For many people, buying a restaurant is a dream come true. But before you sign on the dotted line, it's important to do your due diligence and understand the financials of the business. Here are some key things to look at when evaluating the financials of a potential restaurant purchase.

By understanding the numbers, you can make an informed decision about whether or not buying a particular restaurant is right for you. So let's get started!

Know what you're looking for - what are your goals and objectives for the restaurant purchase?

Before beginning the process of buying a restaurant, it is crucial to define clearly what your goals and objectives are with this purchase. Are you interested in restaurant for rent options or a second-generation space? Are you considering purchasing a franchise restaurant? Other questions that can be answered upfront include budget considerations and what type of restaurant you wish to purchase. 

It is also critical to know how much capital you have available to work with. Will you need restaurant financing? Do you need to make money from the get-go, or can you afford a turnaround situation? Knowing these answers at the outset will help guide your financial evaluation when looking to buy a restaurant and make sure your objectives are met throughout the transaction.

Understand the financial statements - what do they mean and how do they impact your decision-making process?

When evaluating the financials of a restaurant you're considering purchasing, it is essential to understand how much the restaurant is making. Having a firm understanding of the profit and loss statement will inform your analysis of an establishment's potential profit generating capacity and earning potential. In most cases, it is reasonable to expect up to 2 years of the most recent financial data for a profitable restaurant for sale. Very rarely will the seller release further data upfront, as this is something you could request during the Due Diligence process. Tax returns will always be released during the Due Diligence period as well.

When you are reviewing the restaurant financials, look for the Seller's Discretionary Earnings (SDE), which reflects how much the owner/operator would earn in one year. The SDE may also be referred to as Owner Earnings or Owner Benefit. 

Here's a brief breakdown of what to look for in the SDE:

Profit & Loss Statement - This will show you the bottom line of the business. Is it at a level of profitability that you are looking for? How much money you need to earn as a owner will help determine whether a restaurant is a good fit for you. 

Addbacks - These are adjustments made to the net income of the business to more accurately reflect the earnings of a new owner/operator. For example, the $20,000 the current owner spent on a new roof last year would be added back to the earnings since that is not a cost you would inherit as a new owner. These addbacks comes in three main categories: seller's personal expenses, excessive on non-reoccurring expenses, and owner's earnings and benefits. 

Read more about Seller's Discretionary Earnings here.

What do I do if the restaurant isn't making any money?

In some circumstances, the restaurant for sale may be what we call an asset sale. This simply means that the restaurant is not currently profitable, so there would not be any SDE to review before purchase. Instead, inquiring buyers should pay attention to food costs, labor costs, and occupancy costs in the current restaurant operations. These numbers can clue you in to where the operations could be improved, or tell you where you might choose to spend your budget instead. For example, do you need to reduce labor costs and increase your marketing budget to meet the bottom line? Do you need to add delivery or pick-up services to increase revenue streams? Evaluating the operations is another important item to review before buying a restaurant.

Use our Free Break-Even Calculator here.

Consider the risks involved 

While buying an existing restaurant for sale significantly reduces the risks associated with starting from scratch, there is still inherent risk in any business operation. The location, marketing, staff, management, training, and more can all affect the restaurant's overall profitability. If you dream of bringing your own concept to a restaurant purchase, research the surrounding market to see who your potential customers could be. It may even be necessary to investigate the restaurant's own personal history - such as how long it has been open and its past success record - in order to determine whether or not there may be financial risks involved. For instance, will the store need to renovated or repaired in any way that would incur expenses on you as the new owner? Analyzing the restaurant's physical position and its market can provide valuable insight into potential risks when considering the purchase of a restaurant.

Make sure you have enough capital to sustain the business

Many restaurant owners turn to restaurant lending, SBA lending, and unsecured lending options to secure the capital they need to buy a restaurant. For more valuable restaurant listings, prequalification in the form Proof of Funds may be present. What this means is that, even before the name of the restaurant is released, an inquiring buyer needs to provide proof that they have the liquid capital to support the business. If you find that you do not meet the prequalification, then you might consider finding a business partner to join the transaction. 

Learn more about restaurant financing here.

Get professional advice

When evaluating the financials of a restaurant, a Certified Restaurant Broker® can walk you through the restaurant financials and the full process of buying a restaurant.  A professional will bring years of knowledge about the industry and can provide guidance on how best to review the books so that you make an informed decision when buying a restaurant that is financially sound. 

Buying a restaurant is a big decision, and there are many factors to consider before making an offer. It's important to know what you're looking for in a purchase, understand the financial statements, and be aware of the risks involved. Make sure you have enough capital to sustain the business, and get professional guidance from a Certified Restaurant Broker®. With hundreds of restaurants for sale on our website, you can start browsing restaurants for sale today!

Robin Gagnon, Certified Restaurant Broker®, MBA, CBI, CFE is the co-founder of We Sell Restaurants and industry expert in restaurant sales and valuation. Named by Nation’s Restaurant News as one of the “Most Influential Suppliers and Vendors” to the restaurant industry, her articles and expertise appear nationwide in QSR Magazine, Franchising World, Forbes, Yahoo Finance, and BizBuySell. She is the co-author of Appetite for Acquisition, an award-winning book on buying restaurants.