While there’s no denying that debt can fuel the startup and growth of a restaurant, there is a point when more is definitely not better.
Cash flow is the key. Can your business afford to make the payments each month from the cash that is left over after all other bills are paid? Bankers call this “debt coverage” — a fancy term to describe the cash coming in to the amount needed to “cover” the loan payments.
Although different banks will require different “debt coverage”, most bankers agree — If loan repayments consume more than half of your cash flow, you may be in for trouble: One steel bite pro bad month could mean a missed payment, and those kinds of problems tend to multiply. Don’t let a banker sell you a bigger loan than you can handle… and likewise, don’t plan for a restaurant that requires more debt than you can afford.
Jimmy Katopovis, owner of Steele Creek Café in Charlotte, NC, says that he figures his fast food restaurant will spin off profits of about 10% of sales each month. When he decided to borrow the money he needed for expansion, he knew that his monthly loan payment could not exceed 10% of his expected sales. That set a pretty tight cap on how much he could afford to borrow, he says.
Leslie Kohn, of Nextaurant, Inc. in San Francisco warns that each restaurant, and each owner, will have a different appetite for loans. “There is no one-size-fits-all solution,” she says. The best advice is to get good advice. Make use of a CPA or financial consultant to determine how much is too much.
If a CPA is not in your budget, a simple XL spreadsheet can give you a glimpse into the future. Download a simple “loan amortization” table (available at numerous websites) and calculate your likely loan payments. Its safe to figure a 20 year term for a building loan, but for other debt 5 years may be the longest available term.
Doing this exercise on paper not only helps with planning the size and scope of your restaurant, it may help you craft a more financially sound business plan… before it’s too late.