Johnston Processors Limited

Charlie Johnston, President of Johnston Processors Limited, operators of three One Hour Drycleaning franchises, sat in his office in downtown St. John's and considered the information in front of him. It was March 28, 1991, and Charlie's accountant, Harry Wood, had just presented him with a draft copy of his financial statements for the year ended January 31, 1991. "This indicates that we've experienced another decrease in sales and profits," Charlie commented. "Obviously, our bankers will not like this situation at all. This would have a severe negative effect on my other companies. As you know, my wife, Marie, and my daughter, Christina, operate this company. We'll have to analyze this company's situation further to see where our problems are and what can be done to solve them." Harry, of Wood and Smythe, Chartered Accountants, nodded in agreement. "Unfortunately, we won't be able to do the analysis for you. As a small, independent firm, our personnel resources are stretched to the limit at this time of year. Why not ask someone from the University's Small Business Centre to conduct this study?"

Background Information

Charlie Johnston was the operator of several small companies in the Avalon Peninsula region of the Province of Newfoundland and Labrador. Over the years Charlie had been moderately successful, and had, in fact, accumulated considerable personal wealth. Charlie's wife, Marie, was a nominal shareholder in most of Charlie's companies, but


This case was adapted from a case prepared by Professor Wayne King for the Atlantic Entrepreneurial Institute as a basis for classroom discussion, and is not meant to illustrate either effective or ineffective management. Material in this case has been disguised.

Copyright 1993, the Atlantic Entrepreneurial Institute. Reproduction of this case is allowed without permission for educational purposes, but all such reproduction must acknowledge the copyright. This permission does not include publication.


with the exception of the drycleaning franchises, did not play an active role in management. 'When the kids were younger, I felt more comfortable working at home, raising our family," Marie recalled. "However, when Christina, our youngest daughter, finished high school, I found I had sufficient time to make a contribution to the businesses. Originally, I wanted to become involved in some of the existing companies, but they already had management people in place and were operating smoothly. As well, Christina was having difficulty in finding employment. Charlie and I decided that we would look for a new opportunity for Christina and me to start UP."

The Johnstons determined that a franchise arrangement would be the most suitable for Marie and Christina. They felt that franchises had several advantages, including recognition by customers, national advertising, assistance with store design and location, and advice in other areas if necessary. The disadvantages were the high initial franchise fee and the relatively expensive royalty and advertising payments required by the franchise agreement. In 1982 the family spent several months reviewing the 'Business Opportunities' sections of several business magazines and newspapers. They decided to proceed with the acquisition of a 'One Hour Drycleaning' franchise, a self-contained drycleaning store designed to operate from a shopping mall. "We felt that the concept was logical," Marie commented. "A customer could drop off cleaning, shop for a while, and then pick up the cleaned clothes on the way out." In addition, Charlie thought it was favourable that the franchisor indicated that a gross profit percentage (gross margin/sales) of 65% should be earned on sales. Later in 1982, the Johnstons opened their first store in St. John's largest shopping center. The stores were relatively expensive to establish; the initial franchise fee was $40,000 per location, equipment cost approximately $165,000 and leasehold improvements of $75,000 were required.

Over the next four years the company prospered. Two years after the first store was opened, a second store was set up at the other large mall in St. John's. A third store was started about a year after that, also in St. John's. Shortly after the opening of this third store, the company's performance began to deteriorate. Several reasons for this were advanced by Marie Johnston. "First, we can't seem to hire people who care about working any more. Consequently, our turnover is high. just as we get our employees trained to operate the machines, they leave to work at one of our competitors. Also, we have been having trouble with the machines. The manufacturer has no local repair or parts service, so even minor problems can create delays in satisfying customers' orders. We also have more competition. Presently, there are more cleaners in town than ever before. In fact, the operator of the mall where our first and biggest store is located has just allowed one of our competitors, which had a drop-off location there, to install a service somewhat similar to ours. We complained, but there doesn't seem to be much we can do about it."

About a year ago, the Johnstons had been approached by two separate groups who expressed an interest in acquiring one or more of the stores. The first inquiry was from a group of local investors who bought and sold small companies as investments. The second was from an individual who had spent more than 20 years managing a cleaning store for an owner who did not spend much time with the business. This individual had decided to investigate the possibility of acquiring his own store. At the time of the inquiries the Johnstons were not interested in selling, however, Charlie, in particular, was beginning to wonder if this option might still be open. "Interest rates have been falling for some time now. This will help make it easier for prospective buyers to meet their financial commitments. As well, the overall market for drycleaning services is increasing annually through inflation."

Organization

Although Charlie Johnston was listed on the company's records as President, he actually had little contact with it, except to review the monthly sales reports, and to negotiate lines of credit with the company's banker. Marie, as Vice-President, was in charge of the day-to-day operations, assisted by Christina, who worked full time at the stores. The accounting was done by a bookkeeper, Valarie Anthony, who worked at Charlie's office and maintained accounting records for several of his companies.

Marie Johnston originally saw her role in the organization as being in the policy area. However, this had changed recently. "We've had some very difficult decisions to make here in the past two to three years," she said. "Unfortunately, because of the decline in sales, we've had to insist that employees pay for their own uniforms. We've also been unable to adjust wages, except to keep pace with minimum wage movements. We laid off our store managers about a year ago, again for cost-cutting reasons. Since then, Christina and I have spent most of our time going from store to store to ensure things are running smoothly."

The Problem

After the meeting with his accountant, Charlie called a meeting with Marie and Christina and discussed the options available to them. Marie and Christina were positive about the stores and their ability to effect a turnaround. "We are the ones who know the business first hand," said Marie. "I feel that if we spent some money upgrading the stores' appearance, which we have had to allow to deteriorate somewhat, and in overhauling the equipment, we will attract our customers back. We should also increase our advertising." "I'm not so sure," replied Charlie. "We've already invested a substantial amount of our own funds in these stores. Maybe we'd be throwing good money after bad. Besides, our national advertising expenses are already pretty high. I really have no idea whether there is enough business out there for us to be successful. Perhaps I should check to see if the potential buyers from last year are still interested."

The Alternatives

After further discussion, the Johnstons summarized their options as follows:

  • Invest an additional $40,000 of personal funds in the stores to upgrade the appearance and equipment;
  • Increase bank borrowing by $40,000 for the same reason;
  • Sell one or more of the stores;
  • Close one or more of the stores.

At the Johnston's request, Valarie and Harry prepared a statement of cash flow for each store for the most recent financial year. In addition, cash flow statements for the past three years were collected. Also, Marie prepared what she felt were reasonable operating forecasts to support her contention that an additional investment was justifiable. (Exhibits 1 to 3). Charlie was anxious to have the data analyzed and looked forward to the report from the Small Business Centre.

Questions

  1. Evaluate whether the Johnstons are adequately "managing" the company by answering the following questions:

  1. Is there evidence of regular planning and budgeting on the part of management?
  2. Calculate the company's gross profit percentage of each store for 1991 and of the company as a whole for 1988 - 1991. Do you feel they are reasonable? If you were the manager, would you be satisfied with these figures? Do you feel the company is controlling its gross profit percentage?
  3. Is Marie's idea of spending more on advertising a good one? Should she try something else before increasing expenditures on advertising?
  4. From the information provided, how would you assess relations between management and employees?
  1. Using the 1991 actual figures as a base, analyze Marie's operating forecasts. What kinds of increases or decreases can you see? Are they reasonable?
  2. Based on the information given about the company and your assessment of its owners, rank the options open to the company. Provide reasons for your rankings.

Exhibit 1

Johnston Processors Limited
Statement of Net Cash Flow
For the Year Ended January 31, 1991

Store I Store 2 Store 3 Total

$

$

$

$

Sales

396,405

296,894

207,989

901,288

Cost of Sales

178,977

125,009

81,977

385,963

Gross Margin

217,428

171,885

126,012

515,325

Bank Loan Proceeds

22,000

16,000

12,000

50,000

Expenses
Wages and benefits

79,768

59,744

41,854

181,366

Interest charges

14,627

10,945

7,670

33,242

Travel

4,679

3,500

2,454

10,633

Royalties

38,993

29,177

20,451

88,621

Rent

55,316

38,488

26,841

120,645

Advertising

9,295

6,956

4,875

21,126

Loan repayments

31,336

31,336

31,335

94,007

Other operating costs

20,984

15,701

11,005

47,690

254,998

195,847

146,485

597,330

(15,570)

(7,962)

(8,473)

(32,005)

 

Exhibit 2

Johnston Processors Limited
Forecast Cash Flow Statements
For the Years Ended January 31

1992 1993

$

$

Sales

982,200

1,064,860

Cost of Sales

376,476

408,160

Gross Margin

605,724

656,700

Bank Loan Proceeds

40,000

-

Expenses
Wages and benefits

155,720

168,810

Interest charges

14,600

14,600

Royalties

78,576

85,188

Rent

120,645

120,645

Advertising

34,400

37,300

Loan repayments

19,400

17,700

Other operating costs

47,700

47,700

Repairs & maintenance

40,000

5,000

511,041

496,943

Net Cash Flow

134,683

159,757

 

Exhibit 3

Johnston Processors Limited
Statement of Cash Flows
For the Years Ended January 31

1991 1990 1989 1988

$

$

$

$

Sales

901,288

1,034,713

1,122,879

1,027,559

Cost of Sales

385,963

401,899

437,255

397,047

Gross Margins

515,325

632,814

685,624

630,512

Bank Loan Proceeds

50,000

-

-

-

Expenses
Wages and benefits

181,366

181,459

218,033

182,223

Interest charges

33,242

24,777

12,448

13,750

Travel

10,633

15,095

20,410

17,601

Royalties

88,621

99,288

106,297

97,483

Rent

120,645

117,624

114,487

95,176

Advertising

21,126

47,568

30,430

38,078

Loan repayments

94,007

106,969

103,739

75,441

Other operating costs

47,690

53,976

46,524

46,944

597,330

646,756

652,368

566,696

Net cash flow for the year

( 32,005)

(13,942)

(33,256)

(63,816)