CAPE GEORGE FISH 'N CHIPS - CASH BUDGETING

On August 25, 1989, Douglas MacPherson, the new franchisee of Cape George Fish 'n Chips in Antigonish, Nova Scotia, was preparing a monthly cash budget to determine his operating line of credit requirements and to plan his debt servicing for his first year of business.

FRANCHISE BACKGROUND

MacPherson, the merchandising manager for the Antigonish branch of one of Canada's largest drug store chains, had just purchased the Cape George Fish 'N Chips - Antigonish Mall branch of a fish and chip restaurant chain established and managed by the Robinson family of Sydney, Nova Scotia. The Antigonish branch was established in April 1988 and had a profitable first year with sales of $190,118 and net earnings of $28,734 (see Exhibit 1). However, with the Robinsons' decision to pursue growth through franchising, the Antigonish Cape George Fish 'n Chips restaurant had been severed from the chain, and was to begin separate operations on September 1, 1989 with MacPherson as the franchisee.

When MacPherson purchased the branch he had noted that sales volumes were currently down 15% from first year levels. This drop in sales had been attributed to both a decline in the Robinsons' onsite direction and promotion of the branch, and to the opening of another restaurant in the mall. Nevertheless, MacPherson felt he could reverse this decline in sales and had projected a first year income statement for the franchise, (see Exhibit 2). He used the branch's first year's income statement as his starting point.


This case was prepared by Professor Donald G Ross of St. Francis Xavier University for the Atlantic Entrepreneurial Institute as a basis for classroom discussion, and is not meant to illustrate either effective or ineffective management.  Some of the case information was collected by Lisa Mullins (MBA '89).  Some elements of this case have been disguised.

Copyright 1990, the Atlantic Entrepreneurial Institute, an Atlantic Canada Opportunities Agency funded organization.  Repreduction of this case is allowed without permission for educational purposes, but all such reproductions must acknowledge the copyright.   This permission does not include publication.


REVENUE PROJECTIONS

In projecting the franchise's first year revenues, MacPherson felt that a more "hands-on" management and favourable events happening in the Antigonish mall would restore revenues to their first year level, then improve them by a good margin each subsequent year.

A number of factors seemed to support MacPherson's optimistic assumptions. First, the local Canadian Tire Store was to relocate to the mall on September 6, 1989 thereby becoming the mall's second anchor store. MacPherson expected that the Canadian Tire's presence would immediately restore the 15% drop in sales.1 Second, MacPherson felt that more active management, keeping a control on quality and customer satisfaction levels and engaging in more on-site promotion of the franchise, would also increase sales by at least 5%. Finally, MacPherson planned to immediately increase prices by 5% - the current rate of inflation. (MacPherson felt that any acceleration in the rate of inflation could be matched by a corresponding increase in prices.)

EXPENSE PROJECTIONS

In projecting expenses, MacPherson felt that the cost of goods sold percentage would be reduced from 47% to 45% of sales by increasing managerial scrutiny of inventory shrinkage. However, a 5% of sales franchise royalty fee would now have to be paid each year within 30 days of the year-end. MacPherson also felt that with the exception of the items set out below, the expenses shown in the branch's 1989 financial statement would simply rise by the rate of inflation. (Assume these expenses were incurred equally over the year.)

1 MacPherson was basing his expectation of an immediate rebounding of sales on the mall manager's claim that Canadian Tire's relocation would lead to a 30% increase in mall traffic.

The first expense which was expected to be much higher was the franchise's accounting expense. MacPherson estimated that this expense would initially jump to $1,500 per annum because of the yearly audit required by the franchise agreement; it would then rise with the rate of inflation. The accounting expense would be incurred at the end of the franchise's fiscal year-end.

The second expense projected to be substantially higher was interest and bank charges, as MacPherson would have to pay monthly interest on the money he had borrowed to buy the franchise (see Debt Servicing Requirements below), and would also have to pay bank service charges of $50 per month for his operating account. Interest charges were expected to decrease with the payback of the loan, and bank service charges were expected to rise with the inflation rate.

Third, the depreciation expense (calculated as the highest permissible capital cost allowance (CCA) charge), was expected to be higher because the franchise's assets carried a combined value in excess of the figure presented on the 1989 branch financial statement. Although the franchise's assets were in several different CCA classes, MacPherson estimated that the average CCA rate would be about 15%; this would result in a $9,500 first year depreciation expense for the franchise ($126,250 x 15% x 1/2 = $9,500).

Finally, because MacPherson planned to form a separate corporation, MacPherson Services Limited, to run the Antigonish Cape George Fish 'n Chips restaurant, it would have to pay income taxes at the rate of 12%.2 This expense would be incurred at the new company's fiscal year-end.

DEBT SERVICING REQUIREMENTS

MacPherson had acquired the franchise from Cape George Fish 'N Chips Limited for a total purchase price of $126,250 - divided into two basic parts. First, MacPherson had agreed to pay $101,000 for the branch's equipment, leasehold improvements, and goodwill. To finance this part of the acquisition, MacPherson secured $101,000 bank financing - $76,000 directly to the company through a loan against the franchise's assets and $25,000 indirectly through an increase in his personal home mortgage which was lent to the company as a shareholder advance. The bank financing carried, on average, a floating interest rate of prime (currently 11.5%) plus one and one-half percent.3 According to his agreement with the bank, MacPherson would pay interest on the loans at the end of each month in addition to a $500 monthly principal payment in the first year. It was MacPherson's intention to accelerate the loan repayments by making additional payments on loan principal if cash flow permitted.

Second, MacPherson had agreed to pay Cape George Fish 'N Chips Limited an initial franchise fee of $25,250 for the right to operate the branch as a Cape George Fish 'n Chips restaurant. (This initial franchise fee was in addition to the 5% royalty set out above.) It was agreed that the $25,250 owing for the initial franchise fee would be paid over five years using 30% of the franchise's yearly earnings in excess of $10,000 to retire the debt. Yearly payments on the initial franchise fee debt, if any, were due within 30 days of the franchise's fiscal year end.

REQUIRED:

2 MacPherson Services Limited is a Canadian-controlled private corporation eligible for the small business deduction and the two year Nova Scotia provincial tax holiday for small businesses.

3 To calculate the monthly interest payment, multiply the outstanding loan balance by the annual interest rate divided by twelve.

Prepare a monthly cash budget for Cape George Fish 'N Chips for the year beginning September 1, 1989. Advise MacPherson of his operating line of credit requirements, and the timing of additional loan payments, if any, for his first year of business. Since a superior answer will include a sensitivity analysis on the principal assumptions used to construct the cash budget, state clearly any assumptions used in your cash budget and discuss the importance of those assumptions on the prediction of the franchise's cash needs.

OTHER INFORMATION:

1. Sales for the franchise are seasonal as indicated by the following sales figures for the period of August 1988 to July 1989:

August 1988 18,401 February 1989 10,100
September 1988 14,159 March 1989 12,928
October 1988 11,535 April 1989 11,683
November 1988 13,913 May 1989 12,055
December 1988 20,580 June 1989 14,200
January 1989 10,100 July 1989 15,706

 

2. To handle unexpected purchases and minor acquisitions, MacLean wanted to have about $5,000 available at all times -preferably in cash but alternatively, in standby lines of credit, or a combination of cash and standby lines of credit. The franchise started with a zero cash balance.

3. MacPherson was preparing a monthly cash budget from 1 September, 1989 to 31 August 1990. However, to assist in cash flow planning, include the yearly royalty payment and the initial franchise fee payment in the August, 1990 cash flows.

4. Sales tax of 10% was applicable to about 25% of the restaurant's sales and was remitted to the Province of Nova Scotia on the 20th day of the month following the month of collection.


Exhibit 1

Cape George Fish 'N Chips - Antigonish Mall Branch
Income Statement
Year Ended March 31, 1989
(unaudited)

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Exhibit 2

MacPherson Services Limited
Cape George Fish 'N Chips - Antigonish Mall Franchise
Projected Income Statement
For Year Ended August 31, 1990

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