Introducing Lessons From the Line
In a northwest Ohio industrial park, up the highway from a new Amazon.com Inc. warehouse and a soon-to-open solar-panel plant, Peloton Interactive, Inc. is building a million-square-foot factory that it will never use.
The once-hot stationary bike maker is selling the facility, initially set to cost $400 million and to be completed this fall, as it races to downsize a manufacturing operation expanded by leaders who believed Covid-driven demand would outlive the pandemic.
Its miscalculation about demand and the shift in the market have been so costly that Peloton—a company worth nearly $50 billion about a year ago—has laid off thousands of people, had to borrow $750 million to head off a cash crunch and is exploring a sale of a minority stake. It is a reminder that strategic choices—not just pandemic forces—determine how businesses emerge from the crisis. Peloton’s value fell to less than $5 billion this past week.” - Wall Street Journal
BACK TO BASICS
If you’re reading this, you’ve likely seen the intro to our new Harmony Group newsletter and blog: the Commonsense CPA. What you’re reading today is our hospitality focused newsletter, Lessons From the Line.
If you’re reading this, you’re probably one of the 99.5% of our clients that we helped survive the pandemic, and I’m proud to know you.
Now read that prologue quote again.
Peloton’s poor strategic choices destroyed thousands of jobs and burned more than $45 billion of market value in a single year.
Think they’re alone? Try this article about how Amazon swung to its first loss in nearly a decade (and lost hundreds of billions of dollars in market capitalization along the way).
The problems of big businesses may seem remote, but they’re illustrative - the same decision making, economic, and strategic principles apply to businesses of all sizes.
Bottom line: your choices matter.
We are heading into a recession, which sounds scary, but it is simply part of the business cycle: with foresight and smart business decisions, you will survive and thrive. Monthly, moving forward, we’re focusing on helping you deal with this looming challenge by arming you with the right information to make intelligent strategic choices. Some of what we write about may be a reminder, some of it will be new information. Either way, the more you know, the better.
It is my hope that our efforts with this hospitality-focused newsletter will arm you with information to better analyze your challenges, ask more knowledgeable questions, and remind you to loop in your Harmony Group team to help you make great strategic choices.
We’re here for you for anything you need - and my personal line and my team’s line is always open.
Matt Hetrick, CPA
President and founder of Harmony Group Inc.
MERCHANT CASH ADVANCES CAN SET YOU BACK
What can be added to the happiness of a man who is in health, out of debt, and has a clear conscience?” - Adam Smith
At Harmony Group we value our position as trusted advisors to our clients. We hear our clients’ concerns, questions and problems daily as we work together to solve them. Something we’ve been hearing lately is “What the heck are all these small business loan offers endlessly calling my phone and blowing up my email?”
Many of our clients are inundated by offers to take out “loans” and lines of credit from point-of-sale operators, third-party delivery companies, credit card companies and endless boiler room operations besieging our clients with enticing “loan” offers. We’ve put loan in quotation marks in the preceding sentence because what is being offered to clients aren’t actually loans in many cases, they are merchant cash advances.
Merchant cash advances (“MCAs”) are a sale of a portion of your future cash flows for an agreed upon sum of money by the company issuing the advance. In contrast, a loan is a contractual promise to repay money (principal) advanced by a lender with additional interest and some fees.
A quick example will highlight some differences.
Example & Fictitious Restaurant (“E&F”) makes $730,000 a year and wants $20,000 to invest in the business.
Scenario 1
E&F gets a merchant cash advance through their point-of-sale provider who also is their credit card processor. The point-of-sale provider offers “no interest loans”, only a fee of $2,250 (12.5%) that is bundled into the total (now $22,500) to be repaid. In exchange, E&F agrees to allow the point-of-sale provider to withhold 5% of their daily credit card income to pay back the advance, ~$100 per day or ~$3,000 a month. E&F pays back the MCA in 222 days or just over seven months.
Scenario 2
E&F goes to a bank and gets a one-year term loan for $20,000 at a 15% interest rate with the standard amortization schedule in which each payment goes towards paying the principal and interest. E&F makes 12 monthly payments of $1,805.17 for a total repayment of $21,662.
But that doesn’t make sense, right?
The MCA with a 12.5% fee required E&F to pay $445 dollars more than the 15% loan AND over a shorter time. This disparity is because traditional lenders apply payments to principal and interest concurrently while the MCA immediately capitalizes the fee into the loan.
The cost of a loan is evaluated by its Annual Percentage Rate (“APR”). The APR of the E&F bank loan is simple to figure out – it’s 15%. Most credit cards have 25% APR at the high end. But what’s the APR of our “12.5% Merchant Cash Advance”?
E&F’s merchant cash advance APR is 39.54%.
This rate surpasses the maximum interest rates that can legally be charged on loans in almost every state in the country. If this MCA was a loan, it would be criminal. Many MCA providers also control incoming cash flows or require automatic debits so those funds are taken regardless of a business' ability to pay vendors, payroll or other key operating obligations.
Let’s assume that these usurious MCAs are popular, judging by the incessant phone calls. They are popular for two reasons: people are misled about the true cost of MCAs and businesses without adequate working capital often lack better funding options.
Hopefully, we just solved the first problem; let’s tackle the second.
No matter the reason why loans are needed or the wisdom of taking on the loan, a business lacks good options if they can’t get funds when needed or no traditional lenders will lend money to the business.
We extensively monitor our client’s cash flow to help ensure all capital needs can be anticipated. Being a creditworthy business that can get loans from traditional lenders at reasonable costs requires having healthy financial statements – your Profit & Loss (Income) Statement, Cash Flow Statement and Balance Sheet. Our clients generally review Cash Flow weekly and Profit & Loss monthly but sometimes don’t look at the Balance Sheet (a summary of assets and liabilities) as frequently.
After we close out Q2 in June if you don’t regularly review your balance sheet, we suggest you to reach out to your Harmony advisor for a Balance Sheet Checkup explaining the important things that any provider of capital – investors or lenders – will want to see on a Balance Sheet and analyze your restaurant’s Balance Sheet.
Understanding your full financial picture will give you a more accurate forecast of your ability to borrow money and you can safely send all those pitches for loans to voice or junk mail.
LAST BITES
Restaurants Are Feeling Squeezed
The pandemic may be ebbing but many restaurants, especially those frozen out of RRF funding, are feeling the pinch. Forty-one percent of restaurants couldn’t pay full rent in May and only 31% of small businesses say they are fully recovered. Of course inflationary headwinds are also present, with 49% of small businesses reporting cost increases over 20% and only 16% saying they can raise prices a commensurate amount. While this data strikes us as a bit high, it’s imperative to proactively manage costs and prices in this environment – gone are the days of quarterly menu reviews. The news isn’t all bad: Harmony Group, it should be noted, didn’t lose a single client to the pandemic.
Added Fees Receive Mixed Results
With restaurants finding new ways to deal with price increases, many are turning to fees with 36.4% of restaurants adding a service fee. Restaurants are adding fees for service, credit card processing, staff wellness, COVID costs and a whole range of added expenses. Customers are noticing, so a holistic approach for pricing is recommended. Harmony Group clients are leading the way with thoughtful, unintrusive service charges that double as hiring incentives - take Preserve’s optional 4% Labor of Love charge, the first of its kind in the region, which enables them to provide full health coverage and other benefits to their entire team.
TikTok Won't Stop
The social media landscaping is always changing and TikTok has become an important marketing channel for many restaurants. More an entertainment app than social media, TikTok is a place where unpaid viral lift is still possible and restaurants can connect with the next generation of consumers.
Good News from DC Health!
In good news from the DC Health Department, you no longer have to appear in person to get your Food Handler’s License once you have passed the ServSafe Exam. Simply apply here, submit the required documentation and pay the fee and you’re good to go.
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