Chapter 16

Financing and Leasing

Objectives• After reading and studying this chapter, you

should be able to:– Forecast restaurant sales– Prepare an income statement and a financial

budget– Identify requirements for obtaining a loan in order

to start a restaurant– Discuss the strengths and weaknesses of the

various types of loans available to restaurant operators

Objectives (cont’d.)– List questions and the types of changes a lessee

should consider before signing a lease– Discuss the strengths and weaknesses of the

various types of loans available to restaurant operators

Sufficient Capital• Many try to start restaurants with only a few

thousand dollars in capital– Such ventures usually fail

• Number-one factor of failure– Lack of management

• Second factor of failure– Lack of finance and working capital

• Standby amount of cash to open the restaurant and get through unprofitable months of operation

Sufficient Capital (cont’d.)• Commercial banks

– Common source of funds– Lending officers in the banks

• Paid employees, not owners – Also limiting their risks

• Performance is largely judged by good loans• Tend to be ultraconservative

– Want proof of income, debt, employment, and credit history

– Bank also wants collateral • Assets they can take should the loan not be repaid

Sufficient Capital (cont’d.)• Types of loans

– Term loan • Repaid in installments

– Usually over a period longer than 1 year

– Intermediate loans• Made for up to 5 years

– Single-use real estate loans • Typically run less than 20 years

Preparing for the Loan Application• Restaurateur bought furniture and fixtures from

an existing restaurant for $30,000– Money is paid to previous person leasing the

property• Work they had done to set up a restaurant

– Paid after a due diligence• Thorough check to assure everything works and health

department isn’t about to shut it down– Larger restaurants will naturally cost more

• Just a matter of finding a location and price that are right for you

Preparing for the Loan Application (cont’d.)

• Important financial questions: – How much money do you have?– How much money will you need to get the

restaurant up and running?– How much money will it take to stay in business?

Budgeting• Purpose: “do the numbers”

– Forecast if the restaurant will be viable• Sales

– Must cover all costs – Must allow for reasonable profit

• Financial lenders – Require budget forecasts as a part of the overall

business plan

Budgeting (cont’d.)• Basic categories to project sales and

operational costs – Sales– Cost of sales– Gross profit– Budgeted costs– Labor costs– Operating costs– Fixed costs

Forecasting Sales• At best, calculated guesswork

– Many factors beyond control of the restaurant• Examples: economic factors and weather

• Without a fairly accurate forecast of sales– Impossible to predict success or failure

• All expenses are dependent on sales for payment

• Sales volume components– Average guest check – Guest counts

Income Statement• Provides information about financial

performance over a given time period – Allows for analysis and comparison of sales and

costs– Shows income after expenses have been deducted

(net income or loss)

Budgeting Costs• Cost categories

– Fixed costs• Unaffected by changes in sales volume

– Real estate taxes, depreciation, insurance premiums

– Variable costs• Change proportionately according to sales

– Food and beverage costs

Gross Profit• Money left from sales

– After subtracting cost of sales• Must provide for all other operating costs

– Plus leave enough for a satisfactory profit• If insufficient the business must be redone

Controllable Expenses• Expenses that can be changed in the short

term– Variable costs– Salaries and wages – Benefits– Direct operating expenses– Heat, light, and power– Administration– General repairs and maintenance

Uniform System of Accounts for Restaurants

• Benefits– Outlines uniform classifications and presentations

of operating results– Allows for easier comparisons to foodservice

industry statistics– Provides a turnkey accounting system– Is a time-tested system

Balance Sheet• Used to determine a sole proprietor’s or

company’s worth– Lists all assets and liabilities

• Must always balance:– Assets = Liabilities + Net Worth

• Snapshot of financial standing at a given moment in time– Usually at the end of a financial period or fiscal

year

Pre-Opening Expenses• Include:

– Initial purchase of all equipment– Hiring and training of personnel– Preopening advertising

• Fixed costs:– Depreciation– Insurance– Property taxes– Debt service

Pre-Opening Expenses (cont’d.)• Variable costs:

– Change in direct proportion to the level of sales• Examples: food, beverage, labor, heat, light, power,

telephone and other supply costs

Productivity Analysis and Cost Control

• Various measures of productivity have been developed– Meals produced per employee per day– Meals produced per employee per hour– Guests served per wait person per shift– Labor costs per meal based on sales

• Simplest employee productivity measure– Sales generated per employee per year

Seat Turnover• Number of times a seat turns over in an hour

– Some consider the most critical number • Goal rates vary

– Seven an hour to less than one an hour• Depends on the type of establishment

Securing a Loan• Compare interest rates

– One percent over a period of years is big money• Beware of bankers who demand:

– Interest discounted in advance• Borrower pays interest on a lower amount than was

actually received– Compensating balance

• Banker requires a certain amount to remain in the bank at all times

Real Interest Rates• Interest deductions allowable by the Internal

Revenue Service (IRS) – Cut the real cost of a loan considerably

• The higher the tax bracket, the lower the net cost of the interest paid

– Tax laws change frequently

Loan Sources• Include:

– Local banks– Local savings and loan associations– Friends, relatives, silent partners and syndicates– Limited partnerships– Small Business Administrations (SBA)– Small Business Investment Companies (SBICs)

Small Business Administration • User-friendly • Excellent record of success in lending money

to restaurants• Principal parties:

– SBA– Small business borrower– Private lender: central role

Small Business Administration (cont’d.)

• SBA loan requirements: – Right type of business– Clear idea of which loan program is best for you– Knowing how to fill out the application properly

– Willingness to provide detailed financial and market data required

SBICs• Small Business Investment Companies

– Licensed by the SBA– Independently owned and managed – Set up to provide debt and equity capital to small

businesses• Minorities Enterprise SBICs

– Specialize in loans to minority-owned firms– Amounts loaned range from $20,000 to $1 million

or more

Soliciting an SBA Loan• Qualifications:

– Be of good character– Show ability to operate a business– Enough capital to operate on a sound financial basis– Show proposed loan is of sound value or secured as

reasonably to assure repayment– Show past earnings and future prospects– Provide sufficient funds to withstand possible losses

Sequence for Securing an SBA Loan• Items:

– Current business balance sheet– Income statements– Current personal financial statement– List of collateral to be offered– Statement noting total amount of financing and

specific purpose of the loan– Tax returns for the most recent three years

Stockpiling Credit• To make the process smoother, provide:

– Personal financial statement:• Education and work history• Credit references• Copies of federal income tax statements• Financial statement listing assets, liabilities, and life

insurance

Stockpiling Credit (cont’d.)– If in business:

• Business history• Current balance sheet• Current profit-and-loss statement• Cash flow statement for last year• Copies of federal income tax returns• Life and casualty insurance in force• Lease• Liquor license• Health department permit

Other Sources of Money• Include:

– Landlord or landlord's bank– Local government– Selling and leasing back– Public– Selling bonds or convertible bonds– Farmer’s Home Administration– Economic Development Administration – Urban Development Action Grant program

Collateral• Collateral is security for the lender

– Personal property or other possessions assigned as a pledge of debt repayment

• If debt is not repaid, the lender becomes owner of the collateral

• Collateral accepted by banks:– Real estate, stocks, bonds, and savings – Chattel mortgages– Life insurance and assignment of lease– Endorsers, co-makers, and guarantors

Leasing• Restaurant buildings and equipment are more

likely to be leased by the beginner– Less capital is required

• Signer is obligated to pay for the entire lease period– Lease should be good for both parties

• Landlord (lessor) and tenant (lessee)– Beginners should try for a five year lease with an

option to renew

Lease Costs• Approximate five to eight percent of sales

– Can go as high as 12%• Lease costs

– Calculated on a square-foot basis • $2 to $50 per square foot per month

• Lease terminology and length– Consult a lawyer versed in real estate terminology

to avoid misunderstandings

Specifics of Most Restaurant Leases

• Include:– Term of lease– Power supply– Financial responsibility– Roof warranty– Maintenance agreement– Real estate taxes– Municipal approval– Leasing and insurance

Restaurant Insurance• Types:

– Property/building and general liability– Business income– Workers compensation and employers liability′ ′– Employee benefit liability and liquor liability– Equipment breakdown– Food contamination/spoilage– Fire– Several others

What is a Restaurant Worth?• Potential Values:

– Real estate value• Usually determined by competitive values in the

community• Market value of real estate tends to follow the value

set by similar properties in the area– Value as a profit generator