You’ve heard before that 80-90% of restaurants fail within the first year. That’s simply not true. In fact, according to research by Philip Stark at UC Berkeley the number is really 17% in the first year. This goes to show that the average restaurateur really knows their stuff.
A lot of planning goes into starting and running a restaurant. Calculating big variable costs like food and labor costs allows you to run a profitable business, but the details involved in the day to day can overwhelm too. Restauranteurs have to address payroll, HR, marketing, managing teams, maintenance, systems management, supply chain concerns, etc. This year has been particularly daunting with mandates/restrictions brought on my COVID-19. After your immediate needs are addressed, the next big question is how it affects your long-term financial health and goals.
The good news is that financial planning is easily applied to restauranteurs once you condense it all down to what you really need. To build a financial plan, the first step is to gather all the information that you need to make projections. You will need details on all personal: assets, liabilities, income, and expenses. Assets and liabilities will help you develop your personal balance sheet and net worth. Income and expenses allow you to develop a cash-flow report.
For assets, we are talking about things you (and your partner) personally own. Assets include your house, investment accounts, collectors’ items, any real estate/land, and of course your business. If you haven’t had a chance to attribute a value to your business, that’s okay. For now, I would leave the value of the business at whatever base value you think is fair.
Liabilities are easy to identify. Money you owe to others personally: Auto loans, mortgage, HELOC, line of credit, credit cards if you carry a balance (you shouldn’t), and any other type of loan you might have. If you cannot figure out whether to have it on your personal balance sheet, just consider what happens if you default on the loan. If it affects you directly, you need to have all the details perfectly squared away. For each liability, make sure you know when the loan opened, the original balance, what the length (term) of the loan is, what the interest rate is, what the payment is for principal/interest payments, and what the outstanding balance is.
For the balance sheet, list the assets on one side and liabilities on the other. The net difference between the two is your net worth. Now pause for one second. This net number is important, because the higher it is, the better you’ll be able to meet your goals (whatever they are). If you want to buy another business, or expand operations, a very positive net worth speaks to your overall financial health being excellent. If you find yourself in debt up to your eyeballs, with a very negative net worth, it might not be possible to meet your goals. This net worth and balance sheet exercise allows you to take accurate stock of where you are.
For cashflow, we start with income. What pay do you personally take home as the business owner? Does your spouse work? Be sure to include any owner draw, any w-2 or contract employment income. Make a list of the income in one column to ensure you’re keeping track. Login to the social security website too, to understand what social security income might look like for you (and a spouse) for retirement. If you plan to get any other income now or in the future, keep note of that as well.
Expenses and savings both offset the income column. If you are making contributions to an investment account, or savings account, kid’s college accounts, etc. make sure it is listed in a savings column. For expenses, I find it easier to list out the fixed expenses we know are happening. For that, I take liability payments and add in utilities/subscription, taxes, and insurance. Technically, income less your fixed expenses and savings should equal your variable expenses. Any time they don’t, there is an issue with overspending and liabilities should be actively increasing (think a credit card).
Now that you have your cash flow and balance sheet/net worth it’s time to think about the future and goals. Whatever the goals are, you’ll need a number for them, a timeframe, and then you can back into what it will take to meet them. Remember that things become more expensive over time. So, you’ll need to take the present value of that goal and project it into the future when you intend to meet that expense. Our inflation rate has averaged 3.22% annually (this doesn’t seem bad, but it means the cost of something doubles every 20 years). You can find calculators to project a future value for a goal here. In fact, there are a lot of different calculators on this site that will help you evaluate
After you have the value you need to meet you have to work backwards. Where is the money coming from to meet that goal? Where are you investing? If your investment is the restaurant, then you are assuming you will sell it someday. The future value of your goal is future sales price you need. You can use your present value of the business as the starting amount. All you need to do is solve for the rate of return. Now you know what you need to target in growth.
If your goal is retirement, you can back into how much income you will need by considering future cash flow shortfalls. If you know what you need each year, divide that amount by 4%. That should be what you target for your sales proceeds for the business. Or at least what you will need to retire comfortably.
At this point, you should have an incredibly specific target for the future, and you should know what returns you need to get there. When things change along the way, just run back through the motions to check your math. As always, we’re here to help. Contact us with any questions.
Drake Qualls, CFP