Financial Aids in Running a Restaurant
May/June 2007
By Martin L. Tanenbaum, CPA, MTX
Many factors come into play when attempting to operate a restaurant profitably. Most important are initial factors like knowing your market, understanding menu pricing and discerning food and beverage costs. These issues need to be addressed at the outset of your venture, and then need to be constantly adjusted to prevailing market conditions.
As veterans already know, the restaurant business is very unforgiving when it comes to achieving bottom line profits. Average pre-tax profit margins range from four to seven percent (four percent for full-service and seven percent for limited-service restaurants). With margins so tight, there is little room for financial management missteps.
“With margins so tight, there is little room for financial management missteps.“
Unlike many other small businesses that employ full- or part-time financial personnel, most restaurant owners cannot afford that luxury. Their days are often spent jumping from one operational task (or crisis) to another and, as a result, the financial management of the restaurant may not receive the attention that it requires.
No amount of improved financial skills and procedures can solve a restaurant’s financial problems if the cause is inadequate sales. Fixed expenses cannot be brought into line (as a reasonable percentage of sales, that is) if gross revenues are too low. Efforts to maintain an accurate accounting system with well-prepared financial reports that permit proactive day-to-day management will be for naught if revenues are not sufficient for the business to be profitable. That said, here are a few areas that can be corrected by improved procedures or management of your existing revenues, or at worst, by helping to quantify the additional revenues that will be required:
1. Key operating expenses too high relative to gross sales
Food and beverage purchases plus labor costs account for between 65 to 70 cents of every dollar in restaurant sales. These costs are commonly referred to as “prime costs.” A restaurant’s profitability most likely rests with the ability to control prime costs. Unlike utility and insurance expenses that are relatively fixed, food costs can be impacted by more effective purchasing, product handling and menu pricing. Scheduling, hiring practices and the kitchen layout can favorably impact labor costs. It is very difficult for a restaurant to be profitable when prime costs exceed 70 percent. Exceptions do occur, though, such as compensating for these higher costs with favorable rent expense.
2. Food and beverage inventory levels not counted and costed at the end of each accounting period
Many restaurant operators make the mistake of confusing their monthly food and beverage purchases with their monthly usage. A common assumption is that the food purchased during the month divided by the food sales for the period equals the cost of goods sold for food. This is just not so. Without knowing the beginning and ending inventory values, an accurate food cost cannot be calculated. For a restaurant with food sales of $100,000 per month, an inventory difference of $2,000 between the beginning and end of a month, can result in a variance of two percent. This can represent a significant amount of the annual profit of a typical full service restaurant.
3. Inaccurate posting of financial information to accounting system
One of the most common errors in a restaurant’s accounting procedures is posting financial entries to the wrong accounts. This can include daily cash and credit receipts being recorded as income with no recognition of discounts or complimentary meals, inaccurate posting of sales tax collected, gift certificates sold recorded as revenue and not as a liability, and recording capital expenses as ordinary expenses.
4. Daily and weekly financial operating data not collected, reviewed or acted upon
Every restaurant should generate some type of daily and weekly report that summarizes, in a simple and easy-to-read format, all the key daily and weekly operating data such as sales by category, labor by department, food and beverage purchases, beginning and ending inventories, and other fixed expenses allocated on a daily basis to produce a weekly estimate of the restaurant’s net profit. It is very difficult to make corrections that are needed in employee scheduling and product purchasing when all there is to go on is a monthly profit (loss) statement that is not available until the middle of the following month. Making more immediate corrections and adjustments can improve profitability.
5. Current liabilities sufficiently greater than current assets as to impair future ability to pay bills
After recording all your weekly sales and vendor bills go to your Balance Sheet and divide your current assets (cash, credit card receipts in transit, accounts receivable, food and beverage inventory) by your current liabilities (vendor bills, sales tax, lease payments and short term loans due). For example, if current assets equal $32,000 and current liabilities equal $28,000, then the resulting current ratio would be 1.14 ($32,000/$28,000). This is a rough measure of your ability to pay your outstanding bills. In most industries, a ratio of 1:1 is considered to be reasonable. Restaurants typically have lower ratios because they maintain relatively small inventory levels combined with a quick cash turnover (meals are paid for the same day as they are served). Well-established restaurants will typically have ratios over 1:1. Younger, less established restaurants will almost always be below 1:1. If your current ratio is below .7:1, then you should be concerned. While restaurants can survive for long periods with lower ratios than this, it does typically indicate that without an increase in either sales or working capital, you and your business are looking at rocky times ahead.
Martin L. Tanenbaum, CPA, MTX, is a Tax Principal at Tauber & Balser, P.C. He helps clients with estate planning needs and has specific expertise in the retail and restaurant industries. He can be reached at (404) 814.4920 or mtanenbaum@tbcpa.com.
