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Thursday, May 30, 2013

User Friendly Financial Statement Analysis

Assets burn cash.  Loans, credit lines, credit card balance transfers and shareholder investments produce cash.  Managing the sources and uses of cash is crucial to surviving in any business.  Most restaurants fail due to inadequate capital infusion during the start-up phase.  Some people never get the door open for business due to lack of cash.

Cash is king for many restaurants.  Many managers and owners do not understand how to read a balance sheet.  Assets other than cash require cash.  If your receivables, inventories and prepaid expenses increase your assets go up but your cash goes down.

Many restaurants have a difficult time paying suppliers on a timely basis. The impact is significant. Suppliers will add late payment fees, offer tighter credit terms, charge higher prices and in the worst case scenario require cash payment on or before delivery. 

For those readers who do not love accounting and financial statement analysis, there are a few key ratios and formulas which can bring a big benefit with a small effort.

Working Capital Considerations
Ability to pay suppliers is often difficult due to the nature of cash flow in the restaurant industry. Sales turn into cash on the spot or a few days later as credit card charges are wired to bank accounts. Employees are paid with a 7 to 10 day lag (sometimes longer) and suppliers are paid in 30 days.

Using employee and supplier financing works OK until the sales tax payment is due. Cash is plentiful until these statutory payments come due (often with big late payment penalties).  If your company has a rough time making the sales tax payment, a beginner's level grasp of financial statement analysis can help.

Where do you go to help monitor this important issue?  Balance Sheet

The current ratio is calculated by dividing the current assets total by the current liabilities total. Unfortunately, inventory bloat makes the current ratio useless in our industry.

Avoid over stocking your shelves to improve cash flow and reduce spoilage. Substitute the Quick Ratio for the current ratio.

Quick Ratio = (Current Assets - Inventories)/Current Liabilities

A quick ratio below 1.0 is very dangerous. A good ratio is 1.25 or higher.

Capital Expenditures and Financing Options
Capital expenditures are made in the operation to produce a positive future value.  Increases in liabilities, including longer times to pay suppliers and employees, increase cash flow.  Liabilities are a risky way to finance your business.  Managing financial risk will help you grow your business at a sustainable rate.

Compare your equity accounts (common stock, paid in capital, retained earnings) with your total net fixed assets (property, plant and equipment net of depreciation).  A company with a low financial leverage will have more shareholder's equity than net fixed assets.  If a company employs financial leverage, they will have a long term debt figure which reflects loans required to invest in the company.  There are two ratios which you can use to monitor your long term financial health.

Debt to Equity Ratio = Total Liabilities/Shareholder's Equity

Try to stay below 1.0 if possible.  A major manufacturing company (auto plant) may have a ratio of 2.0.  Restaurants should be much lower.  There are publicly held restaurant companies with a debt-to-equity ratio above 10.0.  These companies want to maximize return on equity by using financial leverage to acquire assets.  They may be buying restaurant companies or opening lots of new restaurants. 

Fixed Assets Ratio = Net Fixed Assets/Long Term Debt

Picking an ideal fixed assets ratio depends on your appetite for debt financing and your business health.  One company may have a ratio of 1.0 where the long term debt equals their net fixed assets.  In theory, the ability to repay the debt is high.  I recommend removing net leasehold improvements from your net fixed assets.  If you lose a leased premise, the value of these improvements may be very low.  Equipment may be worth far less than the book value due to a vibrant after market for restaurant equipment.

By performing simple division using a handful of numbers on your balance sheet, you can determine your ability to pay suppliers on a timely basis and keep your long term debt in line with the money raised from shareholders while prudently investing in fixed assets needed to run your restaurant business.

Should You Use Last Year or Budget in the Profit and Loss Statement?

Most accounting programs produce comparative reports using pre-built templates. Restaurant operators need a compass to guide them through the year's tremendous number of ups and downs. Two excellent comparisons are the most popular profit and loss statement formats: Current Year/Last Year (or Prior Year) and Current Year/Budget.

My strong preference is to use Current Year/Budget. The reason I prefer this format is the implicit need to actually construct a budget. Most budgets actually begin with the previous year's figures.

Many companies work on next year's budget at the end of the third quarter (or slightly earlier). They use the results from current year's operations as the foundation for the budget. By making educated guesses for the remaining months in the current year, they obtain a full year profit and loss estimate.

All budgets should address every line in the P and L. For restaurants, the most important number in the budget is revenue. At a minimum, you should break the revenue into food, beverage and other.  Beverage revenue may be more detailed with Beer, Wine, Liquor and Soft Drinks sub-totals in the beverage total. 

If possible, I recommend using both Revenue - Food Catering and Revenue - Beverage Catering for restaurants with significant catering volume.

Cost of goods sold is a very important budget issue.  Food cost and beverage cost are prime costs. QSR and Fast Casual concepts with a high percentage of take-out business should also include disposables in their cost of goods sold.

Direct labor is a high profile item for 2014 budgets.

The federal health care affordability laws will impact direct labor expenses when they go into effect next year. Companies are grappling with issues involving the total number of employees, percentage of part-time employees, seasonal hiring quotas, etc. Because of the magnitude of the health care legislation, comparisons to prior year will not be as effective as comparison to budget.

When you begin getting the budget team prepped this summer, try to get a head start on many key issues: do we have a strategy for company health insurance coverage? what will the additional cost be to offer health care to valued employees who are not covered now? do we need to raise menu prices to cover these costs?

If you decide to retain talented people by offering a top flight health care plan, the premium cost can be used in salary negotiations. Most uninsured or under-insured employees will gladly take a pass on this year's salary bump once they know the cost of their premiums.

If menu prices are required, you need to calculate the impact on check averages, covers and total revenue. Restaurant diners have recently spent less in reaction to increases in fuel costs, higher payroll taxes and slower income growth. Of course, restaurants could benefit from their customers having more disposable income due to their own benefit from new company health care coverage in 2014.

Newly covered people who had been struggling to pay for individual health care premiums will see increases in their income net of taxes and health care premiums.Some uncovered self-employed individuals will have to cover themselves or pay a higher tax.

Understanding your customer base is critical.

Higher menu prices should translate into a lower cost of goods sold %. If you felt the impact of health care coverage could raise your labor costs by 10% and your current labor costs are 30% of sales, you need to budget for a 3% sales increase just to break even.

If your cost of goods sold is 33%, you would expect a decline of 1% since 33% divided by 1.03 is 32%. Again, you would need to carefully budget all expense categories (every line on your profit and loss statement). I'm using the prime costs and revenue figures because of their relative impact on the bottom line.

I see 2014 as a great year to shift from a current year vs. prior year statement format to a current year vs. budget format.

Sunday, May 26, 2013

Food Cost Variances in Regional Chains

Many of my regional restaurant clients show significant differences in the food cost % from unit to unit. It is always easy to find anecdotal excuses for these variances. Examples include: customers at each location have different dining habits, higher sales volume hides some mistakes which surface at lower volume locations, and the higher volume locations have better personnel. Which units should be used as a benchmark? Should the lower volume units be par? Or are these units below the standard? For purposes of growing a chain, I would use the higher food cost % in projections. If a chain always look at the best case scenario in five year plans, they will never hit their target figures due to rosy assumptions.

High Beef Prices Will Impact Food Cost

The drought from 2012 and the major storm damage in both 2012 and 2013 is causing record high beef prices. Current prices are close to levels during the mad cow disease outbreak. As contracts wind down for major chains, decisions will need to be made whether to go long at higher prices or just play the commodity markets using short term future contracts. I just returned from the National Restaurant Show in Chicago. Chicago has plenty of upscale steak houses and most of these restaurants charge enough to offset some of the food cost increase. Value based menus will be impacted as ground beef prices are well above recent years.

Restaurant Data Pros

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