How to Manage Working Capital

If restaurants were opened based on profit-making potential alone, almost nobody would start a new restaurant. But new restaurants open up everyday, largely because of the passion operators have for food and hospitality. The restaurant industry is one of the riskiest around, and yet people are continually attracted to the romance of starting up the next great independent restaurant.

Unfortunately, the vast majority of restaurants fail within three years. Among the many factors that undermine a new restaurant is the lack of sufficient working capital. Most operators know the facts before opening the doors: the average-sized restaurant should have about $500,000 in working capital before opening its doors.

But, obviously, this is far easier said than done, and way too many operators impatiently open the doors to start the revenue stream before building enough capital. This double-edged sword finds operators stuck between the need to open and the need to build capital, and too often finds the restaurant swimming to stay afloat when unforeseen expenses pop up.

Expect the Unexpected

Managing working capital means being prepared when the unexpected pops up. For example, many operators fall into the trap of assuming maintenance won’t be an issue after buying a store full of new equipment. But some essential piece of equipment always breaks, or a natural disaster occurs, or an architectural oversight requires a redesign. These things always happen late at night or right before a busy weekend.

A typical business plan requires that operators know what their break-even point is. This is a product of a mathematical formula based on total operating expenses, the number of seats in the building, and the anticipated number of turns in a typical day. Far less quantifiable is the point at which a restaurant will take off, and the operator will be able to look around and see each seat filled everyday.

Working capital helps ensure that an operator will be able to pay the bills until the restaurant reaches the break-even point. It’s a good idea to work toward having enough working capital to pay the bills for the first three years after opening the doors. This is an essential part of any long-term growth plan in this industry.

Investment

There are a few ways to raise working capital, but private investments are often the best place to start. This is a ground-up business, which makes it hard for the outsider to break into unless they have outside success. But the operator with a track record of success, or who is well-networked and easy to back, has the inside track when it comes to enticing investors to the world of hospitality.

Many operators disdain private investment out of fears of ceding partial control to an outsider. But most operators have assets that are valuable to potential investors, such as:

• The romance of being a part owner of a restaurant
• A private expense account that can be defrayed by ownership equity
• VIP service for investors to impress guests and clients
• Networking possibilities with other investors

Operators too often underestimate the leverage they have when attracting investors, and this is often because they lack the business experience of potential investors. For this reason, spreading the word about investment opportunities is a critical – and overlooked –step for the success of many independent restaurants.

Generating More Capital

In an ideal world, all the working capital a business needs is created prior to opening the doors. But restaurants don’t usually operate in an ideal world. Some combination of business loans and investment offerings may be necessary in a restaurant’s infancy. This is a major reason that new businesses need to create buzz and fill seats, even if it means increasing operating expenses during the first two years.

Private investors and lending institutions are more likely to sense opportunity in a full building. This is one reason that many restaurants choose to err on the side of ramping up expenses like advertising, promotion, and facility operation in order to build revenues, even at the cost of establishing a positive margin.

Developing a business model that sacrifices short-term growth for sustained success is often the best way to keep working capital at comfortable levels. Again, this is easier said than done for the person writing the checks. But this business is all about 20- and 30-year plans. Unfortunately, the first three years can undermine all of the hard work and planning that goes into opening the doors.