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Wednesday, November 28, 2012

Long Term Planning and EBITDA

At the depth of the Great Recession, I was approached by a client for assistance with refinancing his loan portfolio.  Today, the business is flourishing and cash flow is strong.  In any long term planning project (e.g. a five year plan), I recommend taking the viewpoint of the banker.

Successful long term planning for growth involves a clear corporate vision with respect to high level goals and the road map to achieve these objectives.  Investors and bankers are interested in the company’s track record, the economic conditions, local trends, competition and other factors which impact the success or failure of the venture.

Whether your growth plans begin with digging out of a hole or launching a new venture from scratch, you can benefit by thinking like a banker. A favorite metric used to evaluate a business plan is EBITDA (i.e. earnings before interest, taxes, depreciation and amortization).
The earnings figure used is typically Net Income (the bottom line). To arrive at EBITDA (see illustration below), any interest expenses, income taxes, depreciation expenses and amortization expenses are added back to net income.

EBITDA = E + I + T + D + A

E = Net Income

I = Interest Expense

T = Income Taxes

D = Depreciation Expense

A = Amortization Expense

A struggling business may need to refinance in order to weather tough economic times.  EBITDA analysis helps the bankers determine a business’s ability to meet loan payments.  Since the bank will replace current loans with the new facility, the interest expenses paid during the year are added back to net income.  A company reporting a net loss generally has no income tax so the impact in the formula is zero.  Neither depreciation or amortization expenses eat cash so adding back these two numbers shows the bank how much cash is available to make loan payments.

A losing company can have positive cash flow if they have significant net fixed assets. There are many issues involving the quality of fixed assets which have an impact on negotiations. Before approaching a bank for a new loan, it is wise to sell any fixed assets which do not have a positive impact on earnings potential. The cash raised in the sale of these non-essential assets will reduce the amount of the loan required.

Evaluating the sale of a fixed asset helps to understand how your profit and loss statement and balance sheet work together to produce cash. The sale price often is less than the book value of the asset. Let’s use the sale of a delivery truck as an example.

In our example, the company has decided to eliminate the unprofitable delivery service. The vehicle has no use. If the book value is $15,000 and we are offered $12,000, we would book a loss of $3,000. This produces $12,000 in positive cash flow and reduces earnings by $3,000.

Generally, the transaction will not be repeated since the truck is gone and we do not intend to replace the vehicle. The $3,000 loss should be noted so the bank may see the one time nature of the transaction. They will correctly eliminate these transactions from their analysis of future cash flow potential. We have reduced our cash required by $12,000 with no negative impact on our ability to borrow.

The key to success in making these decisions is the evaluation of the ability of any fixed asset to generate future cash flows.

Many companies delay closing an unprofitable unit because they worry about the impact on current earnings. This short sighted approach will impair future cash flow. The closing of a store which is bleeding cash will be treated as a non-reoccurring transaction. There may be additional expenses required such as penalties to break lease commitments and real estate commissions.

The depreciation and amortization expenses of any unit on the chopping block should be used to analyze the loss on the profit and loss statement. If the depreciation and amortization exceed the net loss, the store is still producing positive cash flow. Otherwise, the store is bleeding cash and is a candidate for closure.

Future earnings and cash flow will improve once any losing units are eliminated. These transactions are always shown as one time losses due to the closure of the store. In general, you go to a bank to finance the investment in fixed assets needed to achieve financial and operational objectives.

Clearing the dead wood is seen as a positive by anyone making a decision on your loan application.

In summary, cash flow is not the same as net income. The EBITDA formula helps to measure the cash flow available to meet loan payment obligations. Think like a banker. You can reduce the amount you need to borrow, improve your chance to make payments on a timely basis, and allow yourself to focus on positive activities by evaluating the quality of your fixed assets.

Sunday, November 18, 2012

Labor Cost Control Tips

Cost control in any restaurant or food service operation is highly focused on the two prime costs: cost of goods sold and direct labor.  While the control of perishable stock requires considerable analysis, labor costs can be kept in line with accurate forecasts and a bit of technology.

In my contract feeding career, I came in contact with many old school general managers with green columnar paper drawing manning charts for a bid response.  The goal of the manning chart was to forecast labor cost at incremental population levels.  Our contracts required a price chart based on the number of residents in the construction camp.  For example, the increments would be 0-100, 101 to 2001, 201 to 300, etc.

Our RFP response teams spent hours crunching numbers on their charts.  The hourly wages needed to be increased by burden factors.  Significant labor cost is included in the employer's share of pension investments, unemployment insurance, vacation and holiday pay, mandatory training, union dues and health care premiums.  The burden expenses can raise the base pay labor expense by 20% or more.

In the early 1980s, our ADP office in Denver offered a new management summary report.  The management summary report is a straight forward matrix.  Each row represents a summary by department.  For example, we would create rows for Kitchen/Production, Dining Room and Bar Service, Housekeeping, Maintenance and Management.  The columns recapped Regular Pay, Overtime Pay, FICA, LTD, Vacation Pay, Holiday Pay, Employer's FICA, FUTA and SUTA, Total Expense and Net Pay.

This report could be used to make a journal entry since each row was a debit and each column a credit.  More importantly, management could see the total cost for their department.  Supporting schedules for each department have the same columns and the rows show the cost of each employee in the department.

Since the report clearly showed the total hourly costs, our bid response team began to use the data and stripped their columnar sheets of all the payroll burden columns.  They began to use the total cost per hour in the manning charts.  This meant a lot less number crunching and we saved days previously spent in expensive hotels putting together our bid packages.

As time went on, I was able to demonstrate the direct labor cost estimates the large cumbersome sheets determined could be reduced to a simple straight line formula.  I used the increment midpoints and total column costs to construct a linear regression estimate.  Initially, my new approach was trashed but my calculations were always very close to the numbers on the large spools of calculator tape.

Eventually, I took over the bid team and we reduced the number of increments to 4.  After determining the labor cost for these 4 operation levels, the linear regression estimates were used to fill in the price chart.  We used the increments for the lowest increment (e.g. 0 to 100), the highest increment (e.g. 1,101 to 1,200) and the 2 increments which management believed would be the most active once the real job began.

In the early 1990s, I found a terrific tool for creating employee schedules.  The Scheduling Assistant from Guia International (, which is still available today, runs in Windows and is a easy to use once the setup is completed.  Every employee is setup in the database.  Key data includes all the identification information, the base pay rate, schedule constraints, position, department other data.  My preference is to use total hourly pay costs with all burden included (including vacation and holiday pay accrual).

Once the schedule loads, the forecaster simply draws lines with their mouse to create the schedule.  As the lines are drawn, the program fills in hours and costs in the left columns.  These individual numbers are recapped by day and week at the bottom of the chart.  The program can use one schedule to create a new day of the week.  Any adjustments are made and the whole week is saved.

The scheduling tool can also be used to develop incremental staffing charts.  The most important increments in many 7 day a week operations are Early Week (Monday and Tuesday), Mid-Week (Wednesday and Thursday), Weekend (Friday and Saturday) and Sunday/Holiday.  Seasonal resorts should complete separate staffing chart decks for peak season and off season.  Maximum staffing charts designed to handle major days like Mother's Day are helpful.

These staffing chart totals can feed a linear regression formula to handle any sales forecast level.

Proper use of labor scheduling charts makes direct cost control visual and precise.  Combined with accurate forecasts of covers and sales, management will see a consistent labor cost with specific answers to variances.


Thursday, November 08, 2012

Quality Control and the POS System

An excellent report for tracking quality control is available on the best POS systems.  Micros has an end of period report designed to highlight major issues with an emphasis on employees and adherence to company policies.  The Employee Variance Advisory Report * (see example below) shows discounts, voids, errors, returns, cancellations and transaction anomalies for a shift, day, week, or month.

Careful scrutiny of the discounts, returns and cancellations provides insight into your guest satisfaction performance.  Restaurants with abnormally high returns are serving customers meals which fail to meet customer expectations.  Perhaps the steak was over cooked or the soup was ice cold.  I have been in kitchen offices for many years and the arguments over "fussy guests" always pique my interest. 

Some real issues I recall include:  cole slaw left under heat lamps on a BBQ platter, a steak returned due to a green interior (badly spoiled - not an aging problem), burnt pizza, burnt toast, raw fish, a burger still frozen in the middle, chicken leg with blood in the joint, mushy pasta and rice, salty soup and many wrong orders.  These problems show up in the POS audit report.

Returns indicate customer dissatisfaction with a possible loss of future business, potentially higher food and beverage costs, and potential food poisoning issues.  Voids, discounts, cancellations and check edits impact revenue and profit.

Track the information included on these POS audit reports over time.  Closely monitor the each incident including a description of the problem, the employee responsible, the manager on shift and the solution offered to the guest.  Develop a comprehensive response to customer complaints.  A company can turn problems into opportunities with a top notch customer complaint response program.   

*Thanks to Dave Smelson, Senior District Sales Manager at Micros, for sharing the latest Micros reports with our readers.

Restaurant Data Pros

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