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Thursday, November 29, 2007

Hidden Cash

Let's imagine you have had a slow down in business and your state sales tax payment is due in four days. Should you borrow more money to finance your sales tax payment to your state? This decision is faced by many restaurateurs during their off-season months.

Both your balance sheet and income statement may be used to find cash. For those without any accounting skills, debits eat cash and credits produce cash.

On the asset side of the balance sheet, you'll find lots of items burning cash. You could sell unproductive fixed assets (e.g. obsolete equipment, extra vehicles, unused land, etc.) or close losing units. Reducing your inventory level is another way to improve cash flow. Review your food, beverage and supplies inventories and try to get by with 10% less on hand. Collect any overdue receivables.

On prepaid expenses, renegotiate prepayment terms. Try to convert quarterly prepayments to monthly auto-transfer payments. Try to minimize future increases in fixed assets through operating leases.

The equity side of the balance sheet contains the liability and capital accounts. Many restaurateurs go to this side of the balance sheet to find cash. This may be very expensive money. Fail to take advantage of a vendor early payment option and you'll give up from 1% to 2% of purchases. Vendors who do not offer favorable prepayment terms build their cost of capital into the prices they charge. Poor payers are penalized with higher prices making vendor financing very expensive.

Delaying a tax payment could keep the cash in the bank a bit longer but the cost is astronomical. Taxing authorities charge major penalties with interest on these late payments. Delaying a payroll will create morale problems and productivity can suffer.

Generally, you need to stay current on payments of all current liabilities. This applies to repayment of credit lines and mortgages. In addition to late fees, your ability to fund future growth could be impaired.

Long term debt is the best source from the liabilities side of the balance sheet. This is all debt which does not need to be repaid in the next 365 days. Use this 365day reprieve very wisely if you decide to refinance current liabilities with long term debt. If this becomes habitual, the business could reach a point where debt repayment becomes the sole focus of management.

Raising capital from outside investors may make sense. The cost of this money is usually equal to the growth rate of the company. If you can manage your liabilities well, you'll keep all future growth with the current investors. If you intend to grow sales by 10% each year for the next 5 years and you budget a profit improvement from 5% to 8% net, your profit in year 5 will be 150% higher than today. Do you want to give away this future equity to new investors?

Tuesday, November 20, 2007

Elusive Cash Flow

It is quite common to see restaurant owners work hard all year and make nothing at all. The difference between a winning operation and a loser is cash management. Most of your cash will be spent on payrolls and paying suppliers. Landlords, mortgagees, tax authorities, insurers, banks and equipment companies consume more of your cash. Keeping track of single digit potential profits takes resolve.

Don't be in a rush to spend the operating cash flow. A 5% profit is about 18 days of sales each year. You make 1.5 days of sales each month in this profit range. A rainy weekend may wash away the profit. It's important to forecast cash flow.

With the cost of gas on the rise, consumers are tightening their belts. Some may switch to tap water in lieu of a soft drink. Others are skipping the dessert course. If your profits drop to 3.3%, you'll see only a single day of sales as profit each month. Inclement weather could ruin the entire month's cash flow.

You may not see the problem immediately. A restaurant operation disguises major problems for many days. Bad weather, slightly lower sales on a big weekend, a few slow spots in an otherwise busy week will all go undetected. These are all normal events.

One of the problems in our industry is the speed with which cash comes into an operation. For the uninitiated, it could seem like a fantastic cash cow. Customers use cash and credit cards for most of your sales. It all hits the bank account in days. They pay you in advance for sales taxes you probably pay quarterly. Do you have the cash available to pay your sales tax this quarter? This is typically the first sign of trouble. If you need to borrow to pay the sales tax, positive cash flow may be elusive.

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Saturday, November 10, 2007

Cash Is King?

A well lubricated restaurant model should pump buckets of cash into the bank. Once a unit's fixed investment stabilizes, a decent sales volume will start producing positive cash flow. The Wall Street people monitor a key indicator of business health - EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). EBITDA eliminates many of the financing and accounting policies from the income statement model. EBITDA is not the same thing as cash flow.

If you want to eliminate just the impact of depreciation and amortization from the income statement, OIBDA (Operating Income Before Depreciation and Amortization) is the measure for your report. The starting point in OIBDA is Net Operating Income. Just add back depreciation and amortization.

Once a new restaurant begins experiencing positive OIBDA, they are contributing to interest expenses, debt repayment and the fixed investment made in FF&E (Furniture, Fixtures and Equipment) and Leasehold Improvements (expenses needed to change the space which stay with the property). The operator rarely has any income taxes at this point in the evolution of the business. Depreciation and amortization will swallow up these profits.

After many discussions with new restaurant owners and franchisees, I believe OIBDA less interest expenses may be the best solvency measure. This requires a healthy business with a sales volume high enough to cover current operating expenses and interest on your loans. Operating Cash Flow (OCF = EBIT + Depreciation + Amortization - Taxes) is closely related to my measure. In the formative days, taxes are probably irrelevant. OCF must simply be large enough to cover interest expenses.

A business producing positive OCF has the opportunity to approach other investors to convert debt into equity. They have almost reached the end zone.

With one final push, achieving positive OIBDA less interest expenses, restaurateurs do not need to attract new investment. They have covered themselves and can focus on growth strategies. Their work has produced a "Survivor" model. This is a tremendous accomplishment for the boot strap organizations.

Successful restaurant investors pay income taxes. This cost is a tribute to the operation's ability to cover all operating expenses, the periodic write-downs on investment in the infrastructure and interest payments to the bank. These savvy operators can now look to a second location.

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Friday, November 09, 2007

Slow Periods

I received above average email volume regarding the October Newsletter. Many of the emails were from software solutions providers. Buried in the pile was this excellent contribution by Marcel Escoffier (FIU):

What you say about slow periods is true, but incomplete. One missed opportunity chains experience is the opportunity to "retire" menu items or. actually, put them on "vacation". Menu bloat is a constant problem and can be reduced using this technique. During forecasted seasonal slow times, the operator should put menu items "on vacation". If in a seaside resort, the operator may reduce the menu for the off-season and concentrate on food items appropriate for that off season's climate / clientele. Less expensive comfort food and special occasion foods might remain on the menu while "touristy" foods might go into a brief retirement. Items with high food costs and relatively low popularity would be the first to go off the menu. Some stars (popular and profitable) might be retired for a period, keeping ones associated with low profit high popularity items (i.e., keep the stuff that makes the "value meal" profitable.) Off season is not the appropriate time to experiment except if experimentation involves new, more efficient preparation methods.

Just some added thoughts. - Marcel Escoffier

Restaurant Data Pros

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