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Financial Reports:
What They Mean & How to Read Them
Table
of Contents
"My
place is full, but I have no idea if I'm making money." When
I hear operators say this, I know they are not managing their businesses
efficiently. On the other hand, I have some clients who are so dedicated
to the financial end of the business they know how many covers are
necessary to break-even. Some operators even know how many
guests will order appetizers, desserts and bottles of wine.
It
is not hard to track and calculate the above information. However,
if operators receive this information in a timely fashion, they
will be able to quickly identify problem areas and respond accordingly.
Operators can recognize problem areas simply by reading the financial
statements. Once they can read that information, they can begin
identifying the "red flags."
The
Income Statement and Balance Sheet are the two types of financial
statement reports that allow operators to pinpoint weaknesses and
problem areas. The Income Statement and Balance Sheet should be
prepared and reviewed monthly.
The
Income Statement
The
Income Statement shows how the restaurant performs over a period
of time (i.e. a week, month or year). It takes all restaurant expenses
into account, from prepaid expenses to expenses paid in the future.
Overall, theIncome Statement tells the operator if the business
is making a profit. From there, the operator can begin making changes
in policy and implementing strategies that will help the restaurant
achieve its goals. Should new sales programs be implemented? Is
food cost in line with menu prices? Is the restaurant hitting its
budgets? Can the owner(s) make distributions to the partners? These
are some of the key questions that need to be addressed. The basic
formula for an Income Statement is:
Sales
- Cost of Goods Sold - Expenses = Profit/Loss
The
Income Statement is everyoneís favorite financial statement to review
because it reveals the nature of the restaurantís success. Restaurant
financial statements should be broken down into the following categories:
Sales
Salaries
Employee
Benefits
Controllable
Occupancy
General
and Administrative
Depreciation
Interest
Other
Income
If
sales and expenses are broken down into specific categories, the
operator can easily compare and analyze his or her restaurant to
industry standard percentages. A sample Income
Statement for our case study restaurant, Garyís Tavern, follows
on the next page. Garyís Tavern is on pace to gross over $3.0 million
dollars annually. All
costs are shown as a percentage of sales as well, so the operator
can easily target problem areas. These areas can be investigated
and changes can be made to maximize profits. When reading the Income
Statement, operators need to focus on the following percentages:
|
INDUSTRY
RANGES
|
Cost
of goods sold |
25%
to 39% |
Payroll |
25%
to 37% |
|
Benefits |
4%
to 6% |
Operating/Controllable
expenses |
7%
to 13% |
Occupancy
expenses |
5%
to 14% |
General
and administrative expenses |
1%
to 5% |
|
EBITDA |
19% to (1.5)% |
(EARNINGS
BEFORE INTEREST, TAXES, DEPRECIATION & AMORTIZATION.)
|
|
The
above industry wages have a wide variance. The
challenge to every operator is knowing the ideal percentages for
restaurants of similar type and concept and achieving high net profit
percentages. Gary's Tavern is in industry range for every category
and shows an above average EBITDA (Earnings Before Interest, Taxes
Depreciation & Amortization) just under 13%.
Is
it possible to add another few percentage points to the bottom line?
A one percentage point drop in cost of goods sold or payroll would
result in an additional $36,000
a year! To maximize cash flow and profitability, the operator needs
to identify areas where Gary's Tavern can improve. Once the problem
areas are identified, the operator can implement strategies to increase
Gary's Tavern earning potential.
|
|
M-T-D
%
Y-T-D %
M-T-D %
Y-T-D % |
OCCUPANCY
EXPENSES |
|
|
|
RENT |
15,000 |
4.98% |
165,000 |
5.53% |
13,500 |
4.93% |
148,500 |
5.32% |
|
INSURANCE |
3,500 |
1.16% |
38,500 |
1.29% |
3,150 |
1.15% |
34,650 |
1.24% |
|
UTILITIES |
6,000 |
1.99% |
71,400 |
2.39% |
5,400 |
1.97% |
64,260 |
2.30% |
|
|
TOTAL
OCCUPANCY |
24,500 |
8.13% |
274,900 |
9.22% |
22,050 |
8.06% |
247,410 |
8.86% |
|
|
GENERAL
& ADMINISTRATIVE |
|
|
|
|
|
|
|
|
|
CONTRIBUTIONS |
250 |
0.08% |
3,000 |
0.10% |
225 |
0.08% |
2,700 |
0.10% |
|
OFFICE
SUPPLIES |
3,500 |
1.16% |
38,500 |
1.29% |
3,150 |
1.15% |
34,650 |
1.24% |
|
DUES
& SUBSCRIPTIONS |
100 |
0.03% |
1,100 |
0.04% |
90 |
0.03% |
990 |
0.04% |
|
EDUCATION |
|
0.00% |
1,750 |
0.06% |
0 |
0.00% |
1,575 |
0.06% |
|
BANK
CHARGES |
200 |
0.07% |
2,200 |
0.07% |
180 |
0.07% |
1,980 |
0.07% |
|
PROFESSIONAL |
1,000 |
0.33% |
11,000 |
0.37% |
900 |
0.33% |
9,900 |
0.35% |
|
PAYROLL
PROCESSING |
625 |
0.21% |
6,875 |
0.23% |
563 |
0.21% |
6,188 |
0.22% |
|
TELEPHONE |
1,100 |
0.37% |
12,100 |
0.41% |
990 |
0.36% |
10,890 |
0.39% |
|
SUNDRY |
500 |
0.17% |
5,500 |
0.18% |
450 |
0.16% |
4,950 |
0.18% |
|
LICENSES
& PERMITS |
100 |
0.03% |
1,500 |
0.05% |
90 |
0.03% |
1,350 |
0.05% |
|
|
TOTAL
GENERAL & ADMINISTRATIVE |
7,375 |
2.45% |
83,525 |
2.80% |
6,638 |
2.43% |
75,173 |
2.69% |
|
|
EBITDA |
20,568 |
6.83% |
375,910 |
12.61% |
33,902 |
12.39% |
394,629 |
14.13% |
|
|
OTHER
ITEMS |
|
|
|
|
|
|
|
|
|
|
DEPRECIATION |
4,500 |
1.49% |
49,500 |
16.43% |
4,050 |
1.48% |
44,550 |
1.60% |
|
|
INTEREST
EXPENSES |
4,750 |
1.58% |
55,575 |
1.86% |
5,225 |
1.91% |
61,133 |
2.19% |
TOTAL
DEPRECIATION & INTEREST |
9,250 |
3.07% |
105,075 |
3.52% |
9,275 |
3.39% |
105,683 |
3.78% |
|
|
NET
PROFIT/(LOSS) BEFORE TAXES |
11,318 |
3.76% |
270,835 |
9.08% |
24,627 |
9.00% |
288,946 |
10.35% |
|
|
INCOME
TAXES |
453 |
0.15% |
10,833 |
0.36% |
985 |
0.36% |
11,558 |
0.41% |
|
|
NET
INCOME |
10,865 |
3.61% |
260,002 |
8.72% |
23,642 |
8.64% |
277,389 |
9.93% |
BalanceSheet
The health
of a restaurant can be analyzed from the Balance
Sheet at any point in time (i.e. today, last month or tomorrow).
The Balance Sheet allows operators
to forecast short and long-term cash flow. As important as it is to
review the Balance Sheet,
few restaurants ever bother to prepare it. By checking the accuracy
of the Balance Sheet, an operator
can ensure the accuracy of the Income
Statement. The Balance Sheet
lists all the assets, liabilities and equity of the restaurant. The
formula for the Balance Sheet
is:
Assets
= Liabilities + Equity
In the
simplest terms, assets are what the business owns such as equipment,
inventory or cash. Liabilities
are what the business owes such as vendor bills, loans, notes and leases.
Even a gift certificate is a liability because the restaurant owes someone
a meal at a future date. Equity
is the ownership of the business. The most common form of equity is
stock. Whoever owns the stock owns the equity. (For example, the 5 million
shareholders of Microsoft own the company. Bill Gates just owns the
largest number of shares).
It is important
that assets and liabilities are properly classified on the Balance Sheet. To get a clearer picture of the business, an operator
should break down the Balance
Sheet into sub categories. The breakdown is explained as follows:
Current
Assets - assets with life less than a
year (i.e. cash, credit card receivables, inventory and prepaid expenses).
Fixed
Assets - assets with a life greater than a year that directly
attribute to producing revenue (i.e. equipment, computers, furniture
and leasehold improvements).
Other
Assets - assets with a life longer than a year that are
not directly involved in the production of revenue (i.e. security deposits,
trademarks and artwork).
Liabilities
require a similar classification and are broken down as follows:
Current
Liabilities: debts due within one year (i.e. accounts
payable, accrued expenses, short-term loans and even gift certificates).
Long
Term Liabilities: debts due that extend beyond one year
(i.e. notes payable or long-term leases).
There is
so much information to be gained from the Balance Sheet. For example,
a restaurant that has large debts may have major cash flow problems.
Identifying the current debts from the long-term debts on theBalance
Sheet help determine the short and long term cash needs, as well as
the businessí potential success. Restaurateurs who take on large debts
upon opening could be shooting themselves in the foot. The restaurant
may show large profits based on the Income Statement, but the restaurant
may not have money because it is paying out the outstanding debt (which
is revealed in the Balance Sheet).
Most restaurants
are set up as Partnerships or Sub Chapter S corporations. These entities
pass the profits on to the individual ownersí personal income tax returns.
Note, if a large tax liability develops, there would be no funds available
to make a distribution to cover these taxes.
The Balance
Sheet of Garyís Tavern is shown on the next page. Garyís Tavern
was financed with a lot of debt (see liabilities section of the Balance
Sheet). There is a total notes payable of $775,000 (sum of the notes
payable current portion and notes payable long-term portion) and $175,000
of this balance is due every year. Accumulative interest is shown at
the bottom of the Income Statement (interest payments are in excess
of $4,000 a month). The first $232,000 of Garyís Tavern net cash flow
will be used to amortize and service its debt. The following illustrates
the funds paid back to Garyís Tavern investors:
Interest
|
$
57,000 |
Principal |
$175,000 |
Total
|
$232,000 |
To gain
an even better understanding of the financial condition of Garyís
Tavern, a ratio analysis should be calculated. The following key ratios
should be used when reading the
Balance Sheet:
1)
Current Ratio = Current Assets (CA)
Current Liabilities (CL)
Current
ratio should be 1:1 or greater. Garyís Tavernís ratio is .9:1.
This ratio measures the current health of the business and indicates
short-term cash flow. To get a better sense of its liquidity and cash
flow constraints, the quick ratio is a better indicator.
GARY'S
TAVERN
BALANCE
SHEET
OCTOBER
31, 20XX
ASSETS
|
CURRENT
ASSETS |
CASH
CHECKING |
$782
|
CASH
PAYROLL |
2,500
|
CASH
MONEY MKT. |
10,000
|
TOTAL
CASH |
13,282
|
|
|
|
|
|
AMEX
REC. |
25,120 |
VISA/
MC REC. |
10,500 |
HOUSE
ACCOUNTS |
15,000 |
PREPAID
EXPENSES |
10,000 |
|
60,620 |
INVENTORY |
|
FOOD |
20,000 |
WINE |
200,000 |
LIQUOR |
35,000 |
BEER |
7,000 |
OTHER
BEV |
5,000 |
TOTAL
INVENTORY |
267,000 |
TOTAL CURRENT ASSETS |
340,902 |
|
FIXED
ASSETS |
|
FURNITURE
& EQUIPMENT |
215,000 |
|
LEASEHOLD
IMPROVEMENTS |
1,000,000 |
|
1,215,000 |
|
ACCUMULATED
DEPRECIATION |
(140,000) |
|
NET
FIXED ASSETS |
1,075,000 |
|
OTHER
ASSETS |
|
SECURITY
DEPOSITS |
20,000 |
|
LIQUOR
LICENSE |
5,100 |
|
ARTWORK |
75,000 |
TOTAL
OTHER ASSETS |
100,100 |
|
TOTAL
ASSETS |
$1,516,002 |
|
LIABILITIES
& STOCKHOLDERS' EQUITY |
|
CURRENT
LIABILITIES |
|
CURRENT
PORTION ST DEBT |
$175,000 |
ACCOUNTS
PAYABLE |
150,000 |
ACCRUED
WAGES |
20,000 |
ACCRUED
INCOME TAXES |
5,000 |
ACCRUED
PAYROLL TAXES |
15,000 |
GIFT
CERTIFICATES PAYABLE |
16,000 |
|
TOTAL
CURRENT LIABILITIES |
381000 |
|
NOTES
PAYABLE LT. PORTION |
600,000 |
|
TOTAL
LIABILITIES |
981,000 |
|
STOCKHOLDERS'
EQUITY |
|
CAPITAL
STOCK |
1,000 |
PAID
IN CAPITAL |
199,000 |
RETAINED
EARNINGS |
75,000 |
|
NET
INCOME |
260,002 |
TOTAL
STOCKHOLDERS' EQUITY |
|
TOTAL
LIABILITIES & STOCKHOLDERS' EQUITY |
535,002 |
|
|
$1,516,002 |
|
|
2)
Quick Ratio =
Current Assets-Inventory
Current Liabilities
Garyís
Tavernís ratio is .2:1. This ratio indicates the liquidity of the
business and should be .7:1 or better. Garyís Tavern may have too
much money tied up in inventory. This could affect cash flow as well
as purchasing power with vendors.
3)
Working Capital Ratio = Total Assets
Total
Liabilities
Working
capital ratio should be 1:1 or greater. Garyís Tavernís ratio is 1.55:1.
Long-term cash flow does not appear to be a problem.
4)
Debt to Equity Ratio = Total Debt
Total
Equity
Garyís
Tavern ratio is 1.8:1. This ratio determines if a business is undercapitalized.
Garyís Tavern may be slightly over-leveraged.
5)
AP (Accounts Payable) to Sales Ratio = Accounts Payable
Sales
AP to
Sales should be 50% of
sales. This ratio measures how current a restaurant is with vendors
and indicates future cash flow. Garyís Tavernís ratio is 68%. This
is a high ratio and may indicate short-term cash flow concerns.
Based
on the Balance Sheet and
Income Statement analysis,
Gary's Tavern is a successful restaurant. It has strong profits and
controls a majority of its costs. However, it does have some cash
flow constraints due to the large inventory on hand and the amortization
of debt. To free up funds immediately, Gary's Tavern should shrink
inventory and maximize its bottom line profits. If sales drop off,
it may have trouble meeting its debt service. Without an accurate
Balance Sheet, this kind
of crucial financial information would tend to be overlooked.
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