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.
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.)
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
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.
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 yearend.
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
September 1988 14,159
October 1988 11,535
November 1988 13,913
December 1988 20,580
January 1989 10,100
February 1989 10,100
March 1989
12,928
April 1989
11,683
May 1989
12,055
June 1989
14,200
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)
Source: Company files and bank records.
Exhibit 2
MacPherson Services Limited
Cape George Fish ‘n Chips – Antigonish Mall Franchise
Projected Income Statement
Year Ended August 31, 1990
Source: Company files.