This is the third milestone of your business plan—the financial plan.Tasks:Research the costs, financial statements, cash flow, and risks of your chosen project, attached RobertsD_M2_A2. Based on yo

Business Plan Breakdown: The Simplified Financial Plan

MS6900 A01 The Functional Contribution to Organizational Success

Financial Projections for Acquisition of ABC Kids Center

Capital and Start-Up Requirements

ABC Kids Center is an acquisition purchase of an existing center with approximately 93 children in attendance. The purchase of the center includes $440,000 in business assets, 23 existing staff, and a 6,000 square foot commercial building with an asking price of $500,000. The business assets include customer list, website, and goodwill. The inventory includes all supplies and equipment for the center and is valued at $80,000. The center has the capacity to increase before and after childcare for 10 children and the addition of a summer program for 20 children. The total asking price for ABC Kids Center is $940,000. The present owner has accepted a letter of intent and purchase agreement in the amount of $850,000. At the present time, ABC Kids Center has no outstanding debt.

Revenue is calculated based on several different pricing models, dependent upon age of child and level of service provided. There is a state mandated student to instructor ratio, per age group, that must be maintained, as well as a minimum of 35 square footage of space per child (Ohio Department of Jobs and Family Services, n.d.). Both of these requirements provide restrictions on the ability to maximize growth through sales. New avenues for growth must take both of these factors into consideration, to remain in compliance with the Ohio Department of Jobs and Family Services, which oversees childcare centers in Ohio The student to instructor ratio (S/I) requirement drives salary expense, as even one child over the S/I ratio results in the need to add an extra staff person. As a result, childcare centers have a high ratio of salary expense to revenue, usually in the 50% to 55% range. Some centers include the cost for food and supplies as the cost of sales in the income statement, while other centers list these accounts as line item expenses. The current accounting firm for ABC Kids Center uses the line item expense method.

The purchaser for ABC Kids Center is seeking $850,000 in capital to purchase the center, inventory, and property. The ownership of the business will be a partnership. The new owner will be taking a salary from the business, as a percentage of profit. As the current site director for the center plans to leave two months after the completion of the sale of the business, a new site director will need to be employed to manage the daily operations of the business. There is no other expected staff turnover from the sale. The organizational chart for the leadership of the business will consist of:

• Partner ownership owner and investor with a 49% stake in the business.

• A silent ownership partner and investor with a 51% stake in the business.

• The partnership owners will provide $160,000 in cash equity towards the purchase of the business.

Start-up costs for the business will include a cash down payment, bank loan, Small Business Administration lending fees, closing costs, legal fees, additional $10,000 for increased advertising, and a $50,000 line of credit for operations. The purchase agreement permits the current owner to retain 100% of the accounts receivables and cash on hand the day of the sale. The line of credit will cover the first few months of operations as account receivables are collected. The line of credit will only be utilized if net profit does not cover 100% of the monthly expenses. The following tables detail the existing variable and fixed costs associated with acquiring this business including the start-up costs:

Table 1. Variable Costs

Tables 1 and 2 reflect the existing and forecasted costs for the operation of ABC Kids Center childcare center at the end of fiscal year 2016, and were provided by the current owner of the business. Included in these costs are the increase in advertising to promote the change of ownership and new programs, legal fees incurred for the acquisition, new operating licenses, and the assumption of new debt for the mortgage and business.

Sources of Funding

Financing for the purchase of ABC Kids Center will be a combination of cash equity and a loan from the Small Business Administration. The partnership owners will provide $160,000 cash equity towards the purchase of the business. The remaining balance of the funding will be sought from a local lending institution, who participates in the Small Business Association loan program. To date, Huntington Bank and First Financial Bank have been identified as potential lenders. By utilizing the Small Business Administration’s SBA Veteran’s Advantage loan, ABC Kids Center can finance both the investment for the business and the real property into one loan (SBA, 2016).

By including real estate in the loan, the terms of the loan can be extended from 10 years to 20 years. In addition, the silent partner is a U.S. Navy veteran. As of September 1, 2016, the SBA is authorized, by President Obama, to cut the lending servicing fee by 50% for any approved borrower, who is a veteran (SBA, 2016). The purchase price of $850,000 minus the $160,000 down payment requires the need to borrow $690,000. The service fee for a loan in the amount of $690,000 has a fee of three percent or $20,700. A veteran borrower will be charged half of this or $10,350. This is financed in the loan along with the bank’s closing costs. The commercial business broker, Keate Partner’s, has provided an estimate of $7,000 for closing closes. This brings the total amount to be financed to $707,350.00. Interest rates for an SBA loan are based on the SBA charges for the portion of the loan they guarantee, with the interest rate for the balance of the loan charged by the lending institution. The current interest rate charged by the SBA is based on the ten year treasury rate at 1.8%, plus a fixed rate of .48%, and 1.7% in fees (SBA, 2016). The SBA rate totals 3.98%. Most banks charge the Wall Street Prime Rate, which is currently 3.5% (Bankrate, 2016). The total rate for the loan will average around 7.48%. ABC Kids Center is seeking the most advantageous financing available, and will secure the remaining capital required, with the lending institution that provides the best terms.

Cash Flow Projections

Cash is considered king for small businesses, as it is needed to start, operate, and grow the business (SBA, n.d.). The cash flow analysis provides a snapshot of the projected inflow of cash into the business and the outflow of cash for account payables. The 2017 cash flow projections represent a significant change from the prior ownership, due to the $70,000 annual debt being taken on by the business. To partially offset this additional expense, owner’s salary has been reduced by $25,000 in the first year. One of the benefits for new ownership is that the current owner utilized cash for capital improvements, prior to marketing the business for sale. It is not anticipated that any additional capital improvements will need to be made during the first two years of business.

The first month of the cash flow analysis reflects the $50,000 line of credit issued to cover the operations of the business, as capital for start-up costs. As accounts receivables are collected, they will be used to cover expenses, before utilizing the line of credit. Funds used from the line of credit will be repaid as accounts receivables are received, with a goal of relying 100% on accounts receivables by month six of operations.

At the end of the first year, a planned repayment of 20% of net income will be made to the owner towards repayment of the $160,000 invested capital. Based on long term projections, and growing revenue through expanded services, the cash flow is sufficient to provide an investment return of 15% on the $160k initial investment by the owner, in year eight of operations. After year eight, a percentage of the net income (owner’s equity), through cash flow, will be set aside in a Simplified Employee Pension Plan. A SEP plan has been chosen as it allows flexibility for contributions based on the cash flow of the business (IRS, n.d.). The plan is also 100% employer funded, which will be a value-added benefit to the employees, due to the lower salaries earned in the early childhood education field.

By having access to the prior three year financial statements, a more solid first year cash flow projection analysis can be conducted. The 2017 first year cash flow analysis utilizes the straight line method for variable and fixed expenses. While this method does not account for fluctuations in monthly expenses, the annual cash flow from the business’s last three years of operations (see Table 3), provides satisfactory evidence of the ability of ABC Kids Center to meet its monthly financial obligations. Should ABC Kids Center experience a cash shortfall in a given month, due to unplanned expenses, it can fall back on the $50,000 line of credit. Each month of operation, ABC Kids Center will conduct a comparison of prior month actual financials to projections to assess financial performance. The actual monthly cash flow reports will be used to build the cash flow analysis for the second year of operation, in 2018. This will permit new ownership to accurately budget and plan for expenses in 2018, based on the months they were incurred in 2017. Cash flow is forecasted to remain relatively stable month over month, until 2018 when the new before and after school care and summer program is rolled out, and the next tuition increase is implemented in August of 2017.

Table 3 Cash Flow Projections reflects average monthly income of $69,468 based on the current enrollment of 93 children at an average of $179.00 per week for 50 weeks out of the year and includes the August, 2017 tuition increase. Revenue is billed and collected weekly from each client. The table reflects the payback of the $50,000 line of credit in month six.

Table 3 Year One Cash Flow Projections (Utilizing $50,000 line of credit)

$5,000 Cash on Hand Alert

Table 4 provides a long term cash flow projection for ABC Kids Center based on the first year of operations cash flow analysis. It includes the growth of an additional 30 enrollments, an annual five percent tuition increase, and increases to variable and fixed costs. ABC Kids Center projects hitting $150,000 in positive cash flow in year five.

Table 4. Long-Term Cash Flow Projection

End of First Year Balance Sheet

Table 5. ABC Kids Center Balance Sheet End of First Year

The first year balance sheet reflects assets including cash on hand, inventory, property and goodwill. The liabilities include the short term and long term debt for the purchase loan. Owner’s equity reflects the $160k initial investment. ABC Kids Center will continue its profitable status after its first year of business. The initial $50,000 line of credit will be repaid in full to the lender and the business will make its first repayment for owner’s equity. Cash flow will be more than sufficient to meet debt obligations. The marketing and public relations campaign in the first year will ensure that goodwill is retained.

Income Statements

Prior Three Year Income Statements

For the purposes of seeking funding for the acquisition of ABC Kids Center, the profitability of the center for the past three years must be reviewed. Table 6

reflects the actual sales (income), cost of goods, expenses, and profit for business operations under prior ownership.

Table 6. Prior Three Year Income Statements

Five Year Projected Income statement

Table 7. Five Year Pro Forma Income Statement

Table 7 on page 14, depicts the five year forecast for income. The forecast for ABC Kids Center is predicated on the assumption that the center will remain at 100% capacity, due to the fact that it continually has a waiting list for admission. Growth in revenue is forecasted based on additional sales garnered through before and after childcare services and the addition of the summer program. It is estimated the center will be able to secure 10 additional school age children throughout the school year and an additional 20 school age children for the summer program. The increase on occupancy rate is planned beginning in year 2018, the second year of operation. This will permit the center to advertise and market for the new programs in year one. An extra $10,000 in marketing expense has been budgeted in year one.

Revenue also reflects a standard 5% increase in fees, which is based on historical averages provided by the current owner. Revenue can fluctuate somewhat based on the ages of the children enrolled, i.e., charge for infants is higher than charge for preschool aged children. On the recommendation of ABC CPA firm, increases in revenue is based on a percentage of sales.

For projecting fixed and variable future costs, certain assumptions were made. Annual salary increases for employees is planned at 3 percent based on the World at Work 2015-2016 Salary Budget Survey (World at Work, 2016). Salary increases have been rising from the average 2.2 percent during the 2008 recession to 2.9 percent – 3 percent in 2014 and 2015. As this is a variable cost, it can be adjusted up or down during the annual budget process, based on current economic trends for that particular year.

The inflation rate of 2.0% was used to calculate increases in variable expenses such as utilities and supplies. This rate is based on the projections made by the Congressional Budget Office in their Budget and Economic Outlook: 2016 to 2026 report (Congressional Budget Office, 2016).

The center anticipates no borrowing in funds over the next five years and built this into the financial pro formas. Capital from cash flow will be used to finance any capital purchases that may arise, such as the need for new classroom or playground equipment. Should the center experience an unexpected need for a significant capital purchase, it can fall back on the $50,000 line of credit issued at the time of purchase. Table 8 provides a graphical view of the projected revenue, gross profit, and net income for the next five years.

Table 8. Projected Gross Revenue, Gross Profit, and Net Income over first five years

Break Even Analysis through Cost Volume Profit

The Break Even Point (BEP) is determined when a business reaches enough in sales that the total revenues equal the total costs and the operating income becomes zero (Collier, 2015). ABC Kids Center is the acquisition of a solid business with positive adjusted cash flow and profitability. The prior three year actual financials and the five year projected income and expenses indicate that ABC Kids Center will continue to be profitable, even with the assumption of debt to finance the business. Changes in economic factors could have a potential adverse effect on the business which would impact revenue, profitability, and cash flow. For example, another recession resulting in layoffs of employees would mean fewer families needing childcare service. New ownership may not be able to secure enough enrollment to support the before and after childcare and summer program. This would result in changes to the assumptions made for income. For these reasons, it is necessary to know the breakeven point and at which point a drop in enrollments would result in a loss in profit.

ABC Kids Center will utilize the income statement approach, also known as the contribution margin analysis. A contribution margin income statement requires variable expenses to be subtracted from revenue which provides the contribution margin. To determine the net profit or loss, fixed expenses are then deducted. The amount remaining is the amount available to cover the fixed costs of the business and generate a profit (Peavler, 2016).

To determine how many units must be sold to reach the breakeven point, it is necessary to determine the price per unit. Due to the fact that ABC Kids Center offers a service and not a product, the mean service cost will be used to conduct a Cost Volume Profit analysis (Collier, 2015). The sales price per unit will be calculated at an average of $165 per child per week multiplied by 50 weeks per year. The mean price per unit (service) per child is $8,250 annually. Utilizing the variable and fixed costs for the business, a Cost Volume Profit (CVP) analysis was conducted to determine the breakeven point.

.

The following tables depict three different scenarios based on the number of enrollments needed to break even and the number of enrollments needed to achieve $150,000 in net income. Table 9. CVP - Breakeven

Table 9 indicates that 83 children must be enrolled for ABC Kids Center to breakeven. As of the current date, ABC Kids Center has 93 children enrolled. These additional 10 children add $82,500 to the annual gross income. This exemplifies the need for continuous prospecting for new enrollments and ensuring the retention of enrollments, to maintain an 89% occupancy rate.

Table 10. CVP – Targeted Income $150,000

To generate $150,000 in targeted net income, ABC Kids Center would need to enroll 125 children. This will be achievable under the new ownership’s plan to enroll 30 additional children in the before and after school care and summer program beginning in year two of operations.

Table 11. CVP – Year Two Fixed and Variable Costs

Table 11 reflects the new sales price per unit based on the five percent tuition increase in year one and the new enrollment figure of 125 children. Variable and fixed costs reflect forecasted increases in year two. With these changes, the variable cost per unit goes down and the new breakeven point is 61 children.

By utilizing the Cost Volume Profit analysis, the new ownership can assess the impact changes in enrollment will have on the profitability of the business. In the unlikely event that enrollment would decline, the business will be able to proactively make adjustments to variable expenses to offset the decline in enrollment. Supplies, food and salary expenses would be reduced to maintain profitability.

Payback Period

ABC Kids Center will pay the principal of the capital back to the owner by allocating 20% of the net income each year to the owner. Based on the five year pro forma, a 20% return over the next five years would result in a payback of $72,075 in the first five years of business.

Table 12. Five Year Payback

Table 13. Total Payback

Allocating 20% of the net income each year towards repayment will result in a payback at the end of year eight, with a fifteen percent return on the owner’s original $160k investment.

Table 12. Ratio Analysis

Industry averages retrieved from Hoovers (www.hoovers.com)

Industry averages for ratio analysis and comparison to the operations of ABC Kids Center was gathered from Hoovers (Hoovers, n.d.). Childcare centers fall under the NAICS code of 6244 and the SIC code of 7299, for businesses that provide supervision and educational opportunities for preschool and school age children.

For the liquidity ratio, data for cash, inventory, total current assets, and total current liabilities was taken from the forecasted financial statements for ABC Kids Center. Liquidity is important in this comparison, because the current ratio indicates if ABC Kids Center has enough in assets to produce cash needed to pay off debt (Burke, 2016). The quick ratio indicates how quickly ABC Kids Center could pay off its debts immediately (Burke, 2016). This would include cash and assets that can be converted to cash quickly. While ABC Kids Center could sell off its inventory to raise cash, there is a need to keep in mind that the inventory of a childcare center is equipment that children and teachers utilize in the classroom and on the playground. Liquidity of this inventory should be approached with great caution. Selling inventory should be considered a last resort for this type of business. A ratio under 1 would indicate the business does not have enough short term assets to pay off its debts, if they became due. ABC Kids Center has strong ratios for its first year of business and the growth in cash flow will continue to positively impact this ratio.

Profitability is the goal of every for-profit business and is of significant importance to investors and lenders. The profit margin for a company is determined by dividing net income by sales (Collier, 2015). Growth in sales and prudent management of expenses (cost controls) is central to maintaining and growing profitability. The industry average for profitability is 8% (Hoovers, n.d.). In the first year of business, ABC Kids Center is forecasted to have a 4% profit margin. One of the reasons for the lower profitability is that the business will now be taking on $70k in annual debt that it previously did not experience. In addition, the pro formas developed for the business were based on worse case scenario for expenses in the first year of business. There is opportunity for ABC Kids Center to improve upon this profit margin in the first year. In the second year, with the ability to increase enrollments, the profit margin will increase accordingly.

Debt to equity ratio is calculated by dividing the total debt of the company (long-term and short-term liabilities) by the total owner’s equity (Collier, 2015). The purpose of analyzing this ratio is to determine the proportion of debt and equity the company uses to finance its assets. If the ratio indicates a higher number, then the business carries a high level of debt. The average debt to equity ratio in the childcare industry is 51%. ABC Kids Center a slightly higher ratio of 77%. This higher ratio can be attributed to the need to assume ownership of the facility that houses the center. The majority of childcare centers in the U.S. lease rather than own their own building. In this particular situation, the current owner made the decision to build a “build-to-suit” facility to house her business. The existing owner was not open to leasing the facility and would only negotiate a sale that included the building. This has resulted in a higher debt to equity ratio than currently experienced in the industry. The positive aspect for new ownership is that the business will have a strong cash flow and will be able to meet its debt payment. After the fifth year of business, a portion of the adjusted cash flow will be allocated to debt reduction through prepayment of the mortgage on the building. The goal is for the business to be debt free after 15 years of business.

Risk Assessment

Loss of Goodwill

The prior owners include the executive director, site director, and one assistant director as family members. The center has been a family owned and ran business for almost 30 years in the local community. The new ownership recognizes the need to foster goodwill and establish strong relationships with the current parents and the local community. ABC Kids Center intends to continue the goodwill established by prior ownership through participation in community events and holding annual fundraisers. Relationship building with local elementary schools and churches will be a priority for the new owners. Engaging parents through conducting satisfaction surveys will be initiated with follow-up action plans. Center events such as holiday parties, fieldtrips, and preschool graduation will be planned with parental participation. A high percentage of enrollments comes from referrals. A loss of this referral base would have a negative impact on enrollments and result in a decline in revenue.

A clearly defined marketing plan is established, and with proper execution, will mitigate the risk of a loss of goodwill. The plan includes advertising and promotions to generate new enrollments for the new before and after childcare service and the summer program. Increases to enrollment in these two areas will offset any decreases in the foundational services offered, due to a loss of goodwill.

Licensing

ABC Kids Center will need to apply to the Ohio Department of Jobs and Family Services (ODJFS) for a new license to operate as a childcare center under new ownership. As part of the new licensure process, a site visit will be conducted by the ODJFS to ensure compliance with the state regulations for operation. The purchaser’s agreement includes the provision that the current executive director (owner) will be leaving the business upon sale of the business. The site director (owner’s daughter) has agreed to stay on for a period of two months until a new site director can be hired. The existing site director is not interested in remaining with the business. The timetable for a site visit by ODJFS is unknown. If the visit is scheduled timely after the close of sale, within sixty days, the existing site director will be present. Based on prior site evaluations, there is little to no risk, that anything of significance will be uncovered during a site visit. If the visit is scheduled after the initial 60 days, a new site director will be in place. There is some inherent slight risk, simply based on the new hire’s lack of experience at this site that may be cause for concern during a state visit. It will be incumbent upon the new ownership to hire a seasoned and experienced site director to run the daily operations of the center to mitigate this risk.

Financing

Changes in the Small Business Association’s regulations or banking institutions lending practices may present risk for securing the loan. Economic changes to interest rates could create unfavorable loan terms. There are no concerns with credit worthiness or with the profitability of the business, but changes to terms or lending practices could negatively impact the amount of the down payment required, require additional collateral, or result in higher monthly loan payments. Requiring a higher down payment or additional collateral could hamper the new owner’s ability to secure the funding for purchase. Increases to the forecasted monthly repayment schedule may need to result in lowering owner’s salary, or the capital repayment schedule, in order to maintain a strong, positive cash flow. Appropriate due diligence by the new ownership will mitigate these risks, as long as the closing process for the sale of the business is conducted within 60 days of the signed purchase agreement.

Economic Risk

Changes in the economy that impact employment poses a risk for ABC Kids Center. ABC Kids Center is dependent upon the needs of working parents/caregivers for childcare. A recession or company closures resulting in higher unemployment could result in fewer enrollments. This risk can be mitigated one of two ways. The first is to continue marketing efforts to a broad band of industries, so that the center is not reliant on one or two major employers in the region. The second natural outcome of fewer enrollments is a reduction in variable expenses. Staffing reductions, supplies, and food are three areas that would decline based on reduced enrollment. Detailed management of the variable costs would help to control profitability and cash flow during a downturn. Reductions to owner’s salary, capital repayment, and SEP contributions could be utilized to offset negative cash flow.

Operational Risk

Based on data from the Bureau of Labor Statistics, the early childhood education field will be a growing field for the next ten years (BLD, n.d.). The possibility exists that a new center could open within the vicinity of ABC Kids Center and could capitalize on the same target market. Pricing competition would be a potential risk. ABC Kids Center can mitigate this risk by continuing its focus on relationship building with parents and within the community. In this circumstance, the 30 year history of ABC Kids Center in the region would be an asset to new ownership as the brand has a strong, positive reputation. Other ways to mitigate this risk would be to consider offering incentives to enrollment i.e., one month free, referral bonuses, sliding scale payment schedules based on income, and discounts for multi-children families. To remain competitive, ABC Kids Center may need to lower its planned annual five percent increases in tuition.

Environmental Risk

The risk of the safety of the children at an early childhood education center is a real concern for all parents. The safety record of a center is of importance to parents and to the state regulating agency. Any real or perceived injury or significant illness for a child can result in parental dissatisfaction, state sanctions, and negative publicity for the center. ABC Kids Center will take all means necessary to ensure a safe and healthy environment for all children. The use of surveillance cameras in all of the classrooms will be continued, along with use of password protected electronic keypads at all entrances and exits for the facility. Background screening and safety training will be conducted for every employee. While every precaution will be taken to ensure the safety and well-being of the children, inadvertent accidents and mistakes do happen, which may negatively impact a child. ABC Kids Center will respond immediately and thoroughly to all incidents, while keeping parents and the state fully informed. The responsiveness and proactive steps taken by the center will help to mitigate this risk.

References

Bankrate. (n.d.). Calculator. Retrieved November 1, 2016 from: http://www.bankrate.com/calculators.aspx?ic_id=home_smart-spending_calculators_globalnav

Burke, A. (2016). The Definition of Liquidity in Finance. Small Business Chronicle. Retrieved November 1, 2016 from: http://smallbusiness.chron.com/definition-liquidity-finance-36477.html

Collier, P. M. (2015). Accounting for managers: Interpreting accounting information for decision making, 5th Edition. [VitalSource Bookshelf Online]. Retrieved from https://digitalbookshelf.argosy.edu/#/books/9781119097105/

Hoovers. (n.d.). Retrieved November 2, 2016 from: http://subscriber.hoovers.com.libproxy.edmc.edu/H/industry360/financials.html?industryId=1833

Internal Revenue Service. (n.d.). Simplified Employment Pension. Retrieved November 2, 2016 from: https://www.irs.gov/retirement-plans/plan-participant-employee/sep-contribution-limits-including-grandfathered-sarseps

Ohio Department of Jobs & Family Services. (n.d.). Childcare Center Rules. Retrieved November 2, 2016 from: http://emanuals.odjfs.state.oh.us/emanuals/GetDocument.do?docId=Document(storage%3DREPOSITORY%2CdocID%3D%24REP_ROOT%24%23node-id(493438))&locSource=input&docLoc=%24REP_ROOT%24%23node-id(493438)&version=8.0.0

Peavler, R. (2016). Contribution Margin Income Statement - Breakeven Point in Dollars. The Balance. Retrieved November 3, 2016 from: https://www.thebalance.com/contribution-margin-income-statement-393473

Small Business Administration. (2016). Business loan information for veterans. Retrieved October 31, 2016 from: https://www.sba.gov/offices/district/pa/pittsburgh/resources/sba-business-loan-information-veterans

World at Work. (2016). Base Pay for U.S. Employees Expected to Make Modest Gains in 2016. Retrieved November 2, 2016 from: https://www.worldatwork.org/adimLink?id=78999