Melanie Martinez sighed as she reviewed the profit-loss statement for past month. Her shop, Shear Heaven, started out strong nine months ago, but profits have declined over the past couple of months.

Melanie opted to attend cosmetology school when she completed high school. She worked for another salon for six years before striking out on her own and opening Shear Heaven, a salon specializing in haircuts. Her youth and relatively limited experience made it difficult to acquire outside funding at rates she considered reasonable, so she chose to limit services initially so she could get started without a lot of money. Her start-up capital consisted entirely of personal savings plus a small sum of money her family gave her. Her goal is to eventually be able to operate a full-service salon, but to acquire the financing to expand she needs to prove she can operate her current business successfully.

You and Melanie have been friends since childhood, and you are a Shear Heaven customer. You also completed an accounting degree a few months ago. During a recent visit to the shop, Melanie asked if you would be willing to take a look at her salon’s operational results and help her understand the salon’s revenues and costs. Melanie also asked for a few suggestions to improve profitability.   You’re excited about an opportunity to use what you’ve learned to help a friend, and you agree.

OPERATING INFORMATION

The profit/loss statements for the most recent three months appear in Table 1, presented at the end of the case. In addition to the financial statements, Melanie has provided you with some additional operating information.

Revenues: Melanie charges $15 for a short/medium haircut and $25 for a long haircut.

Direct Materials: Shampoo and conditioner come in gallon-sized pump dispensers. Each gallon yields 128 ounces of shampoo or conditioner. Shampoo costs $12.80 per gallon, and conditioner costs $19.20 per gallon. Short/medium hair requires approximately ¾ of an ounce each of shampoo and conditioner. Long hair requires 1¼ ounces each of shampoo and conditioner.

Styling product (mousse, gel or hairspray) costs $2 for an 8-ounce can. Approximately 75% of customers request styling product. Short/medium hair requires ½ ounce of product and long hair requires 1 ounce of product.

Technicians: Unlike some salons, Melanie’s technicians are employees, not independent contractors. In an independent contractor arrangement, stylists typically pay a fixed fee to “rent” a station from the owner. While the rental income tends to be more predictable, the fixed fee element also means that attracting more clients is not likely to increase the overall profitability of the salon. Melanie believes by having an employer-employee relationship, more clientele will result in more salon profits, which can then be used to expand services. Greater profitability will also make it easier to secure outside financing. She also feels she has more control over the quality of the technicians under this arrangement.

Currently Melanie is available to serve customers for up to 20 hours per week. The remainder of her time is spent on various administrative activities.   None of the stylists work overtime, that is, no stylist works more than 40 hours per week.

Short or medium haircuts require an average of 5 minutes to wash, 15 minutes to cut, and 6 minutes to dry. (Total=26 mins) Long haircuts require an average of 10 minutes to wash, 18 minutes to cut, and 13 minutes to dry. (Total=41 mins)

The average hourly cost of technician labor is $15 per hour, which includes wages, taxes, and fringe benefits. Melanie does not pay herself an hourly rate, but she does draw a monthly salary of $3,000.

Full-time technicians are guaranteed 40 hours per week. They are allowed two paid 15 minute breaks plus an unpaid 30 minute meal break each shift. (Actual=39hours) Part-time technicians are guaranteed 20 hours per week. They are allowed one paid 15 minute break per shift. Melanie does not take a break. (Actual=39hours45miutes)

Receptionists: Melanie employs one full-time receptionist and one part-time receptionist (20 hours per week). The receptionists earn $7.50 per hour. Neither is guaranteed a certain number of hours, but because the shop is open 60 hours per week, both typically work their allotted hours.

Other Costs: Rent on the shop is $2,500 per month. Utilities are $500 per month plus an additional cost based on the number of technician hours required to serve clients (including the time Melanie spends with clients). Advertising costs are typically $500 per month.  

As a specialty shop, it is important that all technicians are highly skilled in cutting hair and that they keep up with the latest hair style trends. Therefore, once a month (after the salon closes) Melanie provides one-hour of continuing education over current style trends and techniques. Melanie’s cost for these sessions is $100. Although the technicians are neither required nor paid to attend these sessions, everyone attends because the sessions meet the state requirements for licensure.

Other Information: The salon is open from 8:30 a.m. – 6:30 p.m. Tuesday through Sunday. The salon is open year-round. Shear Heaven’s tax rate is 25%. For simplicity, assume tax liability is zero when operating losses are incurred.

Armed with the information Melanie provided, you are confident you can help her understand her revenue and cost structure and make a few suggestions for improving her bottom line.

Use the information provided in the case to create an interactive spreadsheet. The spreadsheet should be designed in such a way that a user can play what-if games by changing inputs in a central location. The user should not need to change formulas to make the spreadsheet work. To assist you with this, the following steps are suggested.

A. Create the data section. This section is where a user can make changes to operating hours, tax rate, service mix, revenues and costs. There are three areas to include.

Basic Information

• Operating hours – set up a calculation for monthly average operating hours. The daily operating hours should be a changeable field. The monthly average will be based on the assumption the shop is open 52 weeks per year.
• Tax rate – this should be a changeable field.
• Service mix – the service mix is the number of short/medium and long haircuts on a monthly basis. This should be a changeable field.
• Variable costs – for each variable cost, create a changeable variable. For direct materials, include static fields for the purchase unit and the yield.
• Fixed costs – create a changeable field for each fixed cost.

Material Cost per Haircut

• For each direct material, create fields that calculate the cost of each material per type of haircut.   The percentage of customers requiring a specific material and the amount of material required for each type of haircut should be changeable.

Number of Technicians Required for Planned Sales

• Technician time required by type of haircut

In order to determine the number of technicians needed, it is necessary to know how much time (in minutes and hours) is required for each type of haircut.

• • Wash, cut and dry minutes should be changeable fields.
• Monthly service hours available per month by type of technician based on productive time.
  • Productive time is not the same as paid time.
  • Consider starting with weekly productive time and converting to a monthly basis. Hours and breaks should be changeable fields.
• Monthly technician cost by type of technician.
  • These should be calculated values.
  • Technician rate per hour should be a changeable field.
• Technician hours required for planned sales and # of full-time/part-time technicians required. This should be a calculated value based on service demand and monthly technician hours available. (Hint: do not forget Melanie provides some haircuts to customers.)
• Build a verification function of some sort to verify that the technician hours calculated are sufficient to meet demand without incurring excess technician cost.

B. Create a contribution margin income statement that calculates net income and operating leverage ratio based on changes made in the Data section.