Boston Chicken Case Study essay

Dual-income families are searching for an affordable alternative to preparing meals at home.

Boston Chicken satisfies this need by preparing food that customers view as high quality, healthy and convenient. This home meal replacement is a hit with value-customers” (Pale, 2013). Roger Lipton on the other hand has a different point of view. Lipton feels that “the quality of earnings is very low, since all of Boston Chicken’s income comes from fees, royalties, and interest payments from franchisees, most of whom were financed by the franchiser” (Pale, 2013).Looking at the company’s income statement, Boston Chicken shows tremendous financial results, but once a more detailed look into the financial tenements is taken, specifically with respect to the financing activities, the circumstances change. To provide financing for its rapid growth, Boston Chicken went public in November of 1993. Boston Chicken raises money by issuing stock and issuing of debentures, which they then lend to its franchisees.This creates a problem because there is a high risk that the franchisees will not return the money owed on the loan and the interest on the loan is high.

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The reason for the high risk is that the franchisees will not be able to return the money on the loan is because many of the franchises they ere loaning money to were not profitable. According to Lipton, actual average weekly sales Were only $18,900 per Store, implying that franchisees were losing money (Pale, 2013). Another issue that arises is the way in which Boston Chicken depreciates property and equipment.The way that the company is presenting the value of the property and equipment on the balance sheet is correct, but is incorrect on the useful lives used for buildings and improvements. The useful lives for which the company depreciates its property and equipment for buildings and improvements is 15-30 years (Pale, 2013). This is drastically accelerated compared to the normal standard for depreciating a building or improvement. The normal standard for depreciating buildings and improvements is 39 years using the straight line method.By accounting for depreciation this way the company is increasing the amount of depreciation expense recorded per year.

This accelerates the amount of depreciation expense recorded each year and reduces the amount of years a depreciation expense will be recorded for each building and improvement. With the increase in depreciation expense each year this will create an understatement of net income since more appreciation expense is being recorded earlier than it should be. There could also be a potential problem for Boston Chicken with respect to corporate financial developer loans.There is no amount for allowance for loan losses in either 1 993 or 1994 in the table provided in the book that summarizes credit commitments for area developer financing (Pale, 2013).

According to Boston Chicken, the allowance for credit loss is maintained at a level that in management’s judgment is adequate to provide for estimated possible loan losses. The amount of the allowance is based on management’s review of ACH area developer’s financial condition, store performance, store opening schedules, and other factors, as well as prevailing economic conditions (Pale, 2013).Boston Chicken believes that they will receive 100% of the note receivable back from the franchisees. This belief is harmful to the business since there is no such guarantee on these types of activities. This allowance for loan losses account should have some amount recorded to hedge against not receiving the full amount of the note receivable from the corporate financed developer loan. The typical franchisee was an independent businessman with 15-20 years of relevant management experience, strong financial resources, and a mandate to open 50 to 100 new stores in the region (Pale, 2013).The issue with this was that the only requirement to open up a franchise was the mandate to open 50 to 100 new stores in the region.

There were no other requirements that needed to be met before a franchisee opened a store. The issue with this is that the company should not just want to open a store for the sake of opening a store. There needs to be research involved in showing why it makes sense to open up a store not only in a particular region, but in a specific location in that egging. Research should be done to investigate potential profitability, previous market saturation, and location factors.Not too many companies have a location built without having a good idea of whether Or not that location will be profitable to the company. When looking further into the income statement it reveals an issue with revenue.

It appears after looking at the breakout of revenue, franchise fees account for a large portion of revenue. The issue with this is that this revenue generation will continue to grow in the short term, but probably not in the long term. Revenue derived room initial franchise fees and area development fess is recognized when the franchise store opens (Pale, 2013).

This is a onetime fee that franchisees have to pay when they open a store in their particular region. In the short term this is great because by the end of 1994, the Boston Chicken system operated 534 stores, compared to only 34 stores at the end of 1991 (Pale, 2013). This continued rapid growth will be very difficult to withstand and if the company is not continuing to open new stores at a decent pace, then the company will not be able to continue to record high revenue on their financial tenements.Boston Chicken business strategy was to be the leader in the traditional home cooking with a high level of convenience and value that was available for take-out or on site consumption (Pale, 2013). Its critical success factor is locating and growing in large metropolitan areas. Boston Chicken focused on franchising to large regional developers (Pale, 2013). The company used this strategy to use the developers’ financing, management, and local information to grow further in a region, of which had been targeted by Boston Chicken as one of the 60 largest U.

S. Trampoline markets (Pale, 2013). An additional success factor was focusing on traditional home cooking and being in constant communication with its customers to develop new items.

This was taken care Of through investment in technology. The company invested $8-10 million to build computer software that provided support for its network of stores, and linked headquarters to developer stores (Pale, 2013). The software made appropriate adjustments for the day of the week, the season, and customer preferences at a particular store in making recommendations (Pale, 2013).This may seem like nothing special, but Boston Chicken experiences seasonality with respect to revenue being generated. The company experience lower average store revenue in the months of November, December, January, and February as a result of the holiday season and inclement weather. Using this software enables Boston Chicken to more effectively know when to reorder food supplies and when food was running low up front to be restocked with another rack of chicken or other side dishes.Another few success factors were the company implementation of long-term agreements with key supplies, the introduction of flagship stores, expanded menus, in-store computer feedback from customers, and drive wrought lanes (Pale, 2013).

These success factors help the company improve their operating efficiency and reduce the costs of running and operations of the store. For example, flagship stores included a retail store and a kitchen facility. These Stores would perform the initial stages of food preparation and send the prepared food to the satellite stores, which would complete the cooking process and serve the products (Pale, 2013).This theory increased the value and freshness of the side items, since a flagship had more regular delivery of fresh ingredients. It also led to better insistence in food taste, aided in increased innovation in menu items, and utilized facilities more effectively (Pale, 2013). A risk factor associated with this business strategy is that it can be easily duplicated. There is still a lot of capacity in this market for competitors to get in on a piece of the action.

Competition in the $200 billion restaurant industry was brutal, and several other companies quickly benefited from the company’s success.For example, KEF introduced “rotisserie-gold” roasted chicken and within four months KEF reported that sales of the new chicken had topped $160 million (Pale, 013). The threat of substitute food options is an ever present risk. The company’s business strategy of a home cooked meal is a good idea, but Boston Chicken is not the only option the consumer has. Another risk factor is the revenue that is being generated from each individual store. The firm’s revenue comes from initial franchise fees, royalties, and interest income from area developer financing (Pale, 2013).This is a risk because a lot of this revenue is a onetime fee and will only be generated when a new store is opened or when the store creates sales.

Also, according to Roger Lipton of Lipton Financial Services, in order to break even for a particular store, a franchised store had to average $23,000 a week to cover labor, cost of sales, and other expenses (Pale, 2013). In actuality it appears that Boston Chicken’s actual weekly sales are less than what Roger Lipton says each individual store needs to make in order to break even.As discussed earlier another risk associated with this business strategy has to do with Boston Chicken providing credit to franchise developers. If a particular store has decrease in business and does not continue to be profitable then the franchisee may default on the loan they received. The company is reporting an aggressive growth and not taking into account considerable risks. According to Roger Lipton actual average weekly sales were only $1 8,900 per store, which shows that franchisees were losing money on their undivided al stores (Pale, 2013).Management responded to concerns about the economics of franchisees by reporting that average weekly store sales were $23,388 for the third quarter of 1 995, versus $22,227 for the second quarter, and that EBITDA store margins were running at about 15% -16% (Pale, 2013).

The financial statements of the company are not taking into account he decline in demand of Boston Chicken products. Due to the quick growth in profits from 1992 -1994 the company noted that comparability of operating results from year to year, determining liquidity positions, and capital resources was difficult (Pale, 2013).This swift growth led to a rapid increase in profits, but it risked the regularity in operations the company wanted. The key assumptions behind this policy are that if the reporting of sales decreases the company may have Its appointment of new franchisees slow down. This would be the case if a franchisee sees that other Boston Chicken stores in heir region are not making money, why would they invest their money into something that is not going to make a profit for them. With respect to sale decrease as well, the company may have current franchisees wanting out of the company.An imperative assumption is that if stores are losing money or are recording lower earnings or revenue, the stock prices of Boston Chicken would decline.

The company expected that there would be continued growth in the franchise stores and would drive profits without any detailed calculations showing the profitability or loss of each store. The accounting leslies do not reflect the risks of Boston Chicken. It would make more sense to calculate the profitability figures of the company. Currently it is just showing the amount of revenue that is being generated from initial franchise fees, royalty fees, and revenue from area developer financing.There needs to be more detail as to the profitability of each of the stores. This is important because whether franchisees are profitable or not is a key factor for accessing the value of the notes receivable.

To a small extent, the accounting policies do reflect risk. When taking a look at the cash flow statement, the cash from operating activities is $35,1 78 in 1 994 whereas cash used from financing activities is $270,584 (Pale, 2013). This implies that Boston Chicken financed its activities mainly from issuance of stock and issuance of convertible subordinate notes.The accounting policies that were used by Boston Chicken were used to give the appearance of growth, while neglecting the actual impact that this strategy would have on the future.

There are several adjustments Boston Chicken should make to the firm’s accounting policies. One key adjustment is there should be a recognized amount for allowance for loans losses for the $201 million in loans outstanding (Pale, 2013). There is no way the company can expect to receive 100% back for area developer financing. This is the case especially since it appears that the individual stores are losing money.

If the individual stores are not making a profit the franchisees are not going to be able to pay back the money that was lent to them by Boston Chicken. Also, another adjustment that would be beneficial is to show data on store operations. This would give a clearer picture on how store profits are being calculated and if they are being lactated correctly. This WOUld also help in calculating an amount for the allowance for loans losses that needs to be recorded each year.

Another accounting policy change is how the company is recognizing revenue.Revenue derived from initial franchise fees and area development fees is recognized when the franchise store opens (Pale, 2013). The correct way of recognizing the revenue for franchise related fees and royalties is not when the store opens, but when the fees and royalties are actually received in cash.

With the current accounting policy in place the company is recording revenue earlier than actually received and is overstating revenue in the current period. Looking at the financial statements provided by Boston Chicken leaves a few questions that need to be answered by management.A question that would need to be addressed with management would be about the company’s performance and the quality of the company’s earnings. Having most of the revenue coming from initial franchise fees, royalties, and interest payments from loans to area developers is not high-quality performance. This is the case especially when it appears that many of the individual stores are not profitable. Due to the competitive nature of the market Boston Chicken is in, another question posed to management would be what is the company doing to keep value seeking customers and trying to attract new customers.

It is important for the growth of the company that they not only retain the customers they already have, but that the company continually attracts new customers to their stores. In order for the company to achieve this they have to continually create added value for their customers. It appears looking through the financial information Boston Chicken has presented, that further supplementary information needs to be addressed. Further detail would be asked to be provided by management to get a better understanding of how the company is performing.Information that would be requested pertains to same store sales, distribution of same store sales, late payments by franchisees and security provided by developers such as any other assets outside the franchise corporation.

This information would give a clearer picture of how the company is operating. At first glance Boston Chicken appears to be performing well. When taking a look at the income statement the company has increased its net income from $1 ,647 in 1993 to $20,450 in 994. The net income per share common and equivalent share also increased from .

6 in 1993 to . 38 in 1994 (Pale, 2013). This is the story that Boston Chicken wants to portray to everyone when in actuality there is a different picture being portrayed when looking at the cash flow statement. F-room looking at the cash flow statement it shows that the company’s net cash from operations is $35,1 98 (Pale, 2013). When just looking at this section of the cash flow statement this appears to be a good number for the company, but when comparing it with the net cash used in investing activities a problem rises.

The cash used for issuance of notes receivable is $225,282 in 1994 (Pale, 2013). This portrays Boston Chicken as a finance company rather than a company who is profitable selling valued home cooked meals. Looking at these numbers there is overwhelming evidence that Boston Chicken is not performing well. More of its income should be coming from what home cooked food it is selling to its customers. The cash inflow from the basic operating activity is overshadowed by the financing activities of Boston Chicken. Specifically the cash used in investing activities for the issuance of totes receivable.The market is assuming that the franchisees of Boston Chicken are earning more revenue every week and this growth will continue.

Due to this growth in revenue it will lead to higher incomes and higher per share earnings. The assessment made by the market is incorrect. This is the case because revenues may be projected to be increasing year to year, but that has more to do with how many stores have been opened up in the last three years. This is a factor because most of the revenue generated from Boston Chicken is coming from initial franchise fees, royalties, and revenue room area developer financing.If further digging is done into the financial statements, it appears that many of the individual stores are not profitable. In the longer term there is little chance for success if these individual stores do not begin to start creating profits.

Boston Chicken cannot sustain this growth in the long term without profitability throughout the individual stores. Taking a quick look at the financial statements of Boston Chicken shows an excellent financial result. Upon further inspection of the financial statements this turns out not to be the case.Boston Chicken’s situation is weak and there appears to be little future potential for the company.

The company’s business strategy is based on defective foundations and insufficient planning. The only planning that was even thought about was in the short term with the long term focus being ignored. The company’s statement of cash flows paints a picture of a company growth that is based on financing activities. Due to the fact that the company continually believes that they will receive 100% back from their area developer financing will leave a large hole in future cash flows when the full bet is not repaid.

Without increased profitability within each store Boston Chicken will not be able to continue to grow at the rate they have been currently experienced. It is recommended that Boston Chicken implement a less stringent franchisee policy in order to help them attract financially strong franchisees to their company. It is imperative that Boston Chicken discontinue providing finance to franchisees and focus more on getting each individual store in a place where they are continually profitable year to year. They need to focus more on their revenue being generated from store profitability and sees dependent on initial franchise fees and royalties.

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