Introduction
In the following analytical report, the financial performance of Bob’s Restaurants is assessed. Operating Performance & Selected Sheet Items for the years of 1997-2004 was provided along with Stock Price Performance for Fiscal Years 1996-2004.
The results of the analysis were then compared with the industry standards in order to demonstrate Bob’s Restaurants standing in the restaurant industry. For the purposes of financial statement analysis, ratio analysis was used. After analyzing Bob’s Restaurants a recommendation is made on future actions.
Company Background
Bob’s Restaurants owned 223 restaurants by the end of their 1997-1998 fiscal years; however during 1999 the company closed 10 restaurants and 11 more by end of 2001. Bob’s Restaurants continue losing money and had to close 6 more of their restaurants by 2002.
The company had a tough time by 2003 where they closed 48 of their restaurants remaining only 148 operable sites. By 2004 Bob’s Restaurants owned 138 restaurants, a total of 85 restaurants closed during the years of 1997-2004. In 1998 Bob’s Restaurants experienced a decline in net income from $28 million in 1997 to $5 million in 1998 to negative $6 million in 2004. The higher Stock Price of the company was $25. 25 in 1996 going down to $0. 95 in 2003. Bob’s fiscal year ends August 31. No store closing expenditures were incurred in fiscal years 1994-1996 or 1999.
Bob’s marketing budget averaged 2% of sales in 1997 and 1998, 2. 4% in 1999, 2. 1% in 2000, 1. 6% in 2001, 0. 26% in 2002, 0. 34% in 2003 and 1. 3% in 2004. Total Operating Expenses excludes depreciation and amortization. Net income is net of income tax provision (benefit). The Provision for Store Closings was reclassified as Discontinued Operations (net of taxes) in 2003.
Business Analysis
Numbers provide a way to determine how a business is performing. Measuring financial performance is historical in nature and uses the actual numbers or results from business operations. It tells us what the business has produced, and it compares and evaluates that performance to specific measures. In the business analysis of Bob’s Restaurants the process of Ratio Analysis was chosen as the most suitable for comparison with industry standard indicators which are the most often and in that case solely, available. Several different ratios were used in order to assess Bob’s Restaurants profitability, financial leverage and activity measures. Ratio analysis enables the analyst to compare items on a single financial statement or to examine the relationships between items on two or more statements.
After calculating ratios for each year’s financial data, trends for the company can be examined across years. a. Profitability Ratios. – Profitability ratios are gauges of the company’s operating success for a given period of time. These financial ratios measure the return earned on a company’s capital and the financial cushion relative to each dollar of sales. A firm that has high gross profit margins, for instance, is going to be much harder to put out of business when the economy turns down than one that has razor-thin margins.
Likewise, a company with high returns on capital, even with smaller margins, is going to have a better chance of survival because it is so much more profitable relative to the shareholders’ contributed investment. For most of these ratios, having a higher value relative to a competitor’s ratio or the same ratio from a previous period is indicative that the company is doing well. As most company’s avowed aim is to make profits, it follows that the most important ratios to analyze are the profitability ones. However, these ratios tend to be less analytical. A restaurant has a major investment in assets.
It is essential that there are sufficient earnings to cover the cost of financing and to provide a satisfactory return to the investors. Return on Total Assets (ROTA). A ratio that measures a company’s earnings before interest and taxes (EBIT) against its total net assets. The ratio is considered an indicator of how effectively a company is using its assets to generate earnings before contractual obligations must be paid. The greater a company’s earnings in proportion to its assets (and the greater the coefficient from this calculation), the more effectively that company is said to be using its assets.
Bob’s Restaurants average result of -0. 81% on return on total assets for the past eight years of 1997-2004, compares unfavorably with the restaurant industry standard of 5. 2%. Return on Equity (ROE). Return on equity is one of the most important profitability metrics. It reveals how much profit a company earned in comparison to the total amount of shareholder equity found on the balance sheet. It’s what the shareholders “own”. Shareholder equity is a creation of accounting that represents the assets created by the retained earnings of the business and the paid-in capital of the owners.
A business that has a high return on equity is more likely to be one that is capable of generating cash internally. For the most part, the higher a company’s return on equity compared to its industry, the better. Bob’s Restaurants return on equity for the eight years of 1997-2004 averages -2. 55%, compares unfavorably with the restaurant industry standard of 12. 99% Return on Sales (ROS). A ratio widely used to evaluate a company’s operational efficiency. ROS is also known as a firm’s “operating profit margin”.
This measure is helpful to management, providing insight into how much profit is being produced per dollar of sales. As with many ratios, it is best to compare a company’s ROS over time to look for trends, and compare it to other companies in the industry. An increasing ROS indicates the company is growing more efficient, while a decreasing ROS could signal looming financial troubles. Bob’s Restaurants return on sales for the eight years of 1997-2004 averages 2. 11% compares favorably with the restaurant industry standard of 2. 2% Net Profit Margin.
The net profit margin tells you how much profit a company makes for every $1 it generates in revenue or sales. Net Profit margins vary by industry, but all else being equal, the higher a company’s profit margin compared to its competitors, the better. Bob’s Restaurants net profit margin decreased from 5. 74% in 1997 to -2. 09% in 2004. Therefore, more net sales dollars have been taken up by a high level of spending in payroll and related cost of labor which increased 12% from 1997 to 2001 even with 21 restaurants closed. Another line that affected was an increase in Provision for Store Closings.
Net Profit Margin industry standard is 3% and hence Bob’s Restaurants average -0. 98% rate of net profit margin does not compare favorably. This is mostly due to the decline in revenue during the past six years. A negative ratio, resulting from negative net profit margin, presages serious problems. All the above presented indicators appear to be unfavorable for Bob’s Restaurant when compared with industry results except for Return on Sales. As mentioned already, progressive decrease in revenue impacted significantly on the overall financial measures of profitability.
Liquidity ratios are measures of the short-term ability of the company to pay its debts when they come due and to meet unexpected needs for cash. Show the solvency of a company based on its assets versus its liabilities. In other words, it lets you know the resources available for a firm to use in order to pay its bills, keep the lights on, and pay the staff.
The comparison of current assets to current liabilities is a commonly used measure of short-run solvency, i. e. the immediate ability of a firm to pay its debts as they come due. The current ratio is particularly important to a company thinking of borrowing money or obtaining credit from their suppliers. Potential creditors use this ratio to measure a company’s liquidity or ability to pay off short-term debts. For the past eight years from 1997-2004, Bob’s Restaurants current ratio has been higher than the restaurant industry standard of . 9:1. By the end of their 2001 fiscal year, current ratio went up to 81. 37 averaging the eight year period to 33. 15; only to show the company inability to meet current financial obligations.
The food service industry typically has a low current ratio because of:
- Minimum credit extended to customers,
- Low inventories on hand,
- Quick cash turnover because of rapid inventory turnover.
Usually, the Quick Test ratio does not apply to the handful of companies where inventory is almost immediately convertible into cash such as the restaurant industry. Instead, it measures the ability of the company to come up with cold, hard cash literally in a matter of hours or days. Bob’s Restaurants show intensive cash problems, the company’s quick ratio for the eight years of 1997-2004 averages 26. 4% which compares unfavorably with the restaurant industry standard of .
Financial leverage is another critical area of business decisions as it presents an entity’s ability to pay its debts and its short and long-term solvency. There are several different ratios, but to main factors looked at include debt, equity, assets and interest expenses. Debt to Total Assets Ratio. The debt/asset ratio shows the proportion of a company’s assets which are financed through debt. If the ratio is less than one, most of the company’s assets are financed through equity.
If the ratio is greater than one most of the company’s assets are financed through debt. Companies with high debt/assets ratios are said to be “highly leveraged” and could be in danger if creditors start to demand repayment of debt. Companies with high ratios are placing themselves at risk especially in an increasing interest rate market. Creditors are bound to get worried if the company is exposed to a large amount of debt and may demand that the company pay some of it back. Bob’s Restaurants ratios of 42. 70% (year 2000), 49. 66% (year 2001) show the fact that assets are financed more by debt.
Furthermore, Bob’s Restaurants high ratio can be interpret as a high debt leveraged company. Indicates what proportion of equity and debt that the company is using to finance its assets. Sometimes investors only use long term debt instead of total liabilities for a more stringent test. A low debt/equity ratio implies ability to borrow, where a ratio greater than one means assets are mainly financed with debt and less than one means equity provides a majority of the financing. If the ratio is high (financed more with debt) then the company is in a risky position, especially if interest rates are on the rise.
If the ratio is suspect and the company’s working capital, and current/quick ratios drastically low, this is a sign of serious financial weakness, which is the case of Bob’s Restaurants in this analysis. The company’s ratio is at an average of 95. 23% over the past eight years. The highest ratio reported was in 2003 of 173. 33%. Long Term Debt to Equity. The amount of long term debt on a company’s balance sheet is crucial. It refers to money the company owes that it doesn’t expect to pay off in the next year. Long term debt consists of things such as mortgages on corporate buildings and / or land, as well as business loans.
A great sign of prosperity is when a balance sheet shows the amount of long term debt has been decreasing for one or more years. When debt shrinks and cash increases, the balance sheet is said to be “improving”. When it’s the other way around, it is said to be “deteriorating”. This is the case of Bob’s Restaurants; their Long Term Debt went from $84 million in 1997, $116 million in 2000 to $ 124 in 2002. However, their long term debt improved to $25 million in 2004. Times-interest-earned or Coverage Ratio. A ratio used to determine how easily a company can pay interest on outstanding debt.
The interest coverage ratio is calculated by dividing a company’s earnings before interest and taxes (EBIT) of one period by the company’s interest expenses of the same period: the lower the ratio, the more the company is burdened by debt expense. When a company’s interest coverage ratio is 1. 5 or lower, its ability to meet interest expenses may be questionable. An interest coverage ratio below 1 indicates the company is not generating sufficient revenues to satisfy interest expenses. Bob’s Restaurants average result of 2. 8% for the past eight years of 1997-2004, compares favorably with the reasonable industry interest coverage ratio of over 1. 5. This ratio indicates that the company is generating sufficient revenue to satisfy interest expenses.
Activity or turnover ratios show how many times a company’s inventory is sold and replaced over a period. The days in the period can then be divided by the inventory turnover formula to calculate the days it takes to sell the inventory on hand or “inventory turnover days” Fixed Assets Turnover. Effectiveness in using plant and equipment.
A high fixed asset turnover ratio indicates management’s effectiveness in its use of fixed assets, whereas a low ratio indicates either that management is not effective or that some of those assets should be disposed of to increase ratio. A restaurant can increase its fixed asset turnover rate by increasing the number of seats, or if demand is there, serving more customers during each meal period. Bob’s Restaurants average result of 1. 39 for the past eight years of 1997-2004, is quite low which indicates that management is not effectively using its fixed assets. Furthermore, it’s been fluctuating between 1. 40; 1. 7 to 1. 37 throughout the past eight years.
In other words, it shows the amount of profit from each product unit. The basic principle is the concept of contribution margin — an item’s menu price less its food cost. While a menu item’s contribution margin reveals how many dollars each individual sale of the item adds to your revenue, you also need to know how popular the item is in order to determine the total dollars it nets your restaurant.
The DuPont Model developed by F. Donaldson Brown while working for DuPont de Nemours & Co. is a set of financial ratios and key figures relating to the Return on Investment ROI. It is a technique that can be used to analyze the profitability of a company using traditional performance management tools. To enable this, the DuPont Model integrates elements of the Income Statement with those of the Balance Sheet.
There are three components in the calculation of return on equity using the traditional DuPont model; the net profit margin, asset turnover, and the equity multiplier. By examining each input individually, we can discover the sources of a company’s return on equity and compare it to the industry and its competitors. The DuPont analysis offers a clear overview of the most relevant drives of the ROI and their interconnection; it cannot replace a detailed analysis.
The Total Asset Turnover has been decreasing during the period of 1997 to 2004 showing management inability of utilizing current assets. The Debt Ratio has decreased for the last two years going from 82. 79 to 28. 42 mainly due to the reduction of the total liabilities, indicating that the level of creditor financing has improved. The stock holder’s equity has decreased dramatically indicating not a good management of the company’s equity. The EBIT has decreased for the last two year mainly because the level of interest paid has decreased due to the reduction of liabilities.
The Net Profit Margin has decreased from 1997 to 2004 as the cost of goods sold did not increase at the same level that the sales increased. The Operating Profit Margin ratio was stable in 1997 when compared to 2001 and thane Profit Margin has also been improving for the last year.
The Return on Total Assets has decreased due the decrease in the company’s profitability, while Return on Equity has decreased on the last two-year as the stockholders equity also decreased. Overall it is clear that the profitability of the company has been decreasing for the last years mainly due to the increased in liabilities. The company also demonstrates that the profitability can be improved even further by having better inventory management and productivity maximization on their fixed assets.
Recommendations
First, the poor performance of Bob’s Restaurants is due in part to the high operating costs. To increase profitability, the company should consider reducing their operating costs. One recommendation would be to consolidate operations where possible to reduce labor costs. As mentioned before, labor costs had been rapidly increasing from 1997 to 2001 in spite of closing some facilities.
Restaurant food & beverage purchases plus labor expenses account for 65 to 70 cents of every dollar in restaurant sales. The combined total of these two cost categories, referred to as a restaurant’s “Prime Cost”, are where the battle for restaurant profitability is truly waged. This is not simply because they represent the largest percentage of a restaurant total expense, but also because management has the ability to control them. The layout of the kitchen and the way the menu items are selected can also favorably impact labor costs.
Bottom line, when a restaurants Prime Cost percentage exceeds 70%, a red flag is raised. Bob’s Restaurant has been up to 108%. Inventory is another important component that Bob’s Restaurants should consider monitoring closely. A restaurant that carries too much food inventory will inevitably have higher food costs than it would otherwise.
A typical full service restaurant should have on average no more than 7 days of inventory. Furthermore, Bob’s Restaurants should consider improving their Net Profit Margin. One option would be to work on an aggressive marketing strategy that position the restaurants best in the market. Also, the company should consider pursuing a competitive position as well. In addition, Bob’s Restaurant needs to put its assets based to work so it can produce more sales. Concluding from the above points, 2004 shows dramatically improvement.
Bob’s Restaurants can look forward to a much more efficient and profitable future as a result of implementing these recommendations. The company financials would become more steady and easy to manage. Operating costs will be reduced and these savings would result in better margins. A leaner restaurant would be more agile and competitive which would result in capturing more market share in their participating arenas. Bob’s Restaurants would still seem like a business that is worthwhile to consider staying in the market.
