Starting Your Own Restaurant

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 Conducting a Financial Analysis

There are a number of factors to consider when determining the value of a restaurant you may wish to purchase. This month's column covers the financial analysis, another important area to investigate before making the decision to buy a business. Conducting a thorough financial analysis will not only help you compute the goodwill value of the restaurant; it will also provide you with a sense of the profitability potential of the operation and can also aid you in computing the initial cash investment you can afford to put up for the restaurant purchase.

As with any business purchase, the assistance of a knowledgeable accountant is invaluable. This is especially true when analyzing a restaurant's finances, since an accounting professional who is familiar with the restaurant business can spot patterns and trends in the restaurant's past performance that can help you predict future profitability.

Tax Reports

Your financial analysis should include an examination of all relevant tax filings. These may include:

- federal income tax reports
- federal unemployment tax reports
- state income tax filings
- unemployment tax filings
- state sales tax reports
- workman's compensation reports
- FICA filings
- withholding tax reports
- real property tax documents
- personal property tax documents

You want to make sure that these records are consistent with all the other financial records. These records should also reveal the projected tax liabilities you would incur if you owned the restaurant. Keep in mind, however, that government agencies can increase or decrease tax rates upon change of ownership.

Other Records and Reports

Other records and reports that may be worth investigating include:

- Personnel records provide a long-term average of a major expense item. Be on the lookout for any Department of Labor judgments against the restaurant that may affect the sale of the restaurant.

- Cash budgets indicate the working capital requirements of the restaurant and also point out those times of the year when you may have to borrow short-term money to cover a temporary cash squeeze.

- Credit reports -- such as those available from Dun and Bradstreet, purveyor credit applications or a local credit reporting service -- offer a credit history and may indicate whether you can expect to have any problems obtaining credit from current suppliers to the restaurant.

- Annual shareholder reports may contain audited statements. If not, they may at least make you aware of the seller's expectations of the restaurant's future.

Balance Sheet Analysis

The amounts represented on the balance sheet usually will not be of interest; however, you and your accountant may be interested in some of the patterns, trends and other related ideas that the balance sheet tends to reveal. Some of the things worth noting are inventory turnover, inventory amount, accounts receivable, accounts payable, loans payable, and net worth.

Income Statement Analysis

The most important part of the financial analysis is the income statement analysis. After reconstructing income statements from the past two or three years, your accountant will be able to prepare a projected statement. The critical figure to compute is the anticipated net cash flow you will receive after satisfying all expected expenses. This is the amount of money that will serve as the return on your investment in purchasing the operation.

Key aspects of the income statement analysis include:

- Sales volume analysis shows what influences the sales volume, whether the volume is accurate, whether there are any "off-the-books" sales, potential sales volume, and potential for increasing other income from non-food and non-beverage sales (for example, video games, parking fees, and so on).

- Sales statistics give you a more comprehensive view of the current customer base. Some statistics worth considering are ratio of food sales to bar sales, average check, average gross margin, sales volume per square foot and per full-time-equivalent employee, seasonal trends, and sales volume potential compared to actual sales volume.

- Sales expenses analysis points out the seller's marketing efforts and includes any advertising and promotion expenses, as well as a consideration of potential free public relations opportunities of which the seller has not taken full advantage.

- Pro forma income statement is probably the most important part of the income statement analysis, which is a projection of what the income statement will look like in six months or so after you become the restaurant's new owner. Here, again, your accountant will be indispensable in computing sales and expense figures for key areas, such as gross margin, wages and salaries, employee benefits, payroll taxes, insurance, advertising and promotional fees, income and property taxes, interest and principal payments, leases, licenses, and a number of other factors.

Goodwill Value

Goodwill value represents the excess of earnings capacity over and above the fair or average rate of return that ordinarily would be earned on the restaurant's tangible assets. In computing goodwill value, you and your accountant will want to consider such things as the restaurant's name and the reputation it has built over the years, convenience of location, efficient and friendly service, superior products, unique recipes and hours of operation.

Goodwill value can be negative as well as positive and will be calculated differently by the buyer and the seller.

If your analysis shows negative goodwill because there is an insufficient net cash flow, you should consider ignoring the restaurant purchase opportunity, unless you are interested in adapting the property to another use.