Friday, January 27, 2017

Why your vendors loan you money.


Please enjoy our latest blog post:
Why your vendors give you credit and how to use it to your restaurants advantage.

Check out past blog posts at http://chefsheet.blogspot.com/

“Remember that credit is money” - Benjamin Franklin.

In life we usually pay for things at the point of sale. Think about it. It would be really weird to leave the supermarket with your groceries and be expected only to mail a check for the purchase sometime in the future. Imagine walking out of the Apple Store with a brand new laptop while leaving only a signature as a form of payment. Of course, you can use a credit card to pay for the laptop later, but in the case of credit cards, the bank is providing the credit. In contrast, when your vendors leave food, beverage and supplies at your restaurant, you are not expected to pay for a period of time usually ranging from 10-45 days. In essence, the vendor placed the product on a truck, drove the truck to your restaurant, unloaded everything and drove away without being paid. Why and how do your vendors extend credit, and what does trade credit really mean for your business?

First, there are some technical reasons why vendors provide trade credit. Paying for product on delivery is difficult. For instance, credit card fees are expensive so either checks would need to be cut or cash would need to be ready for the drivers to collect. In addition, giving cash to the driver presents all kinds of security issues. These technical issues aside, the main reason your vendors provide you with credit is so you can buy product from them when you do not have the money up front to pay for it. Restaurants are largely a cash flow business. Companies that supply restaurants know that they will sell more product if they extend credit to the buyer and allow them time to pay for it. Restaurant vendors also know that if they do not extend credit to their clients, then someone else will.

There are numerous benefits of gaining trade credit for your restaurant. For example, let’s say a steak, which you paid $10 for, was delivered to your restaurant on Monday and needs to be paid for in thirty days. When you sell the steak on Tuesday for $30, you will have that $30 in cash without paying anything for the product. So, for the next twenty nine days you can use that $10 you owe for the steak on anything else you need; payroll, insurance, rent.

Using trade credit to manage cash flow is part of the restaurant business. This is why the vendors extend credit, and it is how the business (for most operators) works. The challenge is to be sure that the use of trade credit is not obscuring larger problems within your organization. Restaurants can run up very large trade credit balances. Your financial reporting should include a balance sheet showing your short term liabilities with a section for “Accounts Payable.” Regardless of your P&L, your cash flow or how you feel about your restaurants’ financials, your short term liabilities (and how they change over time) is perhaps the most important indication of how your business is performing. You want this number to be stable or, if your business is seasonal, to reflect the seasonal swings. If your short term liabilities are growing, and it is not an off-season or a slow time of year, this may be a problem. If, at the end of the year, your short term liabilities are greater than they were at the start, there is a problem.

In general, your credit relationship with your vendors will be in-part based on a written agreement and in-part based on your relationship with the vendor. When you begin using a vendor, you will often be asked to complete a credit application. The credit application is really two things; 1) an application detailing the business which the vendor will review and 2) a contract spelling out how the vendor will be paid. In a business as kinetic as a restaurant, things like a credit applications are often done on the fly. It is important to be cautious and thorough when completing credit applications and to make sure you know what you are signing. It is also crucial that you are clear as to who within your organization is allowed to sign these credit applications.

Perhaps the most critical part of any credit application is the continuing personal guarantee. Most small restaurant groups are formed as a limited liability entity. When you sign a personal guarantee, you are agreeing to be personally liable for the debt that the business does not pay. It’s in your best interest to ignore this personal guarantee section until/if the vendor requires it. Some vendors will insist on a personal guarantee, some won’t but may grant longer payment terms with a guarantee, and some will not notice. The question you need to answer is what is the benefit of signing vs the benefit of not signing. Your restaurant may end up being passed through five generations of your family. It may grow to 100 units and go public or it may flourish for just another 10 or 20 years. How much is your accounts payable now and how much will it be in 10 or 20 years? If the business closes, vendors with a signed personal guarantee will have the right to collect any remaining trade balances from the signer personally. You must ask yourself, “what is this eventuality worth to me?”

A vendors’ credit application may also contain language allowing your vendors to maintain a first priority position or file a UCC1 statement. What this means is that your vendor can file a notice with your state’s Secretary of State declaring they have a lien on your assets. A UCC1 works in much the same way a home lenders position is secured. If you ever wish to sell your business (or assets of the business) a title company would first need to obtain a release from the vendor. These agreements can be hard to notice in a large credit application. We recommend you look for words like “security” and “first priority” throughout the application. Again, consider the value/risk of signing such an agreement.

Beyond the credit application, the vendors’ invoices will often spell out other parts of your formal agreement such as interest charges on late payments (which could jump as high as 18% a year). Many invoices allow the vendor to add interest the day the invoice is late. To keep track, consider adding a line item to your financial statement for “Trade Interest.” You may be paying more for vendor interest than you would imagine.
Your relationships with your vendors are very important. Vendors need to sell product as much as you do and are usually flexible if you maintain close communication. For example, if a vendor adds interest to an invoice, try asking them to remove it and then ask that they not do that again. If you’ve worked with a specific vendor for years, perhaps they would accept a letter from you requesting to withdraw a personal guarantee. If a vendor set you up with fifteen day terms, ask them to let you pay in thirty days and explain why this would benefit your business/relationship. Vendors want stability. What scares a vendor is when a restaurant consistently pays their bills on time and then suddenly skips a check without notice or a conversation. Even if things get a bit ‘unpredictable’ for you, maintaining the personal relationship will help. A vendor with fifteen day terms and 2% interest may let you pay in forty five days with no interest if you explain your situation and try to work out a compromise. However, never forget that whenever the vendor decides that the personal relationship is not working out, they can quickly and easily revert to the written agreement; at which point you are thirty days behind and owe a lot of interest.

Trade credit is a powerful tool. It can allow you to make payroll during the slow times and prevent you from needing to write twenty checks a day. Remember that credit agreements can and should be negotiated, you should be cautious with personal guarantees, and never judge your businesses’ performance by cash flow alone.

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- Go to chefsheet.com to see other ways you can save money in your restaurant.

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