“I’m not in the food business- I’m
in the human resources business”.
That was a comment made to me by a
McDonalds franchise owner 10 years ago. The comment has stuck with me. Fast
food restaurants have constant turnover in staff. That issues requires a huge
investment in hiring, training, evaluating- and sometimes firing- staff. So
what happens financially when you increase the hourly rate of pay across the
board?
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McDonalds hourly rate increase
McDonalds recently announced an
hourly rate increase for its workers. As stated here, the raise only applies to
the 1,500 McDonald’s-owned restaurants in the US. The raise does not apply to
franchise-owned stores, which make up 90% of the restaurants and most of the
workforce in the US.
The franchise relationship
In a franchise, an investor-
referred to as a franchisee- purchases the right to use the McDonalds brand and
operate a restaurant for a period of years. Page 45 of the McDonald’s 2013 Annual Report explains the arrangement. The franchisee pays an initial fee and
annual royalties, based on a percentage of sales. So, your royalties are an
additional expense on the franchisee’s income statement. The agreement is
typically in force for 20 years.
Wage pressures on profit
McDonalds defines margins as sales
less operating costs. In 2013, company-owner restaurants saw a 2% decrease in
margins, due in part to higher labor costs. The article explains that the
company will increase wages to “more than $10 an hour by the end of 2016- up
from $9.01 currently.” To keep things simple, call it an 11% increase in labor
costs. Consider the impact of that increase on the financials.
Profitability and cash flow
The firm’s 2013 consolidated
income statement states that payroll and employee benefits account are 17% of
sales. Now, this report includes both franchise-owned and company-owned stores.
This line item includes wages for management- as well as benefit costs that are
not payroll. But the schedule does give you a sense of how much of each sales
dollar goes toward paying employees.
Assume that, if wages increase by
11% (from about $9 to $10), the entire line item of payroll and employee benefits increases by the same percentage.
Payroll and employee benefits would increase to 19% of sales. Again, not a
perfect comparison- but you get the idea. A restaurant would spend 2% more of
every sales dollar on employee costs.
Higher payroll costs also affect
cash flow. If your costs increase by 2%, you need 2% more cash every two weeks
to make payroll- everything else being the same. Instead of plowing 2% of your
cash generation into business growth, you have to use it for payroll.
All of this is food for thought. Carefully
consider the long-term impact of a pay scale increase on
your profitability and cash flow.
Ken Boyd
St. Louis Test Preparation
Author: Cost Accounting for Dummies, Accounting
All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies (2015)
Co-Founder: accountinged.com
(amazon author page)
amazon.com/author/kenboyd
(cell) (314) 913-6529
(email) ken@stltest.net
(website) www.stltest.net
(you tube channel) kenboydstl
Image: creative commons licensed (BY
4.0) flickr photo by Sebastiaan ter Brug
https://www.flickr.com/photos/ter-burg/8969254495/
