How to Create Realistic Financial Projections for Your New Restaurant

An experienced operator recounted his career in the early 1990s when he was recruited to be the general manager and eventually managing partner for a beautiful, upper-casual steak-and-seafood concept. He joined the venture in the midst of construction, about three months before opening.

"Having had success in several nightclub ventures, the general partners spared no expense when it came to design and construction," he recalls. "Thick red leather booths encased in rich mahogany trim set the tone for the dining room ambience that our $1.8 million budget mandated. A constant flow of change orders and delays, including more Italian marble and a $41,000 brass and polished stainless steel revolving door entrance, contributed to ballooning cost overruns. Although the enhancements served to entrench the restaurant as a must-visit destination, the added expenses resulted in a final cost of $2.4 million to get the restaurant open.

Money is only a tool. It will take you wherever you wish, but it will not replace you as the driver. ~ Ayn Rand

"Overshooting the budget by nearly 33 percent meant that additional financing would be needed to pay for the excessive expenditures. Not only was the ROI (return on investment) projection shot, the partners were only able to raise an additional $200,000, leaving $400,000 in payables for which they expected to settle from cash flow.

"A quick rework of our break-even point revealed that we now needed to do $75,000 in sales per week just to break even. Needless to say, this restaurant concept, regardless of how good the food was, how great the service, and how magnificent the ambience, was now a prime candidate for failure due to underfunding."

Fortunately, he was privileged to have had a "fantastic team of managers, staff, and supportive partners," he said, adding "We worked together to lower our break-even point, increase the sales volume and finally, after three long years, achieve a highly profitable restaurant that is still serving fine steaks and seafood today."

Not surprisingly, scenarios such as this are played out every day in the restaurant industry. And unfortunately, the vast majority of underfunded restaurants don't have the luxury of an experienced staff and sufficient revenues to withstand such dramatic shortfalls in their financial projections.

Let's focus on perhaps the most important aspect of your business plan: the financial projections. The process begins the moment your concept has been defined. As with every undertaking, you need to determine the right questions before you seek answers. These include:

• How much will it cost to build?

• Where will the funds come from?

• What are the projected sales?

• What are my break-even sales?

If you plan to invite partners or investors to participate, then you'll also need to answer the following:

• What is the return on investment?

• What is the sales potential?

• What are the growth expectations?

• What is the potential liability?

The answers to these questions can only be found by diligently preparing a realistic set of financial projections, accompanied by an investment analysis and a growth plan.

Money Talks

Some would argue that the financial projection is the business plan. Why bother building a restaurant if it's not going to make any money? For potential investors and lenders, the financials are often viewed as the heart of the business plan and this section will get a lot of attention and even scrutiny from them. This is where they have the opportunity to evaluate the financial viability of the venture and -- all-important -- gain a sense of the risk and return on investment potential the venture is likely to offer.

Even though you may have years of hospitality experience and are an expert at operating a restaurant, lenders and investors want to know you understand the financial side of the business as well. Showing knowledge of the numbers lets them know you see the big picture and are capable of not only running a restaurant but that you also possess the skills to build it as a successful business. Although you may not have a financial background, you'll need to understand the numbers on the various schedules and statements that make up the financial projections section and be prepared to answer questions about the assumptions used to create them.

In fact, writing the financial projections section of a business plan might require you to seek outside assistance from a financial consultant and/or accountant. Still, don't be frightened by numbers if you don't have a financial background. As you plug through the process, you will become more comfortable with the concepts and the calculations. Creating financial projections is the hardest part of the business planning process, but offers a huge payoff. Arriving at realistic and achievable financial projections is perhaps the biggest confidence builder in the startup phase of a restaurant. You know that if you can maintain a realistic sales volume and control known costs at a certain level, you can make a go of it.
The Capital Budget

The first step, and one of the most critical, is to develop a capital budget for your venture. The "capital budget" is a detailed schedule showing all the various expenditures, construction, startup and preopening costs required to get the restaurant open for business. Adequately identifying and estimating the costs of the project at this stage is absolutely crucial. One of the main reasons for restaurant failure is undercapitalization, i.e., running out of startup capital before operating activities have a chance to generate an adequate cash flow to sustain the business. Don't place your restaurant (and future) in jeopardy by not having enough capital to complete your project according to plan or start out in a big financial hole.

Here are the major categories of the capital budget:

Land and building. If the owner/operating entity is planning to own the land and building (versus leasing a facility), the actual or estimated cost of the land and building should be included here. Also include any related acquisition costs such as closing costs, sales commissions, and finder's fees.

Leasehold improvements. In a leased facility, enter the estimated cost of constructing the leasehold improvements less any landlord contributions. Leasehold improvements will include the cost of demolition (if any), construction of walls, ceilings, electrical, plumbing, HVAC, fixtures, flooring and any other hard costs associated with the interior and exterior structural and mechanical components of the building. Also enter any landlord allowance or contribution for the construction of the leasehold improvements, as this will reduce the eventual cost of the leasehold improvements.

Bar and kitchen equipment. Based on your menu, prepare a detailed list of the bar and kitchen equipment you'll need. Obtain actual bids and be sure to consider the cost of delivery, installation and setup. If possible, reference a detail of the bar and kitchen equipment and place it in the appendix of your business plan.

Bar and dining room furniture. If possible, reference a detailed drawing of the bar/dining room furniture and place it in the appendix. Obtain actual bids and be sure to consider the cost of delivery, installation and setup.

Professional services. This section includes costs like architectural, engineering, design, legal, accounting and other professionals and consultants whose services will be used. Obtain cost estimates from these professionals based on the scope of services you plan to have them perform.

New restaurants also get bombarded by every coupon merchandiser, directory, magazine, newspaper, and a litany of other marketing opportunities. You need to create your own marketing plan, or enlist a marketing consultant before deciding on the various vehicles by which you'll market your restaurant.

Organization and development. A variety of costs are placed in this category, including deposits on utilities, sales tax and lease, permits and licenses, menus and other similar costs. Obtain cost estimates from suppliers or other authoritative sources.

Interior finishes and equipment. This section includes interior items such as kitchen small wares, artwork, décor, sound system, POS and other similar items. Obtain cost estimates from suppliers or other authoritative sources.

Exterior finishes and equipment. Items such as landscaping, exterior sign, parking lot and other similar costs are included in this category. Obtain cost estimates from suppliers or other authoritative sources.

Pre-opening expenses. Preopening expenses are standard restaurant operating expenses that are incurred before opening. Included are costs such as food, beverage and supplies inventory needed for menu development, training and opening as well as utilities, interest expense, uniforms, marketing and payroll costs of management and staff. It's common to hire the chef or other management personnel from one to three months before opening, depending on the need for their involvement in the development and startup activities. Hourly staff normally begins training one to two weeks before opening.

Working capital and contingency funds. Very few restaurants are profitable during the first few months of operation. Some restaurants that are quite successful today took a year or more to reach profitability. Some provision should be made in the capital budget for working capital to cover possible operating deficits after opening. It's quite rare to open up a new independent restaurant and start out making a profit in the first month of operation.

It is also important to have a contingency built into the capital budget for change orders and cost overruns. There will always be surprises and unplanned costs when opening a restaurant. Cover yourself by having a contingency equal to at least 5 percent to 10 percent of the total project cost.

Sales Projections

Projecting a realistic and achievable sales volume is at the heart of every restaurant business plan. Nearly all of the restaurant's expenses, as well as the profit, cash flow and return on investment are affected directly by sales volume.

To estimate sales volume in a to-be-developed restaurant, both the average check per guest and guest counts by meal period should be objectively analyzed and projected.

In most restaurants the number of guests served can vary dramatically by meal period and day of the week. For example, many restaurants do as much as 50 percent or more of their weekly sales on Friday and Saturday. This makes it important to consider expected guest activity for every meal period in a typical week.

To get a sense of the level of business that can be expected, it helps to become very familiar with what kind of customer activity existing restaurants experience in your immediate market area. Spend some time in these restaurants and through observation and casual discussions with employees and even managers, inquire about their busy and slow times. Ask about how many table turns they do on different days of the week. Are sales trending higher or lower than last year? If you're tactful and friendly, it's often amazing what information they'll share.

Three sets of sale projections should be prepared:

• Conservative (worst case)

• Moderate (anticipated)

• Optimistic (potential)

The last thing you want to do is build your financial projections and business plan around a best-case scenario. The value of an "optimistic" projection shows you how well the business could perform if all the planets are aligned. It creates some excitement for you and your investors, regarding the potential of the enterprise. A more reasonable strategy is to attempt to build your business plan around a worst-case scenario. We don't suggest that you be pessimistic; however, if you can execute your concept and launch the business based on a conservative sales projection, you are more likely to weather the startup phase of negative cash flow, which is almost inevitable.

Labor Projections

Hourly labor cost is one of the largest expenses in any restaurant. Don't just assume that your hourly labor cost will be some certain percentage of sales just because of what other restaurants are doing. There are many variables that affect hourly labor and they can be different even in what may appear to be very similar restaurant operations. Take the time to project your labor cost by position for each meal period in a typical week based on the level of business activity you actually expect.

Taking into consideration each meal period's covers (number of meals served) and sales volume, estimate the hours and number of employees needed in each position to adequately staff the restaurant.

As a rule, management salaries should not exceed 10 percent of sales. A general manager's salary often runs from 3 percent to 4 percent of gross annual sales. If you're the owner/operator and you're also running the restaurant, you can, of course, pay yourself what you want. For purposes of the business plan, however, it would probably be prudent to keep your compensation within the 3 percent to 4 percent of sales. Your compensation should not become a contentious issue to your lenders or potential investors or detract from presenting the profit potential of the restaurant in the best possible light.

A typical rule of thumb for table-service restaurants is to keep hourly labor (gross payroll) at or below 18 percent to 20 percent of sales. Hourly labor cost on busy nights can be as low as 11 percent to 12 percent of sales, whereas on slow nights, it can be as high as 22 percent to 25 percent. The goal for the week, however, in most cases would be to shoot for an hourly labor cost of 18 percent or less.

Employee benefits include the employer's portion of payroll taxes, workers' compensation, medical and other employee insurance premiums as well as other employee-related expenses. Employee benefits often run 5 percent to 6 percent of gross sales and 20 percent to 23 percent of gross payroll.

The Importance of Job Descriptions

The first step in getting your restaurant kitchen organized is to create a list of duties and responsibilities for each kitchen job position. Job descriptions help your employees understand the expectations and results you look for from their job performance. It's also a good idea to include the skills, training and qualifications needed to perform each job. Job positions and stations typically differ from one restaurant to another and should be unique to an operation.

Assumptions

On the assumptions page, enter the estimates of the remaining operating costs and expenses. We highly recommend you purchase the National Restaurant Association's (NRA) Industry Operations Report as a way to conduct a "reality check" on numbers as compared with industry averages. We also recommend following a restaurant-specific chart of accounts. The following are the major cost and expense categories included in assumptions:

Cost of sales. Estimate cost of sales as a percentage of the corresponding sales category. For instance, if your sales projections list food, liquor, beer and wine sales estimates, based on expected costs and anticipated menu prices you should have a good idea of what the respective cost percentages will be for each. If your sales projections show that you anticipate $100,000 in sales per month, and you have calculated an average food cost of 32 percent, then the food cost portion of your projections will be $32,000.

Please note that when showing percentages for cost of sales, you should show the percentage in relationship to the specific revenue category, not overall sales.

Direct operating expenses. Direct operating expenses usually run 4 percent to 6 percent of gross sales. Some of the direct operating expenses you'll want to include are:

• Auto expense

• Cleaning supplies and services

• Extermination

• Flowers and decorations

• Kitchen utensils

• Laundry and linens

• Licenses and permits

• Menus and wine lists

• Paper supplies

• Security systems

• Tableware and small wares

• Uniforms

Music and entertainment. Depending on the concept and the type of music and entertainment used, expenses in this category can vary significantly. According to industry averages, music and entertainment costs run from an almost negligible amount to as much as 2 percent to 3 percent of sales when live entertainment is employed on a regular basis. Among the costs of music are licensing fees to the performing rights organizations.

Marketing. Marketing includes expenses associated with promotions, advertising and marketing programs and materials. Industry averages show that most independent restaurants spend between 2 percent and 4 percent of sales on marketing-related items.

Utilities. The cost of utilities can vary widely depending primarily on the location, local utility rates and prevailing climate conditions. Most restaurants spend from 2 percent to 4 percent of sales and from $4 to $9 per square foot per year on utilities.

General and administrative. In most situations, "G&A" costs run 3 percent to 6 percent of sales. One big component and factor in this category is the use of credit cards by your customers. Examples of G&A expenses include:

• Accounting services

• Bank charges

• Cash over/short

• Credit card charges

• Dues and subscriptions

• Office supplies

• Payroll processing

• Postage

• Professional services

• Armored car

• Telephone and ISP

• Training materials

Repairs and maintenance (R&M). R&M includes repairs and ongoing maintenance of equipment, building components and landscaping as well as the cost of equipment maintenance contracts. Restaurants in a new facility with new equipment should have below-average repair and maintenance expenses for the first few years at least. As an industry average, R&M runs from 1 percent to 2.5 percent in most restaurants.

Occupancy costs. These include primarily fixed expenses associated with the facility housing the restaurant. Kitchen equipment lease payments (if any) should also be included in occupancy costs. A good rule of thumb is to keep occupancy costs at or below 10 percent of sales. It is often very difficult to generate an adequate profit and return on investment when occupancy costs exceed 10 percent of sales. As a general rule, rent should not exceed 6 percent of sales.

In most restaurants, occupancy costs run $12 to $22 per square foot. However, in many urban locations, particularly in upscale neighborhoods, occupancy costs can run much higher. Still, the 10 percent rule of thumb would hold. Our advice would be to not venture into any location in which you're not confident the restaurant will generate at least 10 times the total occupancy costs in annual sales.

It is extremely important to accurately estimate occupancy costs for the business plan projections. Get at least two estimates from competent professionals in the real estate and insurance industries to determine property (ad valorem) taxes and insurance costs. You can't afford surprises in this area.

Depreciation and amortization. Depreciation and amortization are noncash expenses and represent the arbitrary write-off or expense allocation of capitalized assets like equipment, furniture and fixtures and preopening or startup expenses. Work with your accountant to determine your depreciation and amortization schedules for various capital improvements.

In the operating projections we recommend adding depreciation and amortization back to net income (and subtracting loan principal payments) to arrive at the amount of cash flow generated by the restaurant each year.

Income Statements. Once you've completed the sales, labor, and assumptions projections, you are ready to complete the income statement portion of your plan. This section should include:

Summary 'profit and loss' statement ('P&L'). You should provide a summary P&L reflecting both monthly and annual projections for each of the sales projections levels (conservative, moderate, and optimistic). The summary P&L may be preferred over a detailed version by some people who aren't interested in all the details. It's concise, easy to understand and contains the key restaurant industry ratios most people will want to know.

Use the information gathered for sales, labor and your assumptions to formulate your income statements.

Detailed P&L. Provide a detailed income statement based on the moderate (or anticipated) sales projection. This format will show interested parties the detailed expenses that you anticipate. It also reflects that you have done your homework, and that you actually have a plan for operating the restaurant day to day.

Five-year projections. Many investors know that they can't realistically expect a return on their investment in the first year. A summary projection showing three to five years of profit and loss helps them evaluate the probability of their ROI.

Cash flow break-even. You can pretty much count on any potential investor or lender to ask the question, "What level of sales do you need to cover all your expenses?" By doing a break-even analysis you can not only give them an answer, but also show them exactly how the number was reached. To calculate a break-even point you must first identify all of your fixed expenses. Next, add the percentages of all your variable expenses. Variable expenses include your projected cost of sales, credit card charges, a portion of hourly labor (the portion not included in your fixed costs) and possibly some for paper and other supplies.

Investment Analysis

Once you have completed your financial projections you will have a better understanding of how much and where you need to get the capital it will take to turn your idea into reality. The investment analysis should provide a detailed picture of the investment plan for the restaurant. It should incorporate the sources of funds needed to complete the project as well as a proposed return on investment analysis (ROI).

Source of funds. Funding sources include bank or personal loans, leases, investment capital from partners or owners, or funds from venture capitalists. Would-be investors and bankers will want to know what type of liability the restaurant will assume. For example, if you plan to use a large equipment lease as a means of getting equipment without having to spend the upfront capital, then you need to disclose that. Equipment leases, like bank loans, take a priority over investment capital when it comes to getting paid back.

Capital contributions. Most plans will have only one type of investor such as partners or shareholders. However, in some cases there may be multiple types of capital contributors. An ROI analysis should be presented for each separate investment role or group. Additionally, each investor role should have a brief description of the expected financial requirements, ownership percentage (if applicable), ROI, and an explanation of how that investment role could be affected by unexpected cash requests in the event they are needed.

An ROI analysis should show how long, based on the moderate projections level, it will take for an investment to be paid back. If the payback is anticipated to extend beyond three to five years, you may have a tough time getting an investor to buy into your concept.

Growth Plan/Exit Strategy

An aggressive growth plan can be a double-edged sword. On one side, investors will want to know that if the restaurant is a huge success, they'll have the opportunity to participate in the expansion of the concept. The other side is, don't depend on expansion to make your restaurant concept an attractive investment opportunity.

Use this section of your plan to portray future expansion possibilities and opportunities. This section can also be used to explain exit options for investors who may want to cash out or remove themselves from ownership.

Plan to Succeed

Creating a great business plan requires a lot of work as well as knowledge. Go to seminars. Seek consultants' advice. Get the NRA Industry operations report. Join the National Restaurant Association and its state counterparts. Do your homework.

Creating a business plan for the first time is too daunting of a project for most newbies. ~ Big Dave Ostrander

You may spend 80-100 hours a week at work in or on behalf of the restaurant once you get ready to open. Without a good plan you may have to work that many hours for months thereafter. Spend those hours now to be sure you have a good plan. Many restaurants fail simply for lack of a plan. Others fail because they didn't follow their plan or adjust it as needed.

When it comes down to it, you invest both time and money in getting a restaurant started. Earnest and diligent business planning, especially developing the financial projections, is one of the best ways to invest your time before opening the doors. The payoff can be a long-lasting and profitable enterprise. Plan to succeed.

Break-Even:

It's Like Having Your Own Financial Crystal Ball

Calculating how much sales a restaurant must have to cover all of its costs for a certain period of time, say a week or month, provides tremendous advantages for restaurant operators, including more restful sleep. Some of the advantages of knowing your "break-even":

It tells you the sales volume your restaurant needs every week or month to have any real chance of making a profit. Knowing only your sales volume can give you a good sense of whether you're making or losing money.

Knowing your break-even enables you to respond promptly to sales declines that may put the restaurant in an unprofitable position. During a sales slump, break-even acts like an early warning system. It can tell you that once sales slide past a certain point, chances are you're losing money and you have a real problem on your hands. It's much better knowing that sooner rather than later.

Break-even also gives you a tool to quickly estimate your profit or loss for a period of time, with knowing just your sales.

There are two basic types of costs in business. Those that stay the same regardless of sales volume like rent (unless you're subject to rent as a "percentage" of your sales) and property taxes, which are referred as "fixed" costs. There are also costs that go up or down in direct proportion to sales volume, a good example being food and beverage costs, which are referred to as "variable" costs. These numbers can be derived from your profit and loss statement (P&L).

The basic formula for computing break-even is:

Break-even Sales = Total Fixed Costs / Variable Cost %

Don't worry if you can't determine your fixed and variable costs to the penny. Even arriving at "ballpark" figures will be useful. Let's say, for the sake of example, you determine your total fixed costs for a given period are $25,821, and your variable costs are 34.4% of your total sales.

Applying this formula, you will find that your break-even sales are:

Break-even Sales = $25,821 / 1 - 34.4%

Break-even Sales = $25,821 / 65.6 % = $39,361

We recommend that every restaurateur purchase a copy of the National Restaurant Association's Uniform Systems of Accounts for Restaurants. Our team edited the 8th edition and we believe it is an invaluable accounting and financial resource for restaurateurs and restaurant accountants and bookkeepers.