3 Ways to Survive a Sucker Punch in the Great Recession
By Robert Wagner, CPA

A sucker punch is a blow made without warning, giving a gal or guy no time for preparation or defense. For restaurant operators, the Great Recession has delivered a sucker punch to their businesses. Operators have been “one-twoed” by the perverse and continuing decline in revenues and stubbornly high operating costs.

Some economists have declared the steepest recession in 50 years over; but that is not what it feels like to Georgia’s restaurant owners and operators. Through the first quarter of 2010 there is continued softness in restaurant sales. It’s just not a fair fight when lower sales make it hard to cover fixed costs such as rent, insurance and salaries and still make a profit.

Restaurant operators are not ones to give up - even in the face of very poor odds. They stand and fight as long as there is strength, even after taking a sucker punch or two. But operators can increase their odds of victory. Here are three steps operators can take to improve their chances of staying in the ring.

1. Don’t Mess with the Government

Paying sales and payroll taxes is a big cash drain on a restaurant. It is very tempting to put off paying these taxes and plan to catch up later. Don’t try it! There are two reasons to do everything possible to stay current with your taxes. The first is that penalties are severe for late paid taxes. Penalties and interest combine to make “borrowing” tax dollars by paying late one of the most expensive loans you’ll ever get. Second, officers of the company may be personally liable to make good on unpaid taxes, penalties and interest. That liability could hammer the owners for years after a restaurant closes.

2. It’s the Prime Cost, Stupid

In 1992 Bill Clinton ran a successful presidential campaign focusing on the sorry state of the economy. In his campaign headquarters hung a reminder of the issue that would prove to win the election. It said “It’s the Economy, Stupid”. The sign implied that staying focused on the most important issue on voters’ minds would carry the election. And it did!

Just as Clinton stayed focused on the essential issue, restaurant operators can fight this economic sucker punch by focusing on the basics of running their restaurants. The single most important metric in measuring a restaurant’s health is prime cost defined as cost of sales plus payroll expenses. Of the 100+ restaurants we work with, we have not seen a restaurant in financial trouble that has a consistent and appropriate prime cost.

What is the magic prime cost percentage? For independent restaurant operators it’s 65% of revenues. For franchise operators it’s 60% of revenues. If prime cost is consistently well above 65% of sales, there usually isn’t enough cash to cover other expenses and make a profit.

During the recession many restaurants are seeing prime cost climb to 70% and even 75% of sales. What’s happening? Normally a well-run restaurant can keep a lid on its cost of sales. Almost always the problem is payroll expense. Even when an operator is faced with declining revenues, he hates to cut payroll. The aim is to keep on that manager that’s been there for years or to plan for that sales rebound when more labor will be needed. Whatever the reason, operators hate to cut payroll. But to roll with the punches and fight another day, operators must preserve scarce operating cash. The best way to do that is to get prime cost in line immediately.

3. Reduce Bank Debt

The media is full of stories of debtors who stopped paying the bank - and the bank just let the debt ride. Not a good idea! Lately we’ve seen banks declare business loans in default faster than ever. Big banks have set up huge “special asset” departments meaning bankers working loans in default. The bank machinery handling defaults and foreclosures is running over-time. Don’t get knocked out by that machine.

Studies show that the single best indicator of long-term success of a restaurant company is the amount of debt the company carries. The higher is a company’s debt, the higher the likelihood of failure. It’s a simple concept but hard to correct. After all, how does one reduce debt in a recession? There are only three ways to reduce debt: pay the debt from profits, replace old debt with new debt or pay off debt with additional investment. Of these options, perhaps the only one viable now is bringing in new investment. New investment means giving up ownership perhaps to an outsider and perhaps on unattractive terms. But it is the one way to staunch some of the cash bleeding and guard against foreclosure.

Conclusion

The Great Recession has sucker-punched a lot of Georgia restaurant operators. To have a fighting chance at victory focus on the basics like prime cost, debt reduction and tax liabilities. Watch your numbers and make your swings count!

Robert Wagner, CPA is president of NetFinancials, Inc. which provides a full range of tax and accounting outsourced services for restaurant companies. Phone: 404.874.7002 Email: bob.wagner@netfinancials.com