December 1, 2005 - Jim Laube is the President of RestaurantOwner.com, an online resource center for independent restaurant operators.

For more information visit www.RestaurantOwner.com.

Many bankers don’t understand the restaurant business. They look
for the same financial ratios and financial “rules of thumb” in a
restaurant as they expect in any other type of business.

One of the most blatant areas of misunderstanding is in the area
of evaluating liquidity, which is having the ability to pay your
bills when they come due. To do this bankers usually go straight
to a company’s balance sheet and calculate the current ratio,
which is Total Current Assets  (cash, inventory, receivables)
divided by Total Current Liabilities (payables, taxes and other
bills due within 1 year).

Bankers like to see a current ration of 2 to 1, which is $2 in
Current Assets to every $1 in Current Liabilities.  While this
may be a good benchmark to evaluate some companies, it isn’t a
reliable indicator of liquidity for restaurants.

To validate this you need to go no further than McDonalds and
Brinker International (Chilis, Macaroni Grill), two of the most
financially sound restaurant companies around. They both
consistently carry a current ratio of well under 1 to 1.  

The reason restaurants can carry on quite well financially
without a high current ratio is that it’s a “cash” business. When
a restaurant makes a sale it gets cash on the spot or the next
day if a credit card was used. When many businesses make a sale
they book a Receivable and wait for the cash for 15, 25, 30 days
or even longer.

Also, restaurants carry a low level of Inventory relative to
their sales volume, only about 5 to 7 days worth. Many businesses
carry 30, 60 and even 90 days worth of sales in inventory (a car
dealer & furniture store come to mind).

Receivables and Inventory are both current assets. So a business
that can function without having to tie up lots of cash in these
areas can be highly liquid “provided the company is profitable.”

Restaurants that are profitable almost always generate positive
cash flow. Every day cash is coming into the business which can
be used to pay bills as they come due.

So the next time your banker, CPA or financial advisor starts to
give you a hard time for having an unhealthy current ratio, you
now have some ammunition to educate them about the financial
distinctions of your industry.