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Saturday, February 21, 2009

Finding Your Way Through The Recession

My readers have sent me a number of questions regarding the impact of lower revenue on budgeted profit. Most of these questions come from people who are front line oriented like chefs, f&b controllers and owners. They want to know how to project profits given a drop in sales and they want to know how to answer questions about NOI, EBITDA, EBITDAR, etc.

Generally, cash is king and this is especially so in a recession.

The financial people want to focus on cash flow. Typically, the quickest way to generate cash is a bank loan. Banks are not freely loaning money right now. The second quickest source of cash is paying suppliers slowly. This can be costly in the long-term. Most companies struggling to meet payrolls and quarterly tax payments have found their cash flow threshold. As sales continue to drop they have a cash crunch. These companies start layoffs, slow down payments to suppliers and other tactics in order to meet payroll, rent and taxes.

So how do you calculate the impact of a sales drop? If sales decline $10,000 or $100,000 or even $1,000,000, how does that affect your cash flow. If you are an owner, you need to look at NOI (Net Operating Income) and add back depreciation and amortization [EBDA]. You don't have any corporate colleagues to share the pain so it doesn't make any sense to add back interest, taxes [EBITDA] and rents [EBITDAR].

Let's say your current net operating income plus depreciation and amortization equals 30% of revenue. If you drop $10,000 in revenue and maintained your percentage targets for costs and expenses, you would put $3,000 less in the bank account. The same statement ratio on $100,000 would eliminate $30,000 of cash flow and $300,000 for a $1 million drop.

How do you make up for these shortfalls? You need to put the drop in relationship to your original budget. If you dropped $100,000 from $2 million to $1.9 million, the $30,000 equals 1.58% of $1.9 million. You need to trim about 1.6% from your variable costs (food, beverages, direct labor, supplies, etc.). You multiply the sales % drop by the profit % (30% X 5.26%). I use the $1.9 million instead of $2.0 to calculate my sales drop % because I need to know how to adjust current operations. In my current numbers, I don't have the extra $100,000 in revenue.

If you absolutely hate working with numbers, use the sales drop of 5% and multiply by the 30%. You'll get 1.5% and this will be close. Make it 2% to be safe.

These figures can vary tremendously as the sales drop as a % of budgeted sales increases. Some operators are experiencing drops of 20% in revenue. If you had a $5 million restaurant turn into a $4 million business, you'd be in the 20% club. Perhaps your average entree is in the $25 to $40 range. What do you need to do to survive?

You would be looking for a cost cut of 7.5%. WOW! That is huge. I'm expecting you have already cut costs to the bone and were projecting a break even year. In the short run, many operators in this position are selectively cutting management positions.

Trying to find the $300,000 bottom line short fall in food cost % is probably tantamount to slicing your own throat. If you had your food cost % in line and can't increase menu prices (which may be out of the question for many of you) a 7.5% drop is tough. Cutting portions to achieve a 7.5% of sales drop would certainly be perceived by your patrons. Operators are cutting fat from their staffs to make up most of these shortfalls. A $300,000 cut means 5 key people making $50,000 plus benefits.

For the companies growing sales at this time, your hiring woes will come to a screeching halt. There are plenty of well qualified professionals looking for work this quarter.

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