Advising Our Restaurant Clients Through Challenging Times

As CPAs, we are trusted advisors to our clients. While it is our responsibility to assist with their tax and accounting matters, clients often seek our advice on general business issues. We can all attest to the concerns we were tasked to help our clients address in the wake of the pandemic. Businesses are now coming out the pandemic, generally optimistic for the future. Restaurants, however, after preserving through mandatory shutdowns, capacity limitations, staffing issues and supply shortages are now faced with uncertain economic challenges.

When vaccines became available and mandates lifted, there appeared to be a glimmer of hope for the industry. People became more comfortable going out and restaurants saw the result of pent-up demand and confident consumer spending. Things changed quickly as the economy began to feel the effects of the record government spending and war in Ukraine. Gas prices, interest rates and inflation have soared and talk of potential recession leads the question: what does the outlook for restaurants look like and how can we advise our restaurant clients through these challenging times?

We have received phone calls from clients and prospects, wondering what the value of their restaurant is and wondering if it may be time to exit. In the face of economic uncertainty, the best way to advise our clients is to help them protect (and perhaps even build) the value of their investment. To do this, we as advisors have the opportunity to teach our clients inputs that determine value.  

When valuing any business, a three to five-year look back on financials is standard. With historical inconsistency and recession looming, potential investors will likely use the discounted cash flow approach to value restaurants using projections. When projections are not available, the acquirers’ advisory team will prepare projections based on historical trends, qualitative and quantitative attributes of the company, and the industry and economic outlooks. Helping our clients keep a close eye on their financials and managing their revenues and expenses, will help them protect their value.

In his book, Financial Valuation: Applications and Models, Valuation titan James Hitchner shares three secrets to restaurant valuation. His first secret is knowing the breakeven point, which many restaurant owners do not know. Restaurants are just like any other business and once revenue exceeds breakeven, profit results since fixed costs are covered. Knowing the breakeven point in revenue and average guest value will reveal the required sales volume needed to cover costs, helping clients with menu pricing decisions and cost management.

Hitchner’s second secret is that variable expense per unit falls as volume increases, leading to higher profit margins. In other words, as volume increases, there will be efficiencies by optimizing the use of variable expenses and reducing waste. For example, food is the largest variable expense in restaurants. As volume increases, waste should decrease as more ingredients are being used and less thrown away. Labor too, although a semi-mixed cost, will decrease per unit, as productivity increases. As accountants we are familiar with the concept of utilization, and in any industry you want to run at optimum utilization. Helping our clients to understand the concept of utilization will improve staffing decisions.

Management is Hitchner’s third secret of restaurant valuation. Two restaurants can have identical revenues, but much different bottom lines. One of the major contributors to profitability differences can be management. Now more than ever, retaining talent is of the utmost importance. Restaurant owners should assess their team and incentivize key members to stay. Incentives could take the form of performance bonuses, equity, or phantom stock. These same incentives can be used to recruit outside talent as well. Develop the management team, incentivize them, train them and retain them.

So if the first two secrets are volume based, what factors should our clients consider to preserve the value of their investment?  

Capacity is perhaps one of the biggest obstacles facing the industry and getting in the way of optimizing sales. Coming out of the pandemic, restaurants have been forced to limit hours, no longer because of government shutdowns, but because of staffing trouble. In 2021, 86.3% of accommodation and foodservice workers left their jobs.[1] The Nation’s Restaurant News (NRN) suggests offering referral and retention bonuses to incentivize new and existing team members. Offering flexible hours can attract part time workers such as high school and college aged students balancing school and sports. Having an active social media account and creating a team-oriented work environment can attract and retain talent.

To keep a competitive edge, restaurants should seek to understand customer preferences and develop menus that cater to those desires.  Healthier options that use locally sourced and plant-based ingredients are becoming more popular as well as craft beer. Over 60% of frequent craft beer drinkers say they decide which bar to patronize based on its craft beer selection.[2] Restaurant clients can implement or improve their online ordering and delivery processes to make it easier and faster for customers to order and consider alcoholic beverage delivery. Advertising and communication should be promoted using social media platforms.

To manage costs, when possible, restaurant owners should contract with suppliers to lock in pricing and mitigate increases.  When rising prices are inevitable, they should be passed on to the customer. Since restaurants deal with large quantities of perishable supplies, implementing controls to properly manage and purchase inventory can reduce waste and increase revenues.  Restaurant owners should consider automated inventory management systems to track supplies and order ingredients when levels run low. There are systems available that integrate sales and inventory modules to help forecast future demand for menu items.

Restaurant owners should also consider the following factors and how they might affect their value in the eyes of potential buyers:

• Who owns the real estate, what are the terms of the lease and renewal options? How much time is left on the lease? Are leases assumable to a buyer?
• If the restaurant is a franchise, what is the term and cost of renewal and what is the chance of non-renewal? Are there impending leasehold improvement upgrades required?
• What controls does the restaurant have in place to mitigate employee fraud and theft? These are high risk areas that can quickly affect profits.
• How often are inventories counted? Are all inventories including operating supplies and paper products being inventoried?

Restaurants that persevered through the pandemic are now being faced with significant economic pressures and challenges. As business advisors to our clients, we can help restaurant owners preserve the value of their investment so they can recognize the multiple they seek when they are ready to exit. When you are talking to your restaurant clients, remember Hitchner’s three secrets of restaurant value: 1. Know the breakeven point, 2. Increase volume and 3. Develop management. Help owners to focus on the inputs that will help them preserve or even build value in their investment during these challenging times. In situations where owners are looking to exit within the next three to five years, engaging a valuation professional as part of the advisory team can pay dividends down the road, helping the client to optimize its exit multiple.   

Chris Nadeau, CPA, CVA, CMA, is a manager at O’Connor & Drew, P.C. He is a member of the Massachusetts Society of Certified Public Accountants (Litigation Services Committee), the American Institute of Certified Public Accountants and the National Association of Certified Valuators and Analysts. Michael Doody, CPA, CVA, is a senior accountant at O’Connor & Drew, P.C. He is a member of the Massachusetts Society of Certified Public Accountants and the National Association of Certified Valuators and Analysts. MIchael is a Certified Public Accountant and Certified Valuation Analyst. They can be reached at 617-471-1120 or cnadeau@ocd.com and mdoody@ocd.com.