Imagine for a moment that you’ve found the perfect food business. Your due diligence found no major surprises, so you made an offer that was extremely competitive. Happily, the seller accepted. You were able to secure financing that suits you and the most attractive offer terms include assembling a minor army of loyal and highly skilled employees who are experts in your field. You close the deal, shake hands, and figure out where to put all the money you’re going to make. Then you realize: the actual financial audit hasn’t even occurred.
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Start With the P&L, But Don’t Stop There
Ask for profit and loss statements for the last three to five years. This isn’t just about revenue trends, you’re looking for steadiness. A business that has unaccountably good and bad years should make you wonder.
Next, use the P&L figures the seller provided and check them against the tax returns. If the seller provided the lender or broker with one set of figures and the IRS with another, you’re either looking at under-reported revenue or padded expenses. In either case, it’s probably a big deal. One shows sloppy records and potential tax liabilities, which become your problem the day you buy the business; the other shows premeditation.
Then check the POS data. Tally the daily sales reports and compare them to the bank deposits. If they don’t match, put the question in writing and demand a response supported by documentation. Unexplained discrepancies between the register and the bank account should bring things to a stop.
The Metrics That Reveal Operational Health
Prime cost is where most buyers miss the warning signs. It’s the combined total of labor costs and cost of goods sold. For a food service business to be genuinely profitable, prime cost should stay below 60% of total sales. A seller can present a healthy top-line revenue figure while quietly bleeding out through labor inefficiencies or food waste.
Inventory turnover tells you something similar. If stock is sitting too long, you’re looking at spoilage, poor supplier relationships, or a menu that doesn’t move. Each of those has a cost.
Also look at occupancy costs, rent, property taxes, and any common area maintenance charges. These are fixed. They don’t flex when revenue drops during a slow January. If occupancy costs represent more than 10% to 12% of gross sales, the location’s financial structure leaves very little room for error.
The Numbers Sellers Don’t Advertise
Request a full granular breakout of those add-backs. A few of them are inevitably in your gray area, and one person’s capex is another’s repair, maintenance or cleaning. New equipment could indeed eliminate a future equipment rental, but inadequate upkeep may have already reduced revenues by driving customers elsewhere. New carpet or paint may well increase revenues, but it also may not.
Payroll records deserve the same scepticism. Look for off-the-books labor or family members who’ve been working for little to no compensation. Both scenarios artificially reduce the apparent labor cost. Once you take over and professionalize the payroll, those savings disappear and your prime cost spikes.
The debt service coverage ratio (DSCR) is another figure to calculate carefully. You need to know whether the location’s earnings, after accounting for the acquisition debt, can sustain a comfortable margin during slow periods. A DSCR that’s barely above 1.0 means one bad month puts you in a very difficult position.
From the Books to the Building
You receive numbers via Financial Due Diligence. But when you are looking at the practical things to know when buying a restaurant, many of them are not there on that spreadsheet. How old is the kitchen equipment and what’s its condition? How long have staff been employed at the business? Are there regular customers, and if so, how long have they been coming and how frequently? Are there any long-term suppliers or contracts in place? These and other subtler considerations about your new business will determine how closely the financial diligence lines up with the true post-closing situation.
And none of that makes a difference if the lease gets you. Do your homework upfront. Confirm the lease has an assignability clause and secure the landlord’s agreement upfront to the existing terms carrying over. Avoid surprises after the close because the landlord suddenly has different plans about whether new tenants are going to shoulder a higher proportion of CAM or whether you owe him for some capital improvement he agreed to with the previous owner. Employee retention is part of the analytics too. High turnover means re-training costs that can hit even harder than an unnecessarily large purchase price.
What the Audit is Actually For
Most buyers assume that the financial audit is a mechanism to verify that everything the seller has told them is true. Approach it differently. Use it as a lens for identifying where the business is underperforming relative to its potential, and where the seller’s numbers have been optimized for presentation rather than accuracy.
Every gap you find is either a reason to renegotiate the price or a reason to walk away. In a business where margins are measured in single digits, that discipline isn’t pessimism. It’s the only rational way to buy.
