The Economics of Owning a Restaurant

There are many different costs and factors that go into making a restaurant successful. According to FSR Magazine, 60% of hospitality facilities close within the first year of opening, while 80% close within five years. The largest financial risk to your restaurant business is underestimating the amount of capital you'll need to begin operations and continue to bring in a positive cash flow.

The initial cost of purchasing or starting up a new restaurant is your most important consideration before making the commitment. When planning for this cost, it is important to have sufficient liquid assets over and above your planned initial expenses.

You have three options: franchising, purchasing an existing restaurant, or starting from scratch.

Opening a Franchise

Franchising with a successful national chain can bring instant brand recognition and programs for coaching new employees with assistance for getting to the grand opening of the business. With those value-added services comes a franchise fee that can average between $20,000 and $50,000 per restaurant, according to the Small Business Administration (SBA).

In addition, some well-known national chains are likely to require liquid assets in excess of $1 million. This can put franchising out of reach for the average middle-class entrepreneur.

Buying a Restaurant

The purchase price of a restaurant depends on the quality, the location, and the profitability of the establishment. The quality of the building can save you thousands on potential remodeling costs and repairs.

The location should be ideal for your concept unless you are only purchasing the restaurant for its equipment and furniture. If the restaurant is more profitable, the upfront costs for buying the restaurant are likely to be higher.

Starting From Scratch

Whether the cost of franchising is too much or you want to begin fresh with your own ideas, starting from scratch has many fixed and potentially unexpected costs. The usual costs include equipment, furniture, fixtures, initial food and inventory, signage, insurance, build-out, security deposits, and the first month's rent and utilities.

The benefit of starting your restaurant from scratch is a clean slate for your own ideas without the royalty fees and upfront costs from franchising.

How Expensive Is a Restaurant to Operate?

Building a new franchised location or from-scratch restaurant has similar construction and build-out costs along with employee hiring and training. If you buy an existing restaurant, it can be a turnkey operation from day one with positive cash flow, but it may not exactly fit your needs and desires.

Operating costs such as salaries, marketing, inventory, and maintenance are often underestimated, especially with new restaurants. These costs typically make up around 80% to 90% of total revenue at profitable establishments. Any major decreases in revenue or increases in costs can quickly lead to a negative cash flow. In these circumstances, restaurants may have to consider a restaurant business loan in order to stay afloat.

Ways to Keep Expenses Under Control

To keep expenses in check, you may consider shopping for equipment and utensils using second-hand options. Many of the restaurants that fail liquidate their inventories and equipment to restaurant supply stores, which in turn resell it for much less than you would pay when buying new.

Try to use all of your available word-of-mouth tools to promote your restaurant. This includes leveraging social media, which is often free. It may be worthwhile to use restaurant reservation software, which allows guests to reserve tables online, to help manage your business and keep the restaurant filled. Use energy-saving lights, equipment, and fixtures. It may cost slightly more upfront, but it should pay dividends over time.

Next to food, labor is the largest expense for restaurants. In high-volume locations, a qualified manager is worth the expense to ensure proper inventory management and employee scheduling. Having employees standing around and letting food go unnecessarily bad will kill already thin profit margins that only average between 2% and 6% for the industry as a whole.

The Bottom Line

Initial costs can vary dramatically based on the quality, size and location of your establishment. With sufficient planning and capital, opening your restaurant can be successful. However, to avoid going out of business, your restaurant must keep operational costs in check and grow revenue to ensure a positive cash flow. (For related reading, see The Economics of Owning a Bar.)

Article Sources
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  1. FSA Magazine. "Restaurant Profitability and Failure Rates: What You Need to Know."

  2. U.S. Small Business Administration. "Franchise Fees: Why Do You Pay Them and How Much Are They?"