FINE 332 8.2 Sale/Leasebacks, Budgeting, Reporting, and Variance Analysis

OVERVIEW:

As it was made clear early in the course, liquidity for a firm can mean the difference between continued operation and insolvency. Some firms, despite booking operating losses quarter after quarter, have enough liquidity to keep operating. This is because they generate enough cash to pay suppliers and make payroll.

Many firms have this seemingly irreconcilable situation because they recognize significant depreciation expenses. Since depreciation is a non-cash expense, the firm gains because it reduces its tax expense, which is paid in cash, while at the same time not incurring cash expenses that would lower its liquidity.

Some firms, as you will see in this module’s case, run low on cash because of liquidity crunches or an extended period of poor results, or both. In the case of Breed Aviation Services, the case for this module, it is the latter.

Breed was able to weather the liquidity storm by doing a sale/leaseback of its buildings. In a sale/leaseback, a firm takes fixed assets that it owns and sells them to a financing organization. The seller can make a gain on the appreciation in the value of the building plus whatever equity it made while it owned the asset. Remember that this equity was created as the firm paid down the principal on the mortgage on these assets; as principal is paid down, equity is built up.

So, the firm can get a solid cash infusion from the sale/leaseback, use it to continue operating, and make it through the storm to calmer times when it can operate profitably. Note that leasing is a form of long-term borrowing. Leasing has two major forms: operating and capital. Each of these two has certain rules that must be met to qualify as one or the other. Capital leases are kept on the balance sheet as debt and basically are funding the vast majority of the cost of the assets. Operating leases are not on the balance sheet, but instead, are reported in the notes to the balance sheet. They do not necessarily get included in debt ratios, but most equity analysts do look at the notes to include leases. After all, a lease is a debt!

While the sale/leaseback is presented to you in this module as a concept, the purpose of the module is for you to do something that is very common today – drafting a budget. Budgets are used to guide a firm’s performance targets for the year. Also, in so far as they guide the firm’s targets, they also serve as a target for the departments’ managers to meet in order to be eligible for bonuses.

In this module, you will use the variance analysis methodology to explain the factors that drove the difference between a department’s budget and its actual performance. The case for this module gives you the necessary information to accomplish this. Variance analysis is a key activity of the finance function in a corporation so it behooves us to learn how it is applied.

Also, in this module, you are asked to calculate how Jess and Isabel put together one month’s income statement. In this case, you were given the numbers and you have to back into the formulas. You will then explain how you calculated each line item.

The Bread Airport Services case contains all you need to do the work for this module.

If you want more information on the topics covered this week, you may want to check out the resources tab for a WSJ video on sale/leaseback and accompanying spreadsheet and video showing what the homeowner, Blaine Marburger, is implicitly paying. At the bottom of the resources tab are links to other resources on aircraft sale/leasebacks, other real estate’s sale/leaseback, and variance analysis. “THE FILE FOR THIS IS ATTACHED BELLOW”

QUICK RECOUSES:

WSJ Video Analysis of Sale Leaseback

This video goes over the Wall Street Journal’s video on the plane, Marburger sale leaseback individual, theydid not calculate what Blaine was paying implicitly for the sale leaseback, so in this video show, how I calculatethe implicit rate that is built into the numbers or shown for plain. Price of the home is three hundred fifteenthousand, but the lenders gave up one hundred eighty-two thousand dollars, so that’s 58 percent of the totalhome value. That hundred and eighty-two thousand dollars was used to pay the mortgage on nineteenthousand and that insight, that one nineteen fifty-eight thousand dollars, that’s already victim, they’re notseparate. Then there was a debt repayment to thirty thousand and then a processing fee. Seventy-eighthundred forty-two thousand eight hundred, that leftover cash and pocket for Blaine, twenty-five thousand twohundred. I’m assuming that the debt repayment was used to pay debts owed owed and that twenty-fivethousand went straight into his pocket for consumption going forward and expenses will have in the future. So,the 58 percent, 50 percent would pay debt and fees. Eight percent went into Blaine’s pocket. OK, Blaine has apurchase option in 12 to 16 months of hundred and eighty-seven thousand dollars. And he’s going to pay amonthly rental of 60 hundred dollars, so let’s run on the cash flows at the start, Blaine gets a loan or basicallycash equivalent of the mortgage, which is one hundred nineteen thousand plus the debt repayment of thirtythousand plus a cash left, just thirty-five thousand dollars and. That’s the payment that he receives, thedifference between one hundred seventy-four thousand two hundred and eighty-two thousand given to him isthe seventy-eight hundred fifty. So, we never see someone. OK, so we know we’re coming down. Now everymonth you pay six hundred dollars and you’ll be paying that for a six month. In 16 months, he will assume thathe buys the whole four hundred eighty-seven thousand dollars, he makes the final rental payment. Sixteenhundred, and he pays one hundred eighty-seven thousand dollars for a total amount of one eighty-eight sixhundred. Those are all cash outflows, so they’re all negative. I ran IRR function, and I just ran the normal IRRfunction, which is just one plus IRR all these cash flows. Then, everything for the 12 months, and I get that theIRR kind of implicit rate at seventeen-point two percent can also run what is called the X IRR function X IRRactually used as dates. So I use some sample date so that he borrowed the money on December thirty firsttwenty eighteen and then paid rent over the next six months, at the end of the month, and then the XIRRfunction has in its first argument, it’s the payments made, second argument are the dates, the third argumentsused, the guess that you can give it, like I said, 20 percent, but you could work with something. There’s a slightdifference between the XIRR and the IRR. So, it’s very small. But effectively, let’s just say that for the purposesof Blaine, he’s borrowing seventeen-point three percent mortgage on this home and it’s quite high. But he is introuble, and he made his choice. It’s too bad that he has to pay so much, but so it is. The Wall Street Journal Breed Airport Services
2020 Preliminary Financials
December
22,154
28,989
(6,835)
12 mos.
310,156
536,297
(226,141)
– S,G & A Expenses
= EBITDA
58,032
(64,867)
574,517
(800,657)
– Interest
– Depreciation/Amortization
= EBT
2,000
15,344
(82,211)
27,400
184,128
(1,012,185)
– Taxes
= Net Income
(17,264)
(64,947)
(212,559)
(799,626)
Net Sales
– Cost of Goods Sold (COGS)
= Gross Profit
Breed Airport Services
Balance Sheet
(in ‘000 $)
Cash & Securities
Receivables
Inventory
Other
Current Assets
Fixed Assets
Total Assets
Payables
Accruals
Other Current
Building Sale &
Leaseback
12/31/20
25
142
250
182
52
509
884
(566)
1,393
Current Liabilities
Long Term Debt
Equity
Total Liabilities and Equity
74
48
41
163
890
340
1,393
Debt to Equity
3.10
(550)
126
Receivables
1/1/21 Collection
167
234
250
(237)
182
52
651
318
969
74
48
41
163
340
466
969
1.08
Note: 1/31/21 balance sheet does not reflect January 2021 financial results.
(2)
1/31/21
401
13
182
52
651
318
969
74
48
41
163
340
464
969
1.09
Breed Airport Services
Accounts Receivable
(in ‘000 $)
Month
December
(A)
Receivables
250.0
(B)
Month’s Sales
22.0
(A)/(B)
Days Receivables
340.9
Historical
13.2
22.0
18.0
Must collect
236.8
Breed Airport Services
2021 Financials
Net Sales
– Cost of Goods Sold (COGS)
= Gross Profit
January
55,982
24,311
31,671
%
100%
43%
57%
February
58,221
25,162
33,059
%
100%
43%
57%
Jan.
1,866
13,200
7.1
Feb.
1,941
34,933
18.0
Daily Sales
BS Rec.
DOH
Rec.
– S,G & A Expenses
= EBITDA
18,448
13,223
33%
24%
18,632
14,427
32%
25%
810
182,000
224.6
839
187,000
223.0
Daily COGS
BS Inv.
DOH
Inv.
– Interest
– Depreciation/Amortization
= EBT
2,000
1,344
9,879
4%
2%
18%
2,000
1,344
11,083
3%
2%
19%
1,866
52,000
27.9
1,941
54,000
27.8
Daily Sales
BS Other
DOH
Other
– Taxes
2,075
4%
2,327
4%
= Net Income
7,804
14%
8,756
15%
1,425
74,000
51.9
1,460
84,000
57.5
Daily Exp.
BS Pay. Payables
DOH
1,425
48,000
33.7
1,460
55,000
37.7
Daily Exp.
BS Accr. Accruals
DOH
1,425
41,000
28.8
1,460
47,000
32.2
Daily Exp.
BS Other
DOH
Other
Curr.
Breed Airport Services
Balance Sheet
(in ‘000 $)
Cash & Securities
Receivables
Inventory
Other
Current Assets
Fixed Assets
Total Assets
Payables
Accruals
Other Current
Current Liabilities
Long Term Debt
Equity
Total Liabilities and Equity
1/31/21
401
13
182
52
651
318
969
%
41%
1%
19%
5%
67%
33%
100%
2/28/21
412
35
187
54
687
311
998
%
41%
3%
19%
5%
69%
31%
100%
74
48
41
163
340
464
969
8%
5%
4%
17%
35%
48%
100%
84
55
47
186
340
472
998
8%
6%
5%
19%
34%
47%
100%
Breed Airport Services
2019 Actuals
Net Sales
– Cost of Goods Sold
= Gross Profit
January
68,922
30,326
38,596
February
58,221
25,162
33,059
March
61,715
26,913
34,802
April
66,035
28,797
37,238
May
70,657
30,813
39,844
June
76,310
33,278
43,032
July
81,651
35,607
46,044
August
86,550
37,744
48,807
September
90,878
39,631
51,247
October
87,243
38,003
49,240
November
83,753
36,519
47,234
December
74,540
32,501
42,039
Total
906,474
395,292
511,182
– S,G & A Expenses
= EBITDA
20,677
17,920
18,632
14,427
19,132
15,669
20,472
16,766
21,905
17,940
23,657
19,375
25,313
20,731
26,832
21,975
28,173
23,074
27,156
22,084
25,978
21,257
23,122
18,918
281,048
230,134
– Interest
– Depreciation/Amort.
= EBT
2,500
1,455
13,965
2,000
1,455
11,083
2,179
1,455
12,035
2,179
1,455
13,132
2,179
1,455
14,305
2,179
1,455
15,741
2,179
1,455
17,097
2,179
1,455
18,341
2,179
1,455
19,439
2,179
1,455
18,450
2,179
1,455
17,622
2,179
1,455
15,283
26,293
17,460
186,492
– Taxes
= Net Income
2,933
11,032
2,327
8,756
2,527
9,508
2,758
10,374
3,004
11,301
3,306
12,435
3,590
13,506
3,852
14,489
4,082
15,357
3,874
14,575
3,701
13,922
3,209
12,074
39,163
147,329
4.0%
6.0%
7.0%
7.0%
8.0%
7.0%
6.0%
5.0%
-4.0%
-4.0%
-11.0%
Net Sales
– Cost of Goods Sold
= Gross Profit
100%
44%
56%
100%
43%
57%
100%
44%
56%
100%
44%
56%
100%
44%
56%
100%
44%
56%
100%
44%
56%
100%
44%
56%
100%
44%
56%
100%
44%
56%
100%
44%
56%
100%
44%
56%
100%
44%
56%
– S,G & A Expenses
= EBITDA
30%
26%
32%
25%
31%
25%
31%
25%
31%
25%
31%
25%
31%
25%
31%
25%
31%
25%
31%
25%
31%
25%
31%
25%
31%
25%
– Interest
– Depreciation/Amort.
= EBT
4%
2%
20%
3%
2%
19%
4%
2%
20%
3%
2%
20%
3%
2%
20%
3%
2%
21%
3%
2%
21%
3%
2%
21%
2%
2%
21%
2%
2%
21%
3%
2%
21%
3%
2%
21%
3%
2%
21%
– Taxes
= Net Income
4%
16%
4%
15%
4%
15%
4%
16%
4%
16%
4%
16%
4%
17%
4%
17%
4%
17%
4%
17%
4%
17%
4%
16%
4%
16%
Sales growth rate
Breed Airport Services
Balance Sheet
Cash & Securities
Receivables
Inventory
Other
Current Assets
Fixed Assets
Total Assets
1/31/21
401
13
182
52
651
318
969
%
41%
1%
19%
5%
67%
33%
100%
2/28/21
412
412
311
722
%
57%
0%
0%
0%
57%
43%
100%
Feb. Days on
Hand (DOH) Explanation of methodology
1/31 Cash + [Feb. Net Income + Feb. Depreciation/Amortization]/1000
[Feb. Sales/30]*Receivables DOH/1000
[Feb. COGS/30]*Inventory DOH/1000
[Feb. Sales/30]*Other Current Assets DOH/1000
Sum
1/31 Fixed Assets – [Feb. Depreciation/Amortization]/1000-6000 write-off
Sum
Payables
Accruals
Other Current
Current Liabilities
Long Term Debt
Equity
Total Liabilities and Equity
74
48
41
163
340
464
969
8%
5%
4%
17%
35%
48%
100%
340
472
812
0%
0%
0%
0%
47%
65%
112%
[Feb. COGS+Feb. SG&A]/30]*Payables DOH/1000
[Feb. COGS+Feb. SG&A]/30]*Accruals DOH/1000
[Feb. COGS+Feb. SG&A]/30]*Other Current DOH/1000
Sum
No change
1/31 Equity + Feb. Net Income/1000
Sum
(in ‘000 $)
Breed Airport Services
2021 Budgets
Net Sales
– Cost of Goods Sold
= Gross Profit
Actuals
January
% February
%
55,982 #### 59,221 ####
24,311 43% 26,162 44%
31,671 57% 33,059 56%
– S,G & A Expenses
= EBITDA
18,448
13,223
33%
24%
19,632
13,427
33%
23%
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
– Interest
– Depreciation/Amort.
= EBT
2,000
1,344
9,879
4%
2%
18%
2,000
1,344
10,083
3%
2%
17%
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
– Taxes
= Net Income
2,075
7,804
4%
14%
2,117
7,966
4%
13%
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
####
March
%
####
####
####
April
%
####
####
####
May
%
####
####
####
June
%
####
####
####
July
Budgets
% August
%
####
####
####
####
####
####
Sept.
%
####
####
####
Oct.
%
####
####
####
Nov.
%
####
####
####
Dec.
%
####
####
####
Total
%
####
####
####
MRO Department – 2020 Results
Revenues (billed out):
– Labor (hrs.)
– Labor rate ($/hr.)
– Parts ($/hr.)
Costs:
– Labor (hrs.)
– Labor ($/hr.)
– Parts (% of revenue)
Budget
3,641
120
344
Actual
3,654
121
322
Fav./(Unfav.)
13
1
(22)
3,980
45
78%
3,916
42
75%
(64)
(3)
-3%
Revenues:
– Labor
436,920
– Parts
1,252,504
Total Revenues 1,689,424
Costs:
– Labor
179,100
– Parts
976,953
Total Costs 1,156,053
$ Fav./(Unfav.)
442,191
5,271
1,178,092
(74,412)
1,620,283
(69,141)
166,211
882,143
1,048,354
(12,889)
(94,810)
(107,699)
Gross Margin
Overhead:
– Space
– General & Admin.
– Depreciation
– Legal & Regulatory
Total Overhead
533,371
571,929
38,558
75,000
35,000
68,500
18,000
196,500
75,000
35,000
68,500
18,000
196,500
–
Net before Taxes
Taxes
Net after Taxes
336,871
70,743
266,128
375,429
78,840
296,589
38,558
8,097
30,461
Change in Gross M
Labor Variance
Revenue (hrs.)
Rate ($/hr.)
Costs (hrs.)
Labor ($/hr.)
Total
Change in Gross Margin
38,558
Parts Variance
Revenue (hrs.)
Revenue ($/hr.)
Costs (hrs.)
Costs ($/hr.)
Mark-up
Other
Total
No content – Intentionally left blank
Breed Airport Services: Sale/Leasebacks,
Budgeting, Reporting, and Variance Analysis
Alfonso F. Canella Higuera
October 19, 2021
Without a doubt, 2020 was a horrible year for the world’s economies and in particular for
the aviation industry. Jess Breed thought her fixed-base operation (FBO), Breed Airport Services,
would not make it to 2021 in one piece but it did. Breed made it, burned a lot of cash in process and
was now in peril of defaulting on its bank debt. Things were desperate and called for thinking of a
new strategy to save the firm.
Having operated her FBO for years, saving every possible dollar and reinvesting it in the
operation had given Jess the cushion necessary to weather a year-long storm. She always thought
that there would be another possible Sept. 11th ahead, but she never thought it would be a virus that
would send the industry into a tailspin.
The cause didn’t matter, though. Jess salvaged the business by using up almost all the cash
she had reinvested into Breed over 20 years. Now, 2021 was dawning and everyone was hopeful
that it would be a different case. It was time!
Looking at the fiscal year end (FYE) preliminary numbers, Jess winced at the brutal results
for the year:
Breed Airport Services
2020 Preliminary Financials
December
22,154
28,989
(6,835)
12 mos.
310,156
536,297
(226,141)
– S,G & A Expenses
= EBITDA
58,032
(64,867)
574,517
(800,657)
– Interest
– Depreciation/Amortization
= EBT
2,000
15,344
(82,211)
27,400
184,128
(1,012,185)
– Taxes
= Net Income
(17,264)
(64,947)
(212,559)
(799,626)
Net Sales
– Cost of Goods Sold (COGS)
= Gross Profit
As if the income statement weren’t terrifying enough, the balance sheet looked even bleaker
as the company’s liquidity had dropped precipitously. Cash balances had dropped to $25,000 from
previous levels of over $550,000. The company had $890,000 in debt and equity had fallen to one
fourth what it had been at the start of 2020. Jess had a lot of work to do to fix the balance sheet!
Jess’s daughter, Isabel, had spent the fall semester of 2020 at home as her university had
closed down. Even though she was taking a full course load, she always made the time to help at
the FBO whether it was running the front desk, fueling planes, taking service orders, and learning
about avionics.
That fall term, Isabel was taking a history of aviation course when she came across the story
of Pan American Airways. Pan Am, as it was called, was considered in its heyday one of the classiest
airlines in the industry. Its Clipper service was considered the standard for luxury and efficiency
and it boasted of a round-the-world single price ticket. More importantly, Pan Am had
revolutionized air travel with the use of jet airplanes, jumbo jets, and electronic seat reservations.
Despite all these advances, Pan Am fell on hard times during the 1970s as a result of the spike in oil
prices. In fact, the airline’s financial position had deteriorated so much that it had to sell its iconic
Pan Am building on Park Avenue in New York City to Met Life, an insurer, in 1981 for $400
Million.
Source: Library of Congress.
At the time, $400M was a fortune (well, it is today too but it was a much bigger one then)
and Pan Am was able to continue operating for another 10 years after selling the building – such was
the impact on the company’s liquidity. Still, by 1991, the liquidity had run out and Pan Am filed for
bankruptcy. It was the third airline to go bankrupt that year as Eastern Air Lines and Midway
Airlines had also previously filed for bankruptcy. (Parenthetically, following bankruptcy, Pan Am’s
assets were bought by Delta Airlines.)
Page 2 of 14
Airlines come and airlines go and Pan Am’s demise was a sad event but Isabel discerned a
nugget of truth about how Pan Am managed that demise. This truth could conceivably be used to
throw her mother’s business a lifeline. What if Breed sold its buildings and leased them back, just
like Pan Am had done?
The next morning at the breakfast table, Isabel suggested a sale/leaseback to Jess. She knew
enough about Breed to know that although the business was borderline illiquid, it was certainly asset
rich. It was time to sell those assets for much needed cash.
Four months later, Jess closed the sale/leaseback of the buildings where the FBO operated.
Jess and Isabel celebrated the event eating Milky Way ice cream and watching Tom Hanks star in
Sully. When all was said and done, the balance sheet looked like this:
Breed Airport Services
Balance Sheet
(in ‘000 $)
Cash & Securities
Receivables
Inventory
Other
Fixed Assets
Total Assets
Payables
Accruals
Other Current
Current Assets
Building Sale &
Leaseback
12/31/20
25
142
250
182
52
509
884
(566)
1,393
Current Liabilities
Long Term Debt
Equity
Total Liabilities and Equity
74
48
41
163
890
340
1,393
Debt to Equity
3.10
(550)
126
1/1/21
167
250
182
52
651
318
969
74
48
41
163
340
466
969
1.08
The sale/leaseback could be summarized as follows:
• the buildings were sold for a net $692,000, of which:
o $550,000 was used to pay down the mortgage
o $142,000 went into Breed’s bank account
• the appreciation of the buildings went into Breed’s equity – the formula for the
appreciation is $692,000 – $566,000 (i.e. the book value) = equity gain
Page 3 of 14
Jess knew that Isabel’s suggestion had saved Breed but there was a lot more to be done. With
2021 starting and people itching to get out and about, the aviation industry was looking to get some
of its life back. Still, there were problems and they loomed large – receivables had ballooned to 341
days as customers had strayed from paying back:
Breed Airport Services
Accounts Receivable
(in ‘000 $)
Month
December
(A)
Receivables
250.0
(B)
Month’s Sales
22.0
(A)/(B)
Days Receivables
340.9
Historical
13.2
22.0
18.0
Must collect
236.8
Jess had two choices, she could visit those clients that owed her money and press them to
pay and/or she could sell some of the receivables to a factor. Since she knew her clients a lot better
than any factor, she decided to visit those that she knew had received government stimulus funds
(about 90%) and offer them a one-time 5% discount if they paid right then and there. For the
remaining 10%, she would sell the receivables to a factor at a 10% discount.
She was fairly certain that she could make a go of this but nonetheless she enlisted Isabel to
look at the numbers and make observations. Isabel knew how much business they had done with
her mother and she also knew many of them from her days working at the front desk. She realized
that these clients were fairly well off (even though they had taken a hit during the pandemic
nonetheless) and were men and women “of their word”. She suggested to her mother that they not
sell anything to the factor. She also suggested they ask for 100% of what was due and settle, if
necessary, for 95% of the receivable. She volunteered to go on the client visits and be presented not
just as the daughter but also as the keeper of the books. She argued that it’s hard to lose face to two
people rather than just one. She would prove to be right.
Over the four weeks, Jess and Isabel visited their clients and when all was said and done,
they were able to collect 99% of the receivables. Mind you, Jess and Isabel though that it would be
highly improbable that they’d be able to get 93% if that, but Jess admitted that the clients were, as
Isabel had aptly observed, people of “their word”.
So, of the $236,800 that needed to be collected to get Breed back to its historical average of
18 days receivables, Jess and Isabel managed to collect $234,432. So, in the shuffle, Breed took a
book loss of $2,368 – the difference between the $236,800 it was owed and the $234,432 it finally
collected. This number wasn’t just more than all the cash the company had at year end after the
sale/leaseback, it also happened to be palindromic. Jess and Isabel took it as an omen of better times
ahead.
Page 4 of 14
With the late receivables collected, Breed was now in a much better position to enter 2021
and get back to normal. Just as importantly, its cash position was much improved:
Breed Airport Services
Balance Sheet
(in ‘000 $)
Cash & Securities
Receivables
Inventory
Other
Fixed Assets
Total Assets
Current Assets
12/31/20
25
250
182
52
509
884
1,393
Payables
Accruals
Other Current
Current Liabilities
Long Term Debt
Equity
Total Liabilities and Equity
74
48
41
163
890
340
1,393
Debt to Equity
3.10
Building Sale &
Leaseback
142
(566)
(550)
126
1/1/21
167
250
182
52
651
318
969
Receivables
Collection
234
(237)
74
48
41
163
340
466
969
(2)
1.08
1/31/21
401
13
182
52
651
318
969
74
48
41
163
340
464
969
1.09
It was now time to focus on the 2021 budgets. Jess had not had a chance to get them done
in 2020 because what was the point of doing that when the company was on the verge of insolvency?
With Isabel’s help, she put together the January and February actuals quickly:
Breed Airport Services
2021 Financials
Page 5 of 14
Net Sales
– Cost of Goods Sold (COGS)
= Gross Profit
January
55,982
24,311
31,671
%
100%
43%
57%
February
58,221
25,162
33,059
%
100%
43%
57%
– S,G & A Expenses
= EBITDA
18,448
13,223
33%
24%
18,632
14,427
32%
25%
– Interest
– Depreciation/Amortization
= EBT
2,000
1,344
9,879
4%
2%
18%
2,000
1,344
11,083
3%
2%
19%
– Taxes
= Net Income
2,075
7,804
4%
14%
2,327
8,756
4%
15%
It was Isabel that suggested doing a common size per cent column for the income statement.
That way, Jess could quickly glimpse how Breed’s margins were doing. Also, this made it easier to
draw up budgets going forward as she could use the percentages to drive them.
Again, with Isabel’s help, she took the January and February financials and drew up the
February balance sheet, also common sized:
Breed Airport Services
Balance Sheet
(in ‘000 $)
Cash & Securities
Receivables
Inventory
Other
Current Assets
Fixed Assets
Total Assets
Payables
Accruals
Other Current
Current Liabilities
Long Term Debt
Equity
Total Liabilities and Equity
1/31/21
401
13
182
52
651
318
969
%
41%
1%
19%
5%
67%
33%
100%
2/28/21
412
9
188
54
663
317
979
%
42%
1%
19%
6%
68%
32%
100%
74
48
41
163
340
464
969
8%
5%
4%
17%
35%
48%
100%
76
49
42
167
340
472
979
8%
5%
4%
17%
35%
48%
100%
The new view of the common sized balance sheet was helpful. With it, Jess quickly realized
that Breed was running about 50% debt and 50% equity. The banks liked that Breed was reducing
its leverage and he could use it in the future to line up lower interest rates to reduce costs.
Looking ahead, Jess resolved to reduce Breed’s debt position so that she could weather future
economic upheavals. She understood that the cost of debt is much lower than the cost of equity but
her business depended less on profit maximization and more on her doing what she wanted –
working with people that shared her love of flying airplanes. And now, she was getting the
impression that her daughter was taking a shine to the business. Not just that, she was very good at
it. Her suggestions made her life considerably easier and now she hoped that she would eventually
run the business alongside her when she finished college.
With the February financials put to bed, it was time to do the monthly budgets for the
remaining 10 months of the year. After some discussion with Isabel, who was now the de facto
CFO, Jess decided to use the common size income statement to drive the process. First, however,
she needed to look at a normal year and use that as reference for the monthly budgets.
Page 6 of 14
The reason for looking at past performance is that Jess knew that her business had a
seasonality. People flew more and more often during the summer months and much less during the
winter months. She wanted to inform her monthly budgets with that seasonality and blend that
seasonality with the slow improvement she was seeing in the economy in 2021 as the pandemic
started to wane.
After reviewing the FAA’s forecasts for general air travel and some discussions with clients
and suppliers, Jess and Isabel decided to assume the following revenue growth rates from one month
to the next:
March
+6%
August
+6%
April
+7%
September
+5%
May
+7%
October
-4%
June
+8%
November
-4%
July
+7%
December
-11%
To look at Breed’s seasonality, they put the 2019 numbers on the dining room table along
with their table for 2021. They got to work on the 2021 budget now that the company was back on
firm footing.
After completing the 2021 monthly budgets, Isabel then tackled the variance analysis system
that Jess had implemented years before. This system would help allocate bonuses amongst Breed’s
maintenance, repair and overhaul (MRO) unit’s staff.
The MRO unit did brisk business, was very profitable and cross-subsidized the fuel
operation, which operated at a break-even. So, the financial performance of the unit was of
primordial importance to Breed. Just as importantly, it was paramount to offer the right incentives
to the staff at the shop. They had to feel invested in the performance of their unit and, as such,
should receive bonuses that reflected the unit’s performance.
Breed was strictly a local operation that served a limited clientele of middle-class enthusiasts
that flew elderly single-engine planes. This clientele would go out for a few hours per week, basically
out-and-back, and spend most of their time “hangar flying”. Jess was fine with that as this was her
cohort – no frills, laid back, and flying for the enjoyment.
Jess did not operate a flight school but she did host instructors that used her hangar and tiedowns to park their aircraft. She had once toyed with the idea of selling aircraft but the capital
requirements to meet the minimum inventory of planes quickly put paid to that dream. For her,
Breed was more a calling than a business and yet she understood that hobbies can become money
pits if they weren’t run in the black. And she intended to keep Breed in the black.
Breed’s MRO unit had two head mechanics, Mark and Shane, working 48-hour weeks. They
were paid well but did not get benefits such as health insurance, paid time off, or sick time. As they
explained it: “we eat what we kill.” This was a cut-throat business and clients could go anywhere
for repair work. Depending on the airport’s location, the competition could be fierce, and Breed was
Page 7 of 14
in one of those competitive locations. Costs had to be kept strictly in check in order to make a go of
it and proper budgeting and variance analysis was a way to ensure that.
As said, the vast majority of the aircraft tied down in the airport were elderly and tended to
require more work than newer aircraft. Mark and Shane knew that and over the years had earned a
reputation for high quality work that was reasonably priced with quick turn-around times.
Mark and Shane were eligible for bonuses to top up their pay and since the bonuses worked
off how they ran the operation themselves and the bonus rules were unambiguous and numeric, the
two were happy with the arrangement. Most other units in other FBOs did not get this sort of leeway
but Jess preferred it that way and the system worked – the two mechanics had worked for Breed for
25 and 30 years each.
Under this system, Mark and Shane were not going to leave, forcing Jess to hire new, untested
mechanics – an expensive and uncertain proposition. Also, Mark and Shane were like part of the
family and Jess treated them like what they were – those ensuring the safety of the flying public.
Aside from serving as brand ambassadors with the clients, the unit performed the following
tasks for these clients:
•
•
•
•
•
•
Mechanical and electrical diagnoses
Repair and overhaul of engines
System maintenance
Engine and avionics testing and updating
Assembly and installation of instruments
Recording of maintenance and repair work
Jess not only gave operating leeway to her mechanics but also offered them a transparent
view of the FBO’s overall cost structure. The way she saw it, if the mechanics knew exactly the
costs associated with running Breed, they could come up with novel and practical ideas on how to
reduce those costs. The way the system worked, the FBO would share in whatever cost savings
were achieved with the two head mechanics and their staff.
Breed had a simple profit-sharing system that was based on unit performance versus budget.
The system worked as follows:
Profit over Budget
0 – 5.0%
5.1 – 8.0%
8.1 – 11.0%
> 11.1%
< 0% Bonus $5,000 + 2%* $10,000 + 5%* $15,000 + 9%* $20,000 + 12%* $0 * of the dollar variance to budget Mark and Shane had operating control over everything above the gross margin line except for the labor rate charged per hour ($120). Jess knew it was her business and even though Mark and Page 8 of 14 Shane handled the day-to-day operation, she was the one responsible for the FBO’s financial health and, perhaps just as importantly, its relationship with its clients. The $120/hr. rate was lower than that charged at other FBOs in the area and Jess took pride in that. Deep down, though, Jess suspected that Mark and Shane would raise their rates and put Breed on the slippery slope to maximizing profits and driving away many of its more cash-strapped clients. Jess was transparent and she wanted that transparency to inform its mission of serving its existing client base with an affordable, high-quality service. To make up for the lower labor rates charged, Jess kept close controls on overhead. It was this lower-than-average overhead that gave Breed its ability to operate in such a competitive market. And it was this attitude that factored in Jess’s decision not to become a more full-fledged FBO, with its high capital requirements (and the costs that came with them), a more impersonal service (as it was, Jess was a fixture at the hangar flying bull sessions), and corporate profit targets (those were the beginning of the end in Jess’s mind.) For their part, Mark and Shane knew what a good deal they had. In the past, they had tested the market to see what it was offering in terms of wages and had found out that they were on the high end of the pay scale for mechanics. Not just that, just about no other FBO offered up bonuses for performance. They realized how much real operating power Jess had handed to them. Plus, they also realized that they enjoyed hanging out at the hangar after hours with Jess and the pilots. So, Breed was a bit like a family but with the added advantage that they had chosen it and not had it thrust upon them! Mark and Shane knew they had good numbers for 2020 despite the pandemic and they looked forward to the meeting with Jess to confirm all this. They knew that despite the pandemic, their clients had continued flying as for many of them, it was almost impossible to infect anyone when they were up in their cockpits thousands of feet above ground. Further, many of the clients had taken to flying even more hours in order to escape the oppression of being home bound for weeks on end. So, in a perverse way, the pandemic had actually turbo-charged the operation by having the clients fly more and more often, thus needing more repair and maintenance services. Mark and Shane were quite familiar with the variance analysis system that Jess had implemented and they knew Breed’s results for the year. Still, the meeting, while a formality, came as a relief to everyone as everyone knew that Breed had dodged a bullet in 2020 due to the pandemic. They were familiar with their department’s cost structure and had a reasonable knowledge of the firm’s overall cost structure. Still, what they did not know was just how low the firm’s liquidity levels were, all thanks to the pandemic. In particular, they were not quite as aware of the firm’s slowdown in collecting receivables. They had thought all along that payments were being made by clients as they received their invoices. Clearly, no one had said anything during the bull sessions in the hangar. So, it came as a shock when Jess and Isabel informed them that the firm was inches away from insolvency and was rescued by the sale/leaseback and the collection of receivables from customers flush with government cash that pumped liquidity into the economy. So, after all this was mentioned, Mark and Shane thought there would be no bonuses this year. Jess quickly clarified that they had done well, as everyone well knew, and the firm would Page 9 of 14 share in the profits as this was the basis for continued operation in the future. So, they all sat down and went over the departments results, which were as follows: Revenues (billed out): - Labor (hrs.) - Labor rate ($/hr.) - Parts ($/hr.) Costs: - Labor (hrs.) - Labor ($/hr.) - Parts mark-up Budget 3,456 120 345 Actual 3,648 120 320 Fav./(Unfav.) 192 (25) 3,840 42 80% 3,877 44 77% 37 2 -3% Revenues: - Labor 414,720 - Parts 1,192,320 Total Revenues 1,607,040 Costs: - Labor 161,280 - Parts 953,856 Total Costs 1,115,136 $ Fav./(Unfav.) 437,760 23,040 1,168,092 (24,228) 1,605,852 (1,188) 168,650 899,431 1,068,080 7,370 (54,425) (47,056) Gross Margin Overhead: - Space - General & Admin. - Depreciation - Legal & Regulatory Total Overhead 491,904 537,772 45,868 75,000 35,000 68,500 18,000 196,500 75,000 35,000 68,500 18,000 196,500 - Net before Taxes Taxes Net after Taxes 295,404 62,035 233,369 341,272 71,667 269,605 45,868 9,632 36,235 As Mark and Shane were measured up to the gross margin line for their bonus, the data showed that they were 9.3% to the better on the budget. So, they would be receiving: Item Mark Shane Base bonus $15,000 $15,000 Profit share (9% of favorable gross margin dollars) $4,128 $4,128 Total $19,128 $19,128 Page 10 of 14 As part of the meeting, Jess showed Mark and Shane how the variances worked for 2020. Parts and labor were the two variances which were on the table as explanations of the performance for the year. Jess also noted that the gross margin gains were due ⅓ from gains in the use of labor and ⅔ from gains in the sales of parts. Jess noted that increased billed hours as a percent of total available labor hours had gone up and made up most of the labor variance gain. She was pleased that Mark and Shane had understood that idle time was basically overhead and that being busy working on customers’ aircraft was a surefire way of beating the budget targets for revenue. Mark and Shane said that they understood that clearly and that they were happy, at the same time, that Jess had kept labor charges to clients at $120/hr. thus bringing in more business for them to work on. Clearly, the labor variance showed the benefits of Jess’s vision of entrusting the mechanics to do the work and for her to set rates that made them competitive. The parts variance was a bit more complicated as the parts revenue per service hour had fallen. Mark and Shane noted that one of the key reasons for this variance was the increased usage of imported parts, which came at lower price points. The meeting closed with Jess handing Mark and Shane their bonus checks and all three agreeing that 2020 was an excellent year despite the pandemic. They looked forward to 2021 with great hope. Case Questions Use the yellow colored tabs in the Breed template to: • prepare the March - December budgets using the data provided in the template. Provide a one-page, bulleted listing of what drove your assumptions and why you made them. You must show ALL formulas to receive ANY credit. The last two pages in this case provide a model for completing this part but do not represent the numbers you must use; the numbers you must use are in the template • use formulas to calculate the 2/28/21 balance sheet in the template and EXPLAIN your methodology in the column provided. In other words, you will be doing the work that Jess and Isabel did in the case • calculate the variances outlined in the template using the numbers shown in it. Note that at all times, you must tie to the income statement $ favorable/(unfavorable) variances: In doing this work, keep in mind the various formulas for variances. These are shown below to make your calculations easier. Also, as part of this exercise, you will enter the data presented in the case. Make sure to use the following notation – red numbers are manual inputs of numbers and black numbers are formulas. The table is formatted already and will guide you as to which is which. All variances will use formulas and hard coded numbers will not be accepted. Page 11 of 14 Finally, please submit a summary evaluation of how Mark and Shane did and WHY they got the results they go. So, in effect, you will translate the variance analyses you made into English to explain what happened during 2020 in the MRO unit. You have been given a space to do this in the template provided for Breed. Labor Revenues Revenue (hrs.) = [Actual Labor (hrs.) – Budget Labor (hrs.)] x Budget Labor Rate ($/hr.) Rate ($/hr.) = [Actual Labor Rate ($/hr.) – Budget Labor Rate ($/hr.)] x Budget Labor (hrs.) Costs Costs (hrs.) = [Budget Labor Costs (hrs.) – Actual Labor Costs (hrs.)] x Actual Labor Costs ($/hr.) Labor ($/hr.) = [Budget Labor Costs ($/hr.) – Actual Labor Costs ($/hr.)] x Budget Labor Costs (hrs.) Parts Revenues Revenue (hrs.) = [Actual Labor (hrs.) – Budget Labor (hrs.)] x Budget Parts ($/hr.) Revenue ($/hr.) = [Actual Parts ($/hr.) – Budget Parts ($/hr.)] x Actual Labor (hrs.) Costs Costs (hrs.) = [Actual Revenue Labor (hrs.) – Budget Revenue Labor (hrs.)] x Budget Revenue Parts ($/hr.) x Budget Parts Mark-up Costs ($/hr.) = [Actual Revenue Parts ($/hr.) – Budget Revenue Parts ($/hr.)] x Budget Revenue Labor (hrs.) x Budget Parts Mark-up Mark-up = [Actual Parts Mark-up – Budget Parts Mark-up] x Budget Revenue Labor (hrs.) x Budget Revenue Parts ($/hr.) Other = this is a balancing variance that allows for the sum of the variances tie to the calculated parts variance Page 12 of 14 Page 13 of 14 Page 14 of 14 Blaine Marburger Sale/Leaseback Home value Sale price Home Value 315,000 % 182,000 58% Sale price is used to pay: Mortgage Debt repayment Processing fee Total 119,000 30,000 7,800 156,800 38% 10% 2% 50% Cash left over for Blaine 25,200 8% Blaine purchase option (12-16 months) Monthly rental rate 187,000 1,600 Implicit interest rate (annualized) IRR= XIRR= 17.2% 17.3% Cash flows: Month Date $ Start 12/31/2018 174,200 1 1/31/2019 (1,600) 2 2/28/2019 (1,600) 3 3/31/2019 (1,600) 4 4/30/2019 (1,600) 5 5/31/2019 (1,600) 6 6/30/2019 (1,600) 7 7/31/2019 (1,600) 8 8/31/2019 (1,600) 9 9/30/2019 (1,600) 10 10/31/2019 (1,600) 11 11/30/2019 (1,600) 12 12/31/2019 (1,600) 13 1/31/2020 (1,600) 14 2/28/2020 (1,600) 15 3/31/2020 (1,600) 16 4/30/2020 (188,600) back Notes Mortgage+Debt repayment+cash left over Monthly rent Rent + Purchase option