When you’re just getting your bearings in the restaurant industry or preparing to open your first establishment, finances can be more than a little daunting. Here’s a quick guide on one of the business’s most deceptively complex facets.
What is working capital?
“Working capital” is a technical term for the assets and cash that a business has on hand to cover expenses in the short term, like payroll and inventory, and for longer-term projects like investment and expansion.
How do most restaurants obtain working capital?
No one eats for free, and that’s twice as true in the restaurant business. There are two ways to bring in capital:
First and most obviously, restaurants accrue capital through the income they generate from their services. That means any money coming in through dining in, deliveries, drinks, catering, or whatever else you offer.
Loans are another path to working capital. People think you need to be on the verge of bankruptcy or mired in debt to resort to a loan, but waiting until the going gets rough often makes it harder to be approved for the sum you actually need, due to your circumstances not meeting the bank’s strict criteria.
How do I calculate working capital?
Almost three quarters of restaurants that make it past their first year shut down over the next three to five. Restaurants that persist past the five-year mark overwhelmingly stay open for at least ten. The key is to not let your finances get the better of you, and to scale your budget according to customer flow and expenses. To do that, you need to calculate your working capital. There are two parts to this, and both are straightforward.
First, there’s working capital itself, which is calculated by subtracting current liabilities from current assets. To figure out your assets, add up your annual revenue, the value of any assets you could reasonably sell within a year or business cycle, and any additional funding you’ve picked up that year. Then, calculate your liabilities by adding up the past year’s operational costs, debts, and any other outgoing cash.
Working Capital = Current Assets – Current Liabilities
Second, there’s the working capital ratio, which is calculated by dividing your current assets by your current liabilities.
Working Capital = Current Assets/Current Liabilities
A result of 1 shows you’re breaking even, and a ratio of 1.2 to 2.0 is ideal to ensure a comfortable position, though higher numbers are always better. This is an easy way to check your establishment’s financial health.
How do I effectively use working capital?
Although the concept of working capital isn’t complicated, this can be treacherous. Expenses fall into a few categories.
This refers to general overhead like rent and utilities; literally, the costs associated with keeping the lights on. Reactive expenses can also fall under this remit: anything unexpected that needs to be taken care of for the restaurant to run properly, like repairing broken windows or appliances, upgrading equipment, etc.
Hiring and Employment
One of the most obvious expenses is payroll for cooks, waiting staff, cleaners, delivery personnel, managers, etc. This category is just as fundamental as operating costs.
Apart from the minimum of timely compensation, other employee-related expenses fall under this category, like benefits, paid time off, bonuses, classes, etc.
Replenishing inventory fits in this category, but so can inventory management technology. Investing in this sort of tech is expensive in the moment, but lets you finely control your stock and zero in on unnecessary costs or ways to save in the long run.
Insurance is a luxury until you’re struck by a grease fire or a hardcore weather event. Better to eat a smaller monthly expense than tens of thousands in one fell swoop.
Word of mouth is golden, but you need to actually get customers through the door in order to charm them into regulars. Marketing effectively is now easier than ever, and springing for ads on Google or social media is always good ROI. If you want to be more traditional, sponsoring a local team or event is an evergreen strategy, or even putting our merchandise if you have a unique enough selling point.
Expansion doesn’t necessarily mean jumping straight into opening another restaurant or franchising, though those are certainly options. Whether you build a patio, open a pop-up restaurant, start a catering business or invest in passive revenue streams, it’s always wise to diversify your operation.
Types of Working Capital Loans (each mentions a CCF product)
There are plenty of financing options for restaurateurs, and Capital City Funds offers several:
Accounts Receivable Financing
If you’re waiting for outstanding payments but need the money immediately, you can sell your receivables and get a predetermined percentage of the total amount you’re owed. As the invoices are paid, you receive the remaining money minus the lender’s fee.
Business Line of Credit
Business lines of credit are similar to regular credit cards. You can borrow up to a certain limit without having to apply for funding every time, and once your funds and interest are repaid, you can continue to draw on the line. This is a good safety net for sudden expenses, but can easily cover regular short-term payments if needs be.
Merchant Cash Advance
MCAs can refer to loans with short payment terms and small regular payments, often made at the end of each business day, or to selling a percentage of future credit/debit card sales to a lender in exchange for a lump sum. This brings cash in fast and often doesn’t require you to meet high standards, and if that sounds too good to be true, it is. Rates are high and you lose out on a portion of all credit/debit card sales until the loan is paid off, which can really eat into your working capital, so approach this option very cautiously.
These loans come from the Small Business Administration and provide between $5,000 and $5 million with terms of up to 25 years, with lower rates thanks to their government backing.
Short-term loans are a good option if you don’t want to make a decades-long commitment. These loans come with higher monthly payments over the course of a few months or years, and work well if you need a smaller cash injection.
Franchise Specific Financing
Franchise-specific loans are just what they sound like: they cover the costs of buying and running a franchise location. This can be very costly, well into seven figures, but it often pays off with high sales numbers.
Summary of the above and CTA to apply for a working capital loan.
A restaurant’s razor thin margins can be thrown off course by a bad month or an emergency, especially if you’re just starting out. Capital City Funds has dedicated industry specific experts on hand, with experience working with millions of businesses at all stages of development. Applications are simple and approved on the same day, provided all the information checks out, so you could be receiving up to $500,000 in flexible business loans in no time flat. Still not sure this is right for you? Check out our free quote and contact us by phone or email for a no-strings-attached discussion on how to boost your business without breaking the bank. Let’s talk turkey – or hot dogs, fine cuisine, sushi…