Cash Flow & Purchasing a Restaurant

If you're buying a restaurant, somewhere between plunge-taking and handshaking you'll want to know exactly how much money you can expect to make off your purchase. This number is called the cash flow and is calculated by subtracting the total money spent on operating the restaurant from the total money the business brings in.¹

Just as many sellers are motivated by a bottom-line cash amount they want to walk away with, many buyers are tempted to wave away layers of complex financial detail when the purchase of their dream is in sight. Everyone in the deal is incentivized to picture large profits for the buyer – you included, otherwise you wouldn't be buying a restaurant. Studying the cash flow of a business can bring those high expectations back down to Earth and protect buyers from disastrous miscalculations.

Valuation: Numbers & Opinions

The price of a restaurant will vary greatly depending on where it is, how popular it is, and what condition it's in. The median price for a restaurant is around $150,000.² Small business sales are often priced according to the amount of operating income earned in a year. This doesn't mean the profit earned, but the total amount of money that comes into the restaurant, before subtracting expenses. The sale price typically falls somewhere between 25 and 40 percent of the operating income.

Inexperienced operators may not be able to parse the useful data from the cascade of numbers they'll be facing. Overwhelming information isn't much better than no information at all; should a restaurant be spending half its budget on food, or more? What margin is reasonable for a steak dinner? Is this restaurant over or undercharging customers? Without answers to these questions, knowing a restaurant's cash flow may not tell you everything. The following are a few handy rules of thumb, according to Joe Bastianich, author of Restaurant Man.³

Balancing Restaurant Expenditures

30 percent of your gross intake should go to labor costs.
30 percent of gross intake should go to food and drink costs.
20 percent should go to miscellaneous costs such as rent, equipment, and maintenance.
The remaining 20 percent will be, ideally, profit.

These numbers are optimistic, of course. If you're purchasing a new restaurant, 20 percent profit should be an end goal rather than an immediate expectation. The other numbers will vary greatly depending on the style of foodservice operation you're considering. Consider these ratios a starting point from which to examine the information.

Verifying the Information

Motivated sellers provide at least two years of tax returns, expense reports, and income statements. Official tax returns and expense reports are the best ways to verify what the seller is telling you about the business is accurate. Even trustworthy sellers can be mistaken about their financial prospects, so acquiring as much information as you can will help you make a good decision. These documents not only reassure prospective buyers that the business has been run well, but can also point to areas wise management might be able to improve. If the seller has trouble providing satisfactory documentation for the restaurant's finances, that's a serious red flag.

One way to view cash flow is in terms of owner benefit: the owner's salary, perks and net income as found on tax returns, plus depreciation and interest expense – or, as Entrepreneur.com⁴ defines that, "what the owner was paid and paid out that you will inherit assuming the same business performance."

Owner benefit, however, is easy to misstate. Even when a seller can prove accurate cash flow figures for the current and previous years, don't go by their projections; do your own. Use an accountant, if not a buyer's broker and real-estate attorney with in-the-trenches restaurant experience if you can find one. Don't rely on average sale prices or other local sales to gauge your purchase price, as the lease, equipment, brand, location, and ownership status of each restaurant change the value immensely. Even restaurants down the street from each other could have seriously different prospects, so you'll need to consider local traffic, demographics, visibility, and trade area⁵ as well as the ever-important restaurant cash flow.

References

Restaurant Cash Flow. Upserve.com. Accessed December 2021.
How Much Would Buying a Local Restaurant Cost?. Investopedia. Accessed December 2021.
Restaurant Math. American Express. Accessed December 2021.
Cash Flow. Entrepreneur.com. Accessed December 2021.
How Buyers Evaluate a Restaurant, Bar or Club Business to Determine if It is the Right Opportunity. Restaurant Realty. Accessed December 2021.