AC112 Unit 10 Management Report on a Second Location Example

Next Spring, Not This Fall: A Unit 10 Management Report on a Grooming Salon's Second Location

[Student Name]

Purdue University Global

AC112: Accounting Fundamentals for Management

Unit 10 Management Report

[Instructor Name]

[Date]

Sudsy Hound Grooming, its owner, statements, forecasts and the second-location costs are composite; the textbooks, ratio research and cash study cited are real.

Executive Summary

Renata, I recommend opening the second location next spring rather than this fall, and arranging a line of credit of at least $15,000 before signing a lease. The salon is profitable, earning a 15.1 percent margin in its first full quarter. But its cash is thin for its size, its borrowing has risen quickly, and the new grooming van will take most of the summer's spare cash. Opening a second shop this fall would stack a second large cash outflow on top of the first, in the months when the salon has the least room.

Performance

In the second quarter, April through June, the salon brought in $59,500 of grooming revenue and earned $8,971 of net income, the profit left after every expense is counted, including the wear on equipment. That is 15 cents of profit on each dollar of revenue. Groomers' wages, paid as a share of each groom, take 45 cents, which means the salon's profit grows with bookings but so do its labor costs. Rent of $2,200 a month is the main fixed cost, the one that stays the same however many dogs come in.

Financial Position

The balance sheet, a list of what the salon owns and owes on one date, shows a business that can pay its near-term bills. At June 30 the current ratio, current assets divided by debts due within a year, was 2.16, meaning the salon held about two dollars of cash and soon-to-be-cash for each dollar due within twelve months. Lenders read that figure first for short-term credit (Franklin et al., 2019a).

The figure that argues for waiting is the debt to equity ratio, 0.42 at the end of March, 0.69 by the end of June, and headed toward about 2.5 once the grooming van's $57,600 loan is added in July.

Debt to equity compares what the salon owes to what Renata has invested and kept in the business. At 2.5, lenders would be financing about two and a half times as much of the salon as she does. Research on business failure has long found that heavy debt relative to the owner's stake, together with weak cash flow, is among the earliest warning signs (Beaver, 1966).

Cash Outlook

The cash budget for July through September shows the salon closing August at $4,533 before borrowing, $467 under the $5,000 minimum Renata keeps, because the van's first installment arrives in the month grooming demand falls. September recovers only to $5,380 with $1,000 still borrowed. In other words, after the van, the salon will end the summer with about the same cash it would need for one month of wages and rent. A cash budget, a month-by-month forecast of money in and out, is the tool that shows this; the income statement cannot (Franklin et al., 2019b). Small businesses in a large national sample held a median of only 27 days of outflows in cash (Farrell & Wheat, 2016), and the salon would be at or below that level.

The Second Location

A second shop is estimated to need about $54,000 before its first groom: $34,000 for the lease deposit and build-out of tubs, drains and kennels, $18,000 for equipment and $2,000 for opening supplies. It would likely lose money for its first few months while bookings build, as the first salon's opening month showed. Financing most of the cost would push debt to equity well above 4.

How the Van Changes the Picture

The grooming van is the reason this decision cannot be made on the first salon's results alone. It is a second location on wheels, bought with borrowed money, and it has not yet earned a dollar. If it books four to five dogs a day on its routes, it should cover its $1,168 installment and its fuel and insurance with room to spare, and by next spring it will have a record a bank can read. If it books fewer, Renata will want to know that before committing to a lease that runs for years. Either way, the van's first six months are information the second-location decision needs, and opening this fall would mean deciding without it.

What Renata Can Do This Fall Instead

Three steps would prepare the salon for a spring opening. First, apply for the line of credit now, while the June statements are fresh and the current ratio is still strong. Second, reduce withdrawals to $2,000 a month through December, which would leave roughly $3,000 more in the business by year end and begin to lower the debt to equity ratio. Third, ask the kennel and the veterinary clinic to pay within fifteen days, which would bring forward about $4,000 of cash that now waits a month in receivables. None of these steps costs money, and each makes the spring decision safer.

Risks of Opening This Fall

1. Two large outflows in one half-year: the van down payment in July and the build-out in the fall.

2. No track record for the van: the bank would be asked to lend again before the last loan has shown results.

3. The holiday season: November and December are the busiest grooming months, and Renata's attention would be split between running the first shop at its peak and opening the second.

4. Withdrawals: Renata takes $3,000 a month, about what the salon earns, so equity is not growing to support new debt.

Conditions for Opening Next Spring

1. Two quarters of van results showing it covers its own installments.

2. Cash rebuilt to at least $15,000 by March, through the holiday peak and lower withdrawals.

3. A $15,000 line of credit approved before the lease is signed.

4. Debt to equity below 2.0, which can come from paying down the pickup van loan and keeping more profit in the business.

Recommendation

Wait. Use the fall to prove the van, build cash through the holiday season and arrange credit. Revisit the decision in February with the year's results. If the four conditions are met, sign a lease for a spring opening; if they are not, the shop will be in a stronger position to try a year later.

Appendices

Appendix A, income statement for the second quarter. Appendix B, balance sheets at March 31 and June 30. Appendix C, ratio table. Appendix D, cash budget for July through September. Appendix E, second-location cost estimate.

References

Beaver, W. H. (1966). Financial ratios as predictors of failure. Journal of Accounting Research, 4, 71-111. https://doi.org/10.2307/2490171

Farrell, D., & Wheat, C. (2016). Cash is king: Flows, balances, and buffer days. JPMorgan Chase Institute. https://www.jpmorganchase.com/institute/all-topics/business-growth-and-entrepreneurship/report-cash-flows-balances-and-buffer-days

Franklin, M., Graybeal, P., & Cooper, D. (2019a). Principles of accounting, volume 1: Financial accounting. OpenStax. https://openstax.org/details/books/principles-financial-accounting

Franklin, M., Graybeal, P., & Cooper, D. (2019b). Principles of accounting, volume 2: Managerial accounting. OpenStax. https://openstax.org/details/books/principles-managerial-accounting