Considering Cost Structure Before Buying a Restaurant

What is the cost structure?

Cost structure refers to the level of a restaurant’s fixed and variable expenses in relation to its sales.

Fixed expenses are considered those expenses a restaurant will incur anyway regardless on the number of its guests.  Variable expenses are those expenses that behave in a similar direction and proportion to a restaurant’s sales.

How cost structure may affect a restaurant’s profitability?

Table 1

We see in the table above two different restaurants with the same amount of: sales (300000), total expenses (135000 + 120000 = 255000) and net income (45000).  The only difference between the two restaurants lies in the cost structure which is the level of fixed and variable expenses.  Restaurant B has a larger base of fixed expenses compared to its sales than Restaurant A since its fixed expenses constitute 55% of its total sales.  Automatically, this makes restaurant B more sensitive than A.  This happens because as sales increase or decrease in the future by let’s say 20%, restaurant B (with the higher level of fixed expenses) will experience a higher growth or decline in profits  respectively than restaurant A.

Thus, it would be a good idea for an investor to have a look on the cost structure of an existing  business along with the expected market conditions before making an investment decision.