What is Working Capital? How to Calculate it and Find the Best Loan for Your Restaurant
Having enough working capital is vital for keeping things moving in a positive direction as you round the corner after your first year or two in business. 70% of restaurants that make it past the 1-year benchmark close their doors over the next three to five years, as growth-related expenses climb and traffic doesn’t. But, there’s a light at the end of the tunnel for persistent and dedicated entrepreneurs: 90% of restaurants that make it past five years will stay in business for a minimum of ten years.
Because of the importance of staying on track with your finances as you move forward, you need to familiarize yourself with the operational costs and expenses involved in running (and growing) a restaurant. These are the numbers you need to calculate your current working capital, make projections for the future and decide whether a loan is the best option to help cover expenses.
The Right Way to Get Started: Working Capital Requirements for Restaurants
Beyond the expenses of starting a restaurant, you’ll quickly discover that operational and growth-related costs can add up:
- Keeping up-to-date with rent or real estate payments, especially if you’re starting a second location
- Purchasing inventory
- Signage and other on-location advertising
- Insurance, licenses and permits
- Utilities, including internet
- Point-of-sale hardware and software
- Hiring employees
- Menu creation and printing
- Website design
- Marketing plan
Proper working capital management in restaurants starts before the restaurant even opens, during the initial planning and building phase. But making reasonable and informed sales projections (and considering the above expenses) can help you to determine financing needs.
Basic Working Capital Formula for Restaurant Owners
Working capital is just a formal term for the amount of cash or potential cash you have on hand compared to your overall expenses. In financing, it’s defined as the difference between the assets and liabilities of your restaurant business. Assets are actual money and anything you could reasonably sell for or turn into money within one year or one business cycle. Liabilities are payments you’re required to make during the same period of time.
This leads to a basic formula:
Working capital = current assets/current liabilities
At the minimum, you want a result of one, which shows you’re breaking even at the minimum. The higher the ratio, the better equipped you are to handle known and unexpected expenses.
If your restaurant has been open for a year, approach your working capital calculations by:
Adding all of your annual revenue, and any other funding you might have to put toward your business.
Adding all the operational costs from the past year, along with anticipated costs related to sustaining and growing, like wage increases, new employees, and more equipment. Don’t stop there, though: consider every possible cost along the ladder.
Then, compare the first number to the second to determine how much more capital you need to move your business in the right direction. If you fall far short of this number or want a cushion to fall back on, you might want to consider a working capital loan. 95% of business owners will require additional working capital over the next year, and 50% of these businesses need it to finance growth and/or new equipment.
Types of Working Capital Loans: Which is Right for Your Restaurant?
Restaurant owners have several financing options to bring in more working capital:
- Accounts Receivable Financing – If you offer catering services or wholesale any of your products, you can sell your receivables to a lender and receive a percentage of the total amount your customers owe. Once invoices are paid, the lender gives you the remainder minus a predetermined fee.
- Business Line of Credit – Unforeseen expenses are common in the restaurant industry, and a line of credit gives you access to extra capital to handle these surprises. You can borrow any amount up to your credit limit without the need to re-apply for funding every time. Payments are only required when you have an outstanding balance.
- Merchant Cash Advance (MCA) – Selling a portion of future credit card sales to a lender can bring in extra cash fast, but it’s best to be cautious with MCAs as a source of working capital. Rates tend to be high, and predatory lending practices are common. Opting for an MCA means losing a percentage of every credit card sale until the loan is paid off, which can affect your working capital ratio.
- SBA 7(a) Loan – One of a number of loan options from the Small Business Administration, a 7(a) loan can provide between $5,000 and $5 million in working capital with terms up to 25 years. Because these loans are backed by the government, the rates tend to be lower than for other types of funding. You can also apply for a “small” 7(a) loan if you require less than $350,000.
- Short-Term Loan – When you need money to cover expenses but don’t want to spend the next couple of decades paying it off, a short-term loan provides working capital with terms of a few months to a few years. Shorter terms mean higher monthly payments, but the structure can be beneficial overall if you only require a small amount of working capital.
Working Capital Loans for Franchises
Aspiring or established franchisees have another option: franchise-specific financing. These loans are designed to cover the costs associated with purchasing and meeting the strict requirements of running a franchise location, which can sometimes reach into the millions of dollars. But the expense might be well worth it: franchising and/or expanding is one of the fastest ways to grow your business to 5 million in sales.
Find the Restaurant Financing Options That Work for You
If your current working capital isn’t enough to sustain operations or grow, National Business Capital and Services can help. Funding is available from a network of sources for all types of business expenses, and on-staff financing advisors are available to guide you in choosing which working capital loan option can best meet your needs.