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How to avoid 5 financial pitfalls when opening a restaurant

Understanding the applicability of sound business practices such as cash flow management, benchmarked gross profit margins or salaries to scale can be just as important to the success of a restaurant as the food it serves. Given this, here are five points every restaurateur should consider when starting a new restaurant.

September 14, 2016

By David Natan, Newburg & Company, Certified Public Accountants

Restaurateurs are typically thought of as food connoisseurs, but there is more than food that goes into running a successful eating establishment. Understanding the applicability of sound business practices such as cash-flow management, benchmarked gross profit margins or salaries to scale can be just as important to the success of a restaurant as the food it serves. Given this, here are five points every restaurateur should consider when starting a new restaurant.

1. Spend the proper time on your business plan's financial section. Over the years, we have found restaurant owners who avoid shortcuts within their business plan's financial section tend to have the highest success rate. In fact, this financial section of your business plan is the key ingredient to launching a successful venture, whether this is your first location or fifth location. Some important areas to hone in on are as follows:

Sources and uses of cash, properly project build-out:

Whether you are utilizing conventional financing, private investors, or family and friends, they need to understand how their infusion of cash will be allocated. One of the biggest and most common mistakes we see in practice is not obtaining contractor estimates for the project build-out. Three estimates are certainly better than one, and beware that your passion will often override your budget. Often, construction budgets overruns have a domino effect on your capital raise, creating strains by using thinner working capital than originally projected.

Guest checks projections and overall P&L projections:

Make sure you are utilizing sound methodology and good benchmarks in determining items such as table turnover rates, sales by shift, average guest check, and so forth. New restaurants need to use good comparable data. Consider MRA data or utilizing a CPA firm that has experience with restaurants in your area.

Gross profit margins and labor costs:

Understanding your gross profit margins and labor costs are perhaps the two most important areas in developing a sound financial projection. There is a plethora of data out there regarding gross profit margin averages depending on your mix of liquor, beer, wine, and food. You need to monitor your gross profit margin continually and benchmark against the most pertinent data. Support for your labor costs is vital. Management and staff costs need to be detailed and totaled by job and benchmarked against successful restaurant ventures. 

Determine the most efficient way to finance your restaurant:

Conventional financing is often difficult with your first restaurant but not out of the question. More often than not, however, creative financing comes into play and you need to start with a variety of questions. What is the best way to fund a restaurant with friends and family dollars or outside investors? Do you want to give away equity and deal with the headache of minority owners? Can you develop an attractive debt raise with priority returns and perks? Have you considered potential convertible debt? What are appropriate payback terms? Have you built in the appropriate working capital to provide for a smooth opening?  Answers to these questions need to be integrated into your plan.

2. Select the most beneficial entity type for your restaurant. Meet with your accountant and attorney to review the best options for you. A Limited Liability Company (LLC) provides tremendous flexibility and is often the most favorable entity when dealing with initial year losses. If you have multiple owners and will often have special allocations of income or loss, the LLC is often your best choice.  In contrast, an S corporation may be your best choice if you do not require flexibility and desire a simple ownership structure  There may be significant potential tax saving opportunities in utilizing an S corporation as well. If you have multiple restaurants, you may also want to explore the operational benefits in setting up a management company. Also keep in mind that with the right planning, you could start with an LLC for flexibility during loss years and easily convert over to an S corporation down the road. 
    
3. Set-up a strong accounting process with controls. The most successful restaurants have a tight monthly close process and spend the time upfront to develop proper system, checks and balances. Ensuring that your POS system properly integrates with your software from day one, along with the proper meals tax rates, is extremely important. Some smaller restaurants may use a two- pronged approach and simply post monthly activity from the POS system into their accounting software (e.g. QuickBooks). Different approaches are fine as long as the data is readily available and proper, easy-to-read monthly management reports, can be produced. Some restaurateurs may find that having your bookkeeping team abide by a set deadline to close each month is helpful. Having your team send these reports to your external accounting firm will provide additional checks and balances. While it may prove difficult at times for a small restaurant, attempting to integrate segregation of duties can aid in avoiding potential fraud. Consider review of tasks, dual signatures, etc.
    
4. On-going cash flow management.Once a sound monthly close process is in place, look to integrate cash-flow projections by month with assumptions. Properly account for seasonality trends and be conservative with your expense analysis to start. As you get a few months under your belt, this process will become easier and more and more valuable. Integrate future expansion such as new outside seating, catering service or private dining potentials into your plans.
    
5. Tax planning.Start-up restaurants have significant tax advantages relative to the depreciation options available. The ability to write off equipment and fixtures in your entirety against profits the first year is a potential option, depending on your tax situation. Bonus depreciation options allow you to drive profits into a loss position..  Leasehold improvements also entail a variety of relatively new options with bonus depreciation and other methods that can provide you and your investor’s significant benefit. Tip tax credits can also become very lucrative in offsetting your tax burden. The proper calculation of tip credits from the onset is vital. Most payroll companies integrate this calculation for you and your outside accountant; your best bet is to utilize a payroll company that is very familiar with this process and prepares payroll for many restaurants.

Giving thought to these financial considerations can help any first-time restaurateur, offering a foundation on which to build a solid dining establishment that will last for years to come.