Case Study - Example Restaurant Pty Ltd

Take the example of a small business restaurant with a typical turnover of $750,000, and with profit and expense ratios which fit within industry averages.

Profitability
A forecast shows that the business will produce a Gross Profit of $465,000 (62%), and an operating profit before interest, depreciation and tax of around $142,000 for an owner-operator. The budget and cash flow statements reveal the business factors which give the most leverage for profit improvement. The raw numbers used in this example can be downloaded here (pdf file).

Cash Flow
The cash flow forecasts (on page 2 of the download ) show that the business requires cash to boost its business in quieter seasonal periods, but has surplus cash during peak trading periods. Knowing this allows the amount and timing of borrowings to be predicted with confidence. For an astute manager it should also lead to a questioning of strategies - to examine ways of offsetting the slow cash flow through sales or expense management, or a fresh marketing strategy.

Leveraging Improvements
A quick short-list of sensitivity factors shows a potential for 49% profit gains, and this is typical of most businesses. With a properly constructed budget model, by varying the budget inputs a range of high-yielding factors can be easily identified. Have a look at the sensitivity summary, here (pdf file).

This example shows that a 5% improvement in customer spend would yield a whopping 26% increase in operating profit. In this case, product-pricing, and the amount each customer spends are high-leverage factors. Compare this with a 5% reduction in labour costs, which although significant, would only produce a 6% profit improvement.

At a basic level this suggests that an effort to boost customer spending levels will yield bigger results than trying to reduce labour costs. But of course a closer examination may suggest that both improvements (or indeed neither of them) can be readily achieved.

Taking action - and further analysis
After identifying the high-leverage factors, the next step is to examine each factor in more detail, and brainstorm ways to achieve the suggested results.

For example a 5% reduction in Cost of Goods Sold, potentially yielding a 10% increase in operating profit, might be achieved by:

• changing the sales product mix, or
• re-negotiating terms with suppliers, or
• re-engineering inventory management,

As part of a deeper analysis it's instructive to break sales into categories, and then fully apportion all costs including overheads to see what the profit really is, category by category (or even item by item). The categories used will be specific to the business; for example they might be geographic, demographic, product-related, by selling channel, or some other segmentation which makes sense.

This can be very revealing; sales items with high gross profit margins are not necessarily the most profitable overall. Using this information to make strategic or operational changes can lead to big profit improvements. This kind of information is almost never available from regular financial statements, and therefore is a frequently overlooked opportunity for improvement.

Testing decisions, the "what if?" analysis
Once specific improvement measures have been identified and costed, it's a simple matter to re-run the budget forecasts to ensure that the proposed changes make sense, and that the cash flows of the business are safe.

Having a budget and cash flow forecast is the essential starting point for planning and control. The example business budget and cash flow package used here can be produced in less than a day for almost any business.