This Common Practice Could Hurt Your Restaurant’s Financial Future
For businesses whose customers pay in cash, like restaurants, there is a specific financial practice that – although tempting – can hurt your restaurant’s future in more ways than one.
From criminal consequences to crippling your restaurant’s ability to grow, under-reporting cash sales or skimming from the till can put your business at risk. The phenomenon of income or revenues that are earned and collected (or disbursed) under the table is so significant that it even has a name, the “underground economy.” Representing about $2 trillion annually in unreported business or individual income, it’s a problem the IRS takes very seriously.
Cash-intensive businesses like restaurants are coming under increasing scrutiny by the IRS, and for restaurants that engage in misuse of cash revenues either by hiding cash transactions or using cash to pay employees “under the table,” the consequences can be extremely serious. For example, in 2015 restaurateurs in the Milwaukee, Wisconsin region were indicted with claims that the owners had skimmed millions of dollars of cash receipts from restaurant revenues, defrauding not only the U.S. Internal Revenue Service and its taxpayers, but a bank as well, after defaulting on business loans and renegotiating their debt, costing the bank about $4 million.
A 2013 Forbes.com article also notes that the IRS is looking at small businesses, in general, and cash intensive businesses, specifically as it pertains to both merchant reporting of credit card sales and cash reporting. As a result, many small business owners have since received IRS notices titled, “Notification of Possible Underreported Income,” which can indicate that a business may be later selected for a full-scale audit, should any inconsistencies turn up.
The risk of criminal charges and penalties – if convicted – are not the only reason restaurant owners should steer clear of underreporting cash sales and taking or distributing money inappropriately when it comes to reporting requirements. From a practical standpoint, when a restaurant underreports its own income it may also be crippling itself financially.
When the time is right to grow your restaurant, you may need the assistance of investors, banks or other lenders. Potential investors and lenders are likely to scrutinize every aspect of a restaurant’s operations, including cash flow and income statements. Weakening your restaurant’s financial statements by underreporting or skimming cash revenues means that your business will not be as attractive to potential investors, and it may reduce the amount of financing a bank is willing to extend.
This small business feature article describes in detail why lenders look at a restaurant’s financial statements before extending credit. Noting that lenders will carefully review the company’s balance sheet, income statement and cash flow statement before extending credit, lenders also consider whether they will be able to recoup on their investment in the likelihood a business goes into bankruptcy. Diluting your restaurant’s revenues in any way that detracts from its financial strength could jeopardize your ability to obtain a restaurant loan, line of credit or restaurant equipment financing.
Even at an individual level, paying the owners or employees of a restaurant in cash without reporting it as income can damage their personal financial strength and puts everyone involved at risk. Savvy investors and lenders will likewise have a strong understanding of cash flow reporting and management practices. If they perceive a restaurateur is willing to cut corners when it comes to reporting revenue or hiding cash receipts, they may determine that the restaurateur is untrustworthy. Once damaged, a restaurant’s reputation is difficult to restore.
Showing Off Your Restaurant’s Financial Strength to Investors and Lenders
In addition to ensuring proper transaction, revenue, income and payroll practices, your restaurant can show off its financial strength, making itself more attractive to potential investors and lenders in the process. Writing a formal business plan and generating formal financial statements including monthly balance sheet, income and cash flow statements create the type of paper trail that banks and lenders turn to when evaluating business credit decisions.
Two financial statements will be especially important to creditors: Cash Flow Statements and Income Statements. A Cash Flow Statement shows how much money came into and went out of your restaurant in a given time period (usually monthly). If your restaurant cannot show that it has adequate cash flow to make financing payments, it may not be considered by lenders or investors.
An income statement summarizes the total revenues your restaurant received during the time period (usually monthly). These are revenues earned from customer transactions as well as any other activities that produced income, such as selling used furnishings or equipment, or interest earned. From this total, all expenses incurred during the time period are deducted, with the bottom line of the report indicating “net income.” When your restaurant is able to demonstrate a consistent history of positive net income, in addition to a history of positive cash flow on monthly cash flow statements, it will be more attractive and better-able to obtain a line of credit or some other type of financing when needed.
The bottom line is this: Underreporting or hiding a restaurant’s cash transactions is never a good idea. The potential negative consequences far outweigh any temporary or perceived gain, and can even cripple a restaurant’s ability to obtain the financing they need to grow.
What about you? Do you have a question about restaurant financing you would like to see covered on the Kabbage blog? Tweet your question to us @KabbageInc or leave your question in the comments below.