A 25-year veteran of the restaurant industry, Jim is the owner and operator of RestaurantOwner.com, and a sought-after industry speaker.
Frequently, I find myself in a conversation with an operator that goes something like this:
"I own a restaurant, and my food cost is around XX%, my labor is running XX% or so, and my rent is $X,XXX per month. How are we doing with a net income of XX%?"
Obviously, I don't have enough information (or time) to make an intelligent response to such an intricate question, but to get the operator thinking in the right direction, I ask for two pieces of information about the restaurant: its annual sales volume and its approximate square footage (the size of the entire "footprint" of the facility, including storage, restrooms, hallways, etc.) I then do a quick mental calculation of sales per square foot, which, in my opinion, is the single biggest profit driver in the business.
At the very least, it's a great place to start when assessing the profit potential of most any restaurant.
Top profit-determining factor: sales per square foot
Awareness of your annual sales per square foot, in most cases, will give you a fairly accurate sense of the profit potential of a table-service or quick-service restaurant. For example, if a quick-service operator is doing $400,000 per year in 2,000 square feet ($200 PSF) I would immediately suspect they were losing money, or barely getting by at best, due to insufficient sales volume. Given anything close to market lease rates and a typical cost structure, it's probably impossible to make any money in this situation, even if management and staff are doing a fabulous job of controlling operating costs.
Conversely, take a 2,000 square-foot table-serve independent restaurant doing $600,000 ($300 PSF). If its occupancy costs are not excessive and they are doing a reasonable job of controlling key operating expenses, I would expect them to pull in at least $30,000 (5 percent of total sales before income taxes) and as much as $70,000 (net income before tax).
The point is this: There is nearly always a direct correlation between a restaurant's sales per square foot and profitability -- or at least profit potential. The following chart is based on a rather unscientific combination of sources that includes operator surveys compiled in the National Restaurant Association's Industry Operations Reports, as well as my own experience working with independent and chain restaurant companies, which operate literally thousands of table-service and quick-service restaurants.
Restaurant Industry Guidelines for Assessing Profit Potential:
| Operational Yield || |
$175 - $275
$225 - $300
$275 - $400
$300 - $425
Please note: I define "Moderate" profit as net income before tax (NIBT) of between 5 percent and 10 percent of net sales. "High" profit would produce a NIBT of more than 10 percent of net sales.
There are exceptions
Keep in mind that this chart reflects a compilation of a large number of restaurants and also reflects averages for certain operating costs that can vary widely depending on geographic location and other factors. A good example is rent expense.
In some areas, prevailing rental rates may be more than twice the industry average. Such a location is midtown Manhattan, where I know of operators paying rental rates in excess of $80 PSF annually (plus ad valorem taxes, utilities and insurance). In such extreme cases, the above sales PSF numbers would be low when dealing with rental rates above the typical restaurant occupancy costs of between $13 and $20 PSF.
The owner's cut
Another issue impacting the profitability of every independent restaurant is the compensation paid to the owner. Since this varies greatly from restaurant to restaurant, it can make it difficult to gauge a restaurant's profitability accurately.
For instance, it's common for many owners, when a restaurant is getting established, to take nominal compensation or none at all, despite their active engagement in the business every day.
Just as commonly, owners of highly successful restaurants pay themselves substantial incomes. For example, I know of an independent operator's W-2 that consistently runs in seven figures, from one restaurant. That one restaurant, however, does more than $700 in an annual sales per square foot.
So to equalize the effects of high or low compensation paid to a working owner, consider this fairly good rule of thumb:
The total gross compensation of a take-charge, do-it-all kind of GM or chef's is based on 3 percent to 4 percent of net sales. Therefore, assuming the owner is involved in the business in the same way, i.e. performing the functions of that chef or GM, take that same figure (3 percent to 4 percent of net sales) and treat it as actual gross compensation paid to the owner.
Knowing that figure allows you, in most cases, to better evaluate your restaurant's profit potential because you can more easily compare your operating results to industry averages.
Additional articles by Jim Laube:
* FINANCIAL MANAGEMENT: Educate your staff about the cost of your business
* FINANCIAL MANAGEMENT: Know your numbers
*FINANCIAL MANAGEMENT: Preparing a monthly P&L won't give you the best numbers