Boston Chicken - Case Study Example

7th August 2017

Introduction

Boston Chicken is a US based firm that is headquartered in Golden, Colorado. Being one of the players one the players in the American fast casual outlets, Boston Chicken, which was established in 1989, has significantly invested in brand diversification and pricing with the objective of meeting the needs of its customers. Some of the key products that the restaurant provides include rotisserie-cooked chicken, salads and vegetables. Despite stiff competition from pizza, Boston Chicken has continued to enjoy strong customer loyalty not only due to its value for convenience and low prices, but also due to operative distribution of its brands in the local and foreign markets. Under the effective leadership of Scott Beck, Boston Chicken success was based on management team that had extensive experience in the management of fast-food outlets and operations of franchises in the fast-food sector. Key executives that made significant contribution to the success of the firm included Taco Bell and Red Lobster. This analysis will identify some of the critical areas that have backed the successes of Boston Chicken business strategy, general company performance, risks and recommendation to the management on how to address the accounting challenges that the company faces.

Statement of the issues

Boston Chicken business strategy was to be a home meal replacement by consolidating fresh, flavor and appealing meals that were related with traditional cooking processes. This innovation was appropriate given the level of competition that Boston Chicken expected in the US market. However, the innovation required the company to look for external sources of finance, making Boston Chicken to sign franchise agreements with established area developers. Additionally, the company provided sizable loans to the developers to assist them finance new restaurants (Feagin, Orum & Sjoberg, 1991). On its part, Boston Chicken financed the loans through issuing its convertibles debts and public stock. Consequently, this strategy had impacts on business risks, finance strategies as well as Boston Chicken capital structure.

Analysis

The primary business strategy that is applied by Boston Chicken is differentiation. To attain its overall corporate strategy, the company adopted four approaches. First, it implemented franchising to larger regional developers after making extensive evaluation of their management experience and financial resources. Secondly, it relied on product diversification by introducing food choices in the market. Thirdly, it used the area developer franchise model to expand its operations. Fourthly, the company made significant financial investment in improving its computer system with the objective of creating strong link between the network of stores, head office and developer stores.

Boston Chicken business strategy had two key critical factors. First, as opposed to selling to smaller franchises, it embarked on franchising to large areas developers. The objective of this strategy was to use local information, area developers’ resources and their finance management to establish more stores in the area. The second critical factor was that Boston Chicken valued its customers. Besides providing various food products to the customers, it offered low prices and used computer system to improve its communication with the customers. In this way, the customers could give feedback on the quality of the brands. The computer software also improved communication between members of its supply chain, market study as well as financial reporting (Belch & Belch, 2012). The long-term agreements with major suppliers were also a key factor since it had positive impact on the supply of the raw materials thus maintaining productivity of Boston Chicken products.

Business strategy that was applied by Boston Chicken faced certain risks. First, Boston Chicken expended very fast. The company operated 34 stores as the end of 1991, which rose to 534 stores at the end of 1994. With Boston Chicken opening a new store within 2 days, its net income rose from a loss of $2.6 million to a profit of $16.2 million. Nonetheless, such rapid growth comes with increased costs. These included extra salary costs, high costs of goods and increased administrative expenses. The second risk is that, fast food sector is characterized by stiff competition. Boston Chicken faces stiff competition from KFC and pizza. For instance, immediately when Kentucky Fried Chicken (KFC) rotisserie-gold brand in the market, it earned more than $160 million within four months. The third risk is related to becoming breakfast retailer when Boston Chicken extended into the bagel market segment. By investing $20 million in Progressive Bagels, the company faced a risk since it was entering a new market using a different customer base instead of the existing avenues. Not all its customers would relate Boston Chicken as a breakfast outlet.

Boston Chicken reporting on its performance and risks is aggressive. The policies applied by the company are not adequate to deal with the risks of large amount of stock and rapid growth. On its reporting policies, Boston Chicken applies key assumptions. First, it indicates that pre-opening costs are repaid within one year. Secondly, it assumes that revenues from the company-operated stores are recognized in the period beverages and food products are sold. Thirdly, revenues generated from are development fees and original franchise fees are acknowledged when franchise stores store opens. Fourthly, deferred financing costs are re-paid over the period when the financing was done. Fifthly, royalties are recognized at the same period when associated franchise store revenues are generated. Sixthly, financing costs related to notes receivable by franchises are treated as earned. Another assumption behind company accounting policies is that the notes are structured in such a manner as to give the parents the alternative of converting the loan into equity in the franchisee using the rate of 12-15% premium over the equity during the establishment of franchise.

According to my view, Boston Chicken accounting policies do not reflect the risks. In calculating the risks, it would be prudent to compute the profitability figures of Boston Chicken. The key aspect for accessing the values of notes receivable would be to determine whether franchises make profit or not.

The adjustment that I would make includes changing the assumption of revenue recognition. As indicated in BC Consolidated Statements of Operations, the total revenue increased from $42, 530 million in 1993 to $96, 151 in 1994. Consequently, this made the company costs to increase. For instance, costs of products sold increased from $11,287 in 1993 to $15,876 in 1994, as the result of opening more company-operated stores. Additionally, as the result of increasing the number of workers in company-operated stores and support centers, salaries and benefits increased from $15,437 to $22,637 in 1993 and 1994 respectively. Without considering the increase of other costs, Boston Chicken should absorb the higher costs of products sold and salaries which emanated from establishing new stores since it assumed it had a continuous success.

The adjustment that would also be vital for Boston Chicken is to take a provision for bad debt. As noted in 1993 balance sheet, the differed franchise revenue was $2,255 million which increased to $5,505 million in 1994. This indicated that franchises faced problems in paying royalties and other related fees. The provision for bad debts would therefore ensure areas developers’ financial problems are addressed. The third adjustment would be to recognize unattained revenue when the company receives fees from franchises. As noted, Boston Chicken recognized its revenues only when franchise stores are established. Instead of recording the fees as preopening expense, franchise stores should amortize the fees through the entire franchising duration.

Boston Chicken performance depends on effective accounting and management policies. It is clear that the company has many revenue streams related to income, however, it has also omitted various issues from all types of financial statements to the investors and they need to take many steps to show the true financial condition of the company. Besides, the management has failed to candidly show the risks faced by Boston Chicken. The management needed to combine all the financial statements for all the franchises. This is due to the fact that if they do not include these numbers, the company financial statements would not show the true financial status. While looking at the asset section of the financial statement, it is clear that most of them were from the accounts receivable and notes receivables from the franchisees and area developers who were financed by the company. Due to this, the investors would not rely on the given financial statement to take a look related to big picture. Further, the company did not estimate the allowance for bad debt and over-estimated the net income of the company as it did not have contra asset account. Further, they did not take the franchisee’s capability to pay back the loan extended to them by the company.

Based on the role that Boston Chicken management played including providing vague and undetailed information, I would ask the managers to indicate some key issues. First, I would ask them to provide detailed information regarding the performance of stores. This will entails how each store performed. Secondly, I would ask them to provide information related to real-company operational and exclude royalty revenues that hide the actual performance of a store. Thirdly, I would ask them to show the late payments by franchises. In this way, I would establish the credit worthiness of the franchises. Fourthly, I would like them to provide comprehensive information on other securities provided by region developers apart from franchise corporation. This would also be a way of establishing the financial ability of the developers.

Boston Chicken performance can be established looking at the financial ratios using the 1993 and 1994 financial reports. Different metrics such as efficiency ratio and liquidity among others can be used to know how the company is performing.

Efficiency ratio

Efficiency ratio shows how an organization is using its resources. One of the usefulness of this ration is that it indicates how effective a company uses its internal assets and liabilities (Houston et al, 2009).

Efficiency ratio

1993

1994

Average collection period

Days*Accounts receivables/credit sales

17.8

24.8

Turnover of cash ratio

Net sales/Working capital

0.23

0.50

The table above shows that Boston Chicken Average collection period was high in 1994 and low in 1993. This means that in 1994, the company was taking slower than in 1993. Based on the turnover of cash ratio, it shows that the company was able to replenish its cash balance faster in 1994 as compared to 1993.

Liquidity ratio

Liquidity ratio measures the rate at which a firm deals with short term liabilities. Lower ratio shows that the firm is not able to manage short term liabilities.

Liquidity ratio

1993

1994

Current ratio

Current assets/Current Liabilities

1.27

2.17

Operating cash flow ratio

Cash flow from operations/Current Liabilities

0.78

1.29

The table above shows that in 1993 and 1994, Boston Chicken was able to able to settle its short term liabilities (Houston et al, 2009). The operating cash flow ratio was higher in 1994. This means that in 1994, the company was able to cover its current debts more times than in 1993.

Summary, conclusion and recommendation

Boston Chicken differentiation business strategy, which was focused on making it a home meal replacement and provides excellent products to the consumers, had notable impact on its performance. The background of the problem is the signing of quite a number of franchise agreements with established area developers and sizable loans to the developers to assist them finance new restaurants. As noted in the paper, even though the strategy had critical factors, it was faced by more risks that the management ignored. Additionally, use of poor accounting policies and assumptions affected the company financial performance. Given the importance of shareholders role in Boston Chicken success, it is imperative for the management to use independent auditors to carry out future financial performance. I also recommend that the company adopt continuous accounting policies and avoid assumptions that are not guided by independent accountants. The management should also adopt the culture of giving true and reliable information for them to gain shareholder trust and loyalty.