Which Hospitality Business Should I Buy?

Which Hospitality Business Should I Buy?

Considering Cost Structure Before Investing In A Hospitality Business

Have you ever thought of the importance of the cost structure before making an investment decision?

Do you know how cost structure may affect profitability?

Frequently, people may prefer to acquire an existing restaurant rather than starting one from scratch since it has an established clientele.  However, before you make a decision to buy a restaurant, you need to consider several factors.  One of them is the restaurant’s cost structure.

What Is The Cost Structure?

Cost structure refers to the level of a restaurant’s fixed and variable expenses in relation to its sales.

Fixed expenses are considered those expenses a restaurant will incur anyway regardless of the number of its guests.  Examples of fixed expenses are the management salaries, rents, insurance, marketing, most utilities, taxes, depreciation and amortization expenses and other administrative and general expenses.

Variable expenses are those expenses that behave in a similar direction and proportion to a restaurant’s sales.  Examples of variable expenses are the food and beverage costs, some salaries for periods of excessive demand or special events and selling expenses.

How Cost Structure May Affect Performance?

Someone now may say, “OK, how the cost structure influences a restaurant business? “  Let’s have a look at Table 1:

Table 1

Restaurant A Restaurant B
Number of covers annually 10000 10000
Average spending per cover $30 $30
Variable cost per cover $13,50 $9,00
Sales revenue 300000 100% 300000 100%
Less: Variable costs 135000 45% 90000 30%
Contribution margin 165000 55% 210000 70%
Less: Fixed costs 120000 40% 165000 55%
Net income 45000 15% 45000 15%

Yes, but still, both owners experience the same amount of profits?We see in the table above two different restaurants with the same amount of sales (300000), total expenses (255000) and net income (45000).  The only difference between the two restaurants lies in the level of fixed and variable expenses.  Restaurant B has a larger base of fixed expenses compared to its sales than Restaurant A since its fixed expenses constitute 55% of its total sales.

That’s true! However, potential investors may consider two things.

First, restaurant B needs more customers to cover its fixed expenses.

Secondly, both businesses may have more or less customers or covers in the future? How these changes in market demand may affect performance for the two restaurants?  Let’s have a look in the following two tables.

Assume sales increase by 15% along with variable expenses for both restaurants and fixed expenses remain the same.

Table 2

Restaurant A Restaurant B
Number of covers annually 11500 11500
Average spending per cover $30 $30
Variable cost per cover $13,50 $9,00
Sales revenue 345000 100% 345000 100%
Less: Variable costs 155250 45% 103500 30%
Contribution margin 189750 55% 241500 70%
Less: Fixed costs 120000 35% 165000 48%
Net income 69750 20% 76500 22%

Assume sales decrease by 15% along with variable expenses for both restaurants and fixed expenses remain the same.

Table 3

Restaurant A Restaurant B
Number of covers annually 8500 8500
Average spending per cover $30 $30
Variable cost per cover $13,50 $9,00
Sales revenue 255000 100% 255000 100%
Less: Variable costs 114750 45% 76500 30%
Contribution margin 140250 55% 178500 70%
Less: Fixed costs 120000 47% 165000 65%
Net income 20250 8% 13500 5%

Looking at the two tables above we can easily observe that restaurant B is more sensitive than A.  Why?

In Table 2, we see that as sales activity increases by 15%, restaurant B (with the higher level of fixed expenses) experiences more profits than restaurant A.

In Table 3, as sales decline by 15%, restaurant B makes less profit than restaurant A.

Conclusion

It’s clear that the higher level of fixed expenses of restaurant B creates a greater sensitivity or risk for the business since profit performance is affected more than restaurant A when market conditions change over time.

Thus, cost structure clearly may affect operating outcomes (profits) for a restaurant business when business performance and/or market conditions change.

Finally, cost structure may be a factor that potential investors need to consider before making an investment decision between alternative options.

What do you think?

Which restaurant is a better investment decision?

Which restaurant would you choose to buy?

Why would you choose to invest in one restaurant over the other and under which circumstances?

Yiannis Megaloeconomou

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Comments ( 2 )
  1. BobbuBrowne
    May 3, 2017 at 2:51 am
    Reply

    Hello! Cool post, amazing!!!

    • Yiannis Megaloeconomou
      May 24, 2017 at 7:36 am
      Reply

      I am glad you like it.

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