Adam Garfield, CPA

So I get a phone call from this client of mine last week.  Great guy, good restaurateur, successful.  His lease is just about up, and he tells me his landlord wants to renegotiate it.  The landlord wants to up it by about fifteen percent the first year, then 3% each year thereafter over ten years.  The client wants me to figure out what percent of sales his new lease expense would be based on current and projected sales.  I know what he’s doing, which is he is zeroing in on a single expense percentage figure.  He’s heard that if rent is over X% of sales, then it isn’t a good deal.

While I agree that this is an important factor to consider no matter what the circumstances, I tried to sway him to what I saw as the bigger picture.  After all, he’s the restaurant guy, I’m the numbers dork.  And the bigger picture was how much this was going to cut into his draws.  Because his restaurant does well.  He takes home north of six figures each year with relatively minimal involvement.  And the bottom line was that the rent increase, despite its relative heft, would perhaps put an additional $7K or so into the landlord’s hands compared with current rent.

Now, seven thousand dollars is a lot of money, except for Puff-Daddy, who drops that on Ciroc each Saturday night.  To us dredgers, it is a pretty big chunk-o-change.  But . . . compared to what my client takes out of the restaurant, and given that his business has established itself as a pretty solid operator in the market, I suggested to him that as long as he could put his head on the pillow not wondering if he’d be better off trying to sell his business, he would be better off taking the deal.

My client is very good at watching his pennies, and I laud him for that.  Too many restaurant owners do not pay enough attention to every expense, and it ultimately hurts them or worse, spells their doom.  But in this case, with a popular, entrenched locale, plenty of cash flow, and the hassle of closing shop and selling (not to mention where else to invest the proceeds), the narrowed focus on the new rent being too high of a percent of sales doesn’t work.

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The donuts are ready to be fried.  The yoo-hoos are ready to be, um, yoo’ed.  It’s all there.  Then the rent negotiations screech to a halt not unlike Carrot-Top’s career (one can hope).  You see, the landlord wants to include a percent rent clause.

Since everything in life is negotiable, except whether or not “Weekend at Bernie’s” is the stupidest movie ever, you may want to see if your landlord is willing to budge on this issue.  You might first want to simply cross out this clause just to see if s/he is bluffing, or thinks you are reading all of the fine print.  If this doesn’t work, you could ask to have the initial base rent lowered in exchange for having percent rent kick in at a lower sales volume.  From your perspective, maybe you can afford the additional rent if in fact you’re selling enough donuts.

Back to the example from my previous blog, let’s say you both agree that rent will be $36/square foot instead of $39.  This would make the annual rent $126,000 instead of $136,500.  This saves you $10,500 per year.  The caveat is that the landlord counters with an eight-percent rent clause instead of a seven-percent one.  Meaning if sales are more than $1,575,000 ($126,000/.08 or 8%), then you pay percent rent on the difference.  Remember that in the previous example, sales had to be more than $1,950,000, or $375,000 more for the year before this happened.  So if sales for the year under this revised negotiation were $1,950,000, you would pay $30,000 in percent rent ($375,000 x 8%). 

It’s a classic risk/reward issue.  Do you want to risk paying more rent in better sales years in exchange for paying less rent during leaner times?  I hope you can see that this can be a tricky area of a lease, so pay close attention to it.  Get help if you feel you need it.  Put pencil to paper and run the numbers.  Be comfortable that it will work for you.  And for heaven’s sakes, drink more yoo-hoos!

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Okay, it’s time to get your brain into numb mode, because as a follow up to our last little fireside chat, we’re going to talk about how percent rent is calculated.  Let’s say you find this groovy-looking end cap at a strip mall (they’ve got an All-a-Dollar store there, so you already know it’s a slam-dunk) with 3,500 square feet of space.  Perfect for your donuts & Yoo-hoo themed restaurant.  The landlord has offered it for $39/sq ft, and you snatched it.  After all, if you can’t do $2 million in sales on donuts and Yoo-hoos, you don’t deserve to be in the restaurant business.

The annual rent based on these fun figures is $136,500.  Simply multiply the dollar amount per square foot times the number of square feet to determine this.  Now comes the kicker.  The landlord may insert, let’s say, a seven-percent rent clause.  This means if base rent is less than 7% of total sales for the year, additional rent kicks in.  To calculate this sales figure, divide annual rent by seven percent ($136,500/0.07).  This equals $1,950,000.

So to translate all this nonsense, if your store sales are more than $1,950,000, base rent becomes less than seven percent.  And because of that, percent rent emerges.  To illustrate, that idea you had to put Yoo-Hoo into the the filled donuts instead of crème or jelly really paid off, and sales went to $2,500,000.  The difference in sales between that amount and the threshold of $1,950,000 is $550,000.  With a seven-percent clause in the lease agreement, you’d pay an additional $38,500 in percent rent ($550,000 x 7% or 0.07).

Are the additional sales worth the additional rent?  This point is arguable.  And more importantly, negotiable.  We’ll talk about it in more detail next blog.  Meanwhile, pass me the one with the little sprinkles on it.  Woo-hoo! (or Yoo-hoo).

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The palms are sweaty as you scratch off the last hidden number with that borrowed penny from the lotto card.  So far, the first six numbers have hit, and you’re $15,000 richer.  “Good thing I went with my dog’s birthday numbers instead of my mother-in-law’s,” you think to yourself.  The digits begin to appear behind the silvery dust.  And you’ve just gone seven-for-seven, turning $15K into $1.5 million.

The downside is instead of $2,200 in taxes, you’re likely paying about $700,000.  Can you live with it?  Sure.  But it doesn’t quite seem fair.  More money.  More tax.  Such is the fate of living in the world of a graduated tax system.

Well, negotiating the lease agreement for your restaurant premises might be a bit like this.  Because some landlords will include what’s called a percent rent clause into the agreement.  What it basically does is require you to pay additional rent if your sales exceed a certain dollar amount.  More sales.  More rent.

The idea behind it is that because store sales are high enough then there is additional value in being at the location you’ve chosen.  And because of that, the additional value gets transformed into additional rental dollars for the building owner.

How exactly is it calculated?  Is it ever beneficial?  Can I really put a ho-ho dispenser in my brand-new jacuzzi that I bought with my lotto winnings?  Come back and I’ll try to address them.  At least the important ones.  And by the way, the answer is no, but you can install one that spits out cheetos.

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Is there such thing as too much of a good thing?  Krispy Kremes?  Might as well be crack cocaine.  The NFL?  Give me a bag of Doritos, cold sodas and a bathroom, and call me next week.  U2?  U bet.  Leno?  Well, I’m actually a Letterman guy.  Have you ever seen Jay not ask a question to a guest that includes the phrase “Now lemme ask you something”.

Labor is both a good and necessary thing for a successful restaurant.  But including what I call fixed labor costs when looking at the overall labor component of the profit and loss statement is misleading.  Most restaurants have staff on hand who are salaried.  Back-of-house managers, the general managers, perhaps even some shift staff, and others may be paid a fixed rate for their work. 

When measuring labor cost as a percentage of sales for the period, it is important to separate out hourly labor, which should vary depending on sales volume, from fixed labor.  A $50,000 per year GM is still a $50,000 per year GM whether sales are $800,000 or three million plus dollars.  Including her salary gives a skewed perception of real labor cost, because her wages are in that expense category whether you’re hearing crickets when you walk in or can’t hear your companion above the crowd buzz.

As an example, let’s say your business raked in $1,200,000 in sales last year.  All non-management labor (hourly employees) comprised $240,000, which is twenty percent of total sales.  Management labor added another $80,000, or about 6.7%.  You might think that total labor as a percent of sales was 26.7%.  And you’d be right.  Now we look at 2008.  The recession hit you as well, my friend, despite your introduction of the ‘Really Really Awesome Blossom’ appetizer.  Sales fell to $900,000.  Non-management labor was $198,000, or 22%.  You still paid your managers $80,000, or 8.9%.  Total labor cost:  thirty point nine percent.  The ‘but’ at the end of all of this is that labor didn’t really go up 4.2%.  It went up two percent.  Fixed labor costs are just that - fixed.

So, when preparing your financial statement, keep fixed labor costs separated from variable ones.  It’ll help you keep a more realistic sense of how your labor costs are holding up.

 Now if only the ‘Really Really Awesome Blossom’ was made out of Krispy Kremes.  Lard-o-licious!

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Freebies.  Giveaways.  Two-for-ones.  Ten percent off.  Good neighbor breaks.  Corporate favors.  Air Supply medleys.  Employee discounts.  All of these financial elements (okay, all but one of them, which just creates a pool of barf) and others create a couple of things: 1) less money in your pocket as the restaurant owner and 2) the chance to include some useful accounting detail on your eatery’s profit and loss statement.

 Whether you’ve got a $200 Staples cash register or a state-of-the-art POS system in place, take advantage of the opportunity to separately identify and account for all the different discounts you provide to your customers and employees.  Create multiple buttons on your registers to key in all of these items as they occur.  They’ll give you a wealth of information on your income statement.

When you cash out your registers at day’s end, the inexpensive register or pricey POS system should be able to separately identify and account for all of these items.  Why bother with all that, you ask?  Well, because I want to create more mindless work for you, that’s why.

Actually, this detail can help you track what kind of response you’re getting from that mailer you recently sent off.  It’ll let you know if you are giving away too many free employee meals.  It could also tell you if your employees who operate the registers are accurately keying in these items.  It’ll tell you if you need to go stumping for your business a bit more at “Teen Angst Threads” in the adjacent strip mall. 

So don’t lump all of your discounts into one button on the register.  You’ll find out considerably more by slotting each item into its own category, and including them all on your restaurant’s financial statements.

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Okay, so perhaps that one never enters the gray matter. But, maybe it should, at least at some point, because restaurants make purchases like this all the time. A $300 meat slicer, here, a four-hundred dollar laptop there, and even an $89 cordless phone. All of these items are designed to last the business more than one year (that’s the theory, anyway). And because they are designed this way, tax geeks like me have to decide if they should be put on the profit and loss statement as an expense, or put on the balance sheet as what’s called a fixed asset. This is usually designated for big-ticket purchases of kitchen equipment like walk-in freezers, ovens, dishwashers, and other similar items.

Many restaurants like to show as much net income (income after all expenses) on their financial statements. As such, they would rather have any item, even relatively inexpensive ones like the phone, not show up on the profit and loss statement. Its cost digs directly in to the bottom line. And the phone will probably get you by until at least 2010 (unless you drop it in the fryer - ‘Mmmm, deep-fried phone’). That arguably meets the book and tax definition of a fixed asset.

So, whaddya gonna do? I usually advise my clients to pick a dollar amount over which questionable items will be booked as fixed assets, and under which they will be booked as small equipment purchases. As small equipment items, those costs go on the income statement instead of the balance sheet. They serve multiple purposes there: they allow your tax person to decide if they will remain as an expense on the income tax return or get put as a fixed asset, they provide a definitive cut-off point (perhaps $500 is the threshold) for the income statement versus balance sheet argument, and in some states where items such as this are subject to property taxes, they can be easily identified when preparing those statements for the city or county requiring them. For my clients, I use a category we call ‘smallwares’ so we know these are small-ticket pieces of equipment.

Now, back to reality. Go with the red Nano. From what the kids tell me, chicks dig the red ones.

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So your restaurant manager is rocking the place, as the kids like to say.  Food costs are down, labor costs are in check, the rats are mostly at bay, and the customers are fat, tipping, and happy.  Then comes the request:  “Uh, boss, can you show me the financial statements so I can get a sense of how ‘Pig Feet - Who Knew They Were Delicious?!’ is doing this period?”

The sweat beads are forming on your temple.  You don’t want to show Mr./Ms. General Manager, despite your overwhelming trust, to look at all aspects of the profit and loss statement.  You don’t particularly want him to know how much you pay in rent, what your utility costs are, let alone how many bags of Sour Patch Skittles you bought and hid in the ‘back room supplies’ accounting category (just kidding - especially if you’re an IRS agent reading this).

There are a lot of reasons to not show a non-equity individual, even one as involved as the operations manager, all financial aspects of your restaurant.  Most pointedly, it’s none of their business.  As the owner, you are the one who took the risk to open your doors.  You are under no obligation to share a significant component of your financial doings with the manager.  Would you show him your income tax return?  Your 401K statement?  Of course not.  So there is no need to feel you owe him a complete glimpse of the restaurant’s operational activities.  It fosters envy and perhaps even an effort by the manager to think she can go out and duplicate your efforts at a new location of her making.

So how to handle the reasonable request to let them know if they are hitting their numbers in the important categories?  Why a tailor-made profit and loss statement, of course.  In my world of restaurant accounting, it’s usually called a ‘controllable profit and loss statement’.  Which is just a fancy-schmancy way of including only those categories  over which the manager has control.  Food and labor costs are the main two items.  You could also include repair costs, office supplies, uniforms and laundry, and even utilities, where the manager has significant say over how long a gas-powered grill is run, for instance.

Prepare one every accounting period for him.  Review it together.  It’ll be a bonding moment (-”Hey, why the he$# is the ‘latex gloves’ expense up $225 this period?”-  -‘;Um, balloon night?’-).  It’s the carrot to help motivate the manager to keep costs under control.  And that’s just another way to bring more profit to the bottom line.

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I was down in southern Utah this past week for a family reunion.  The phrase ‘family reunion’ is actually Latin:  the word ‘family’ means ‘periodic gathering’, and ‘reunion’ means ‘of people you could barely tolerate when you were a kid, let alone an adult’.  Actually, we had a very good time with a number of extended relatives who I admire and whose company I enjoy.  And by a number I mean two.  Again, just kidding.  Great folks who I am happy to know and with whom I enjoy reminiscing.

While we were there, I took my immediate family to a restaurant called Texas Roadhouse Steakhouse.  You may be familiar with it.  Texas-themed joint (I aint no Texan, but I done figured that one out by the name), stainless steel tubs of unshelled peanuts at every table, lots of knotty alder, cartoon-drawing, oversized head pictures of country celebrities (Willy Nelson, Faith Hill [mmm . . . Faith-a-licious], that dude whose dad pitched for the Phillies), and plenty of yee-hawness to go around.

Our server was a guy who looked the part of a roadie for ZZ-Top.  Big-ol seventies ‘do, long sideburns that connected to a mustache (just like the bass player from the movie ‘This is Spinal Tap’), long-sleeve tee shirt underneath a short-sleeved one.  Now, I’m no Zagat wannabe, but he was about the best server I’ve ever had.  I had my four monsters in tow, who range in age from sixteen to 7 (actually, sometimes the sixteen-year-old acts like he’s seven - or more like 3), and he went out of his way to make sure all their food and beverage needs were more than accommodated.

I had a meat-a-saurus hankerin’ (this is, after all, a Texas steak place so the word ‘hankerin” seems appropos), so I got steak, pulled pork, and ribs, and he made sure I had all the sauce coverage I could handle.  He refilled drinks before they were empty, was willing to change out a cooked steak that wasn’t quite done the way one of my boys liked (we passed, but the offer was nice), and he kept things hopping.  He wasn’t stingy with the to-go containers, and checked back more than he probably needed to on how things were going.  He explained the way their meat was cooked and cut, how their sirloin steaks were a tender cut above the rest.  He made Jeeves look like Homer Simpson in comparison.

He received a well-deserved tip that was notably higher than normal.  I thought about this when I tallied up the cost of the additional items he brought to our table, including extra rolls, honey butter, and the other aforementioned items.  Probably no comparison, his tip being considerably higher.

He brought in additional tip income for himself and the other wait staff, and an eventual return trip from a very satisfied customer.

My point?  Pretty simple.  Good customer service is nearly priceless in its impact on a restaurant in goodwill, good word-of-mouth, and revenue.  Props to the guy at Texas Roadhouse who admirably served our needs.  And props to all of you restaurant owners who make sure your wait staff do the same things.

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Thirty days hath September.  April, June, and . . . Morgan Spurlock (google it).  Or those dudes from the band Humble Pie (likely even a more obscure reference).  While those Romans were pretty brilliant in coming up with a calendar, they failed to think through its usefulness to restaurants.

Their utter thoughtlessness aside, setting up your accounting periods on a monthly basis is, in a word, stupid.  Well, not really stupid, more like, uh, dumb.  Okay, that’s too harsh.  But there’s some really good reasons to go to a four-week period over a monthly period.  Comparability is the biggest one.

October has thirty-one days to it.  Always has, always will, unless somebody comes up with a better plan.  So why go to a twenty-eight day accounting period, when October 2008 has thirty one days, and so will October 2009 (hey, optimism in keeping your doors open - nice!)?  November always has thirty days.  The only weird one is February, and that only happens every time we elect a new president.  Pretty thoughtful of the Romans to help remind us about that, because otherwise we’d never know.  You can compare months nearly as easily as anything else, right?

Well, sort of.  October 2008 has four Sundays, Mondays, Tuesdays, Saturdays, and five Wednesdays, Thursdays, and Fridays.  That’s important because rare is the establishment whose sales do not fluctuate based on what day of the week it is.  My local Fuddruckers, a customize-your-own-burger place, has a Tuesday kids-eat-free special.  It’s not because they’re generous.  It’s because they want to get more business. Tuesdays are slow.  Looking ahead to October 2009, there are only four Wednesdays and a fifth Saturday.

So when you compare your October 2009 sales with October 2008, and sales are eleven percent higher next October from this one, part of it may be due to that extra Saturday, when foot traffic is usually greater.

Using a four-week accounting period solves this problem.  Each of the seven days gets included four times.  Every year, every period.  So when you’re comparing, let’s say, Sunday October 5 2008 through Saturday November 1, 2008 against Sunday October 4, 2009 through Saturday October 31, 2009, you’re comparing the same seven days times four inclusions for each period.  And it takes the fluctuation of sales over the course of each week out of the mix.

With four weeks to each accounting period, you’ll want to have thirteen of them each year to create a semblance of a calendar year.  Of course, all you calculus majors are going, “yeah but 28 days times 13 periods equals 364, and there are three-hundred sixty five days each year.”  Don’t worry, Uncle Adam’s got you covered.  That one day shortage every year (adding an additional day every fourth or leap year) gets factored in as a fifth week at your discretion every six years.  To keep comparisons the same, you can multiply the single five-week period that occurs in that sixth year by 80% (4 weeks/five weeks), to effectively pro-rate that period.  It then approximates a four-week accounting period.

So, the next time you’re looking at that ‘Puppies & Kitties in Love’ calendar and you see thirty or thirty-one days staring back at you, you can smile knowing that, in your world, in ways that really matter, there are only twenty-eight of them.

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