Pre-opening costs are amortized over one year.
• Financing costs on notes receivable to franchisees are shown as earned. However, the
company makes no allowance for defaults on these notes.
• The amount of Notes receivable totaled more than $200m at the end of 1984, with a
further 131m of notes already committed
• The notes are structured to give the parent the option to convert the loan into equity in
the franchisee at a 12-15% premium over the equity price at formation of the
franchise
• We can estimate the income statement effect of changing the assumption for
franchisee defaults.
1% 3% 5%
allowance allowance allowance
• The company shares both the upside and downside risk for financed franchise
restaurants according to agreement of franchise.
The accounting policies followed by Boston chicken do not reflect the risks. For
calculating risk, it would be more appropriate to calculate the profitability figures of the
company. Whether franchisees are profitable or not is a key factor for accessing the value
of the notes receivable.
($ in thousands)
Company operated store revenue $40,916
Average number of owned stores 39.5[(38+41/2)
Revenue per average store $1,036
Gross margins (100%-15,876/40,916) 61.2%
Less royalty and promotion fees 10.8 %( 5%+2%+3.75%)
Residual 50.4%
From this residual margin franchisees have to deduct wages and salaries,
administrative costs, depreciation, interest, and taxes.
The average system sales per week for the third quarter of 1995 were 23,388 and
EBITDA margins were 15%-16 %.( $ in thousands)
• The analyses indicate that the franchisees are profitable at this level of sales ($1,216).
• Some franchisees appear to be having cash flow problem. Boston Chicken had been
forced to make advances to franchisees to fund local and national advertising.
The company effectively has control over the financed area developers through its
option to purchase. At this stage we recommend that Boston chicken should opt for
the consolidation of the Financial Statements which would entail the following
benefits:
(1) The royalty, franchise fee and interest income would be eliminated.
(2) The company would show its share of the sales revenue and cost from the stores.
(3) The notes receivable would be eliminated and the company would report its share
of the assets and liabilities of the franchisees
The analyses done above are based on limited information and average data is
incomplete, since it only takes one franchisee to fail, and Boston Chicken will incur a
large loss in Notes receivable. Hence the pertinence of gathering more comprehensive
information from the management. Some additional information required would be
Same store sales
Distribution of same store sales
Late payments by franchisees.
Security provided by developers such as any other assets outside the franchise
corporation.
Looking at the financial ratios, we can predict the financial health of the company
Efficiency
ratio 1993 1994
Average
collection Acc receivables *days/year/
period net sales 17.81660005 24.82657487
Turnover of
cash ratio Net sales/Working capital 0.232 0.505
Efficiency ratios are used to predict how effectively company is utilizing its
resources. They are typically used to analyze how well a company uses its assets and
liabilities internally.
Average collection period is increasing that is now company is taking more time to
collect its credit sales which will ultimately increase short term borrowings but at the
same time higher turnover of cash means company is able to generate more cash over
a period. So net effect will be minimum.
Liquidity ratios are a measure of how company manage to fulfil its short term
funding. Higher ratio indicates that company can easily manage its short term
liability. Over the year we can see ratios are increasing which is a good sign for a
company who is in expansion mode because such companies frequently needs cash.
Profitability
ratio 1993 1994
Gross profit (Sales-COGS)/Sales 0.734 0.834
net profit margin net profit/sales 0.015 0.168
Net income/shareholder's
ROE equity 0.007 0.062
ROA Net income/ Assets 0.006 0.038
Profitability ratios are used to assess a business' ability to generate earnings as
compared to expenses over a specified time period. Return on assets indicates revenue
they are generating by utilizing each unit of asset. Higher ratio of ROA and ROE over
the year means they are receiving more over the years with same amount of
investment. Also increase in Gross profit and net profit means they are generating
more with less cost involved.
Boston chicken is able to maintain high profitability, liquidity and efficiency ratio
which reflect company have a potential to sustain over the period. Also since they are
expanding, so they need funds which can be easily arranged but also we can see that
over the year Revenue/ Store is also increasing. Therefore it can be concluded that
market is still unsaturated and there is lot more to explore.
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