Financial health is critically important to your success as a McDonald’s Owner/Operator. To help you measure your financial health, we’re doing a series of articles on the McDonald’s financial standard ratios, what they entail and how to improve them.
If you missed it, check our introductory article Understanding and Managing Financial Ratios for McDonald’s Franchisees.
In today’s article, we’re going to address the Trailing Twelve-Month Liability Turnover. This ratio represents the number of days of next month’s sales needed to cover any working capital deficit.
But before we get into the calculation of the ratio, let’s address the concept of working capital.
Working Capital
Working capital is the capital of a business used in its daily operations. It’s a balance sheet (financial position) concept which measures your financial position.
In the QSR business, working capital is calculated as your total current assets less your total current liabilities plus 11/12’s of your Current Portion of Long-Term Debt (CPLTD). Current assets are cash and those assets convertible to cash within 30 days (such as your cashless receivables and inventory).
Current Liabilities are those debts that need to be paid in the next 30 days (such as payroll and sales tax). Generally speaking, the only item in Current Liabilities on your balance sheet that isn’t due and payable in the next 30 days is CPLTD. CPLTD represents the next 12 months of bank debt principal payments.
As a result, to adjust the total current liability number on your balance sheet to the amount of liabilities due and payable in the next 30 days, 11 months of debt principal payments are added back to the total current liability number.
Practically speaking, your working capital is a measure of how much cash you’ll have available after your current assets are converted to cash and you pay your liabilities which are due in the next 30 days. The resulted net working capital is your cash reserves that are available for future day-to-day operations, for reinvesting in the business, and for growing the business. The recommended minimum working capital is between $50,000 - $75,000 per McDonald’s restaurant depending on your situation.
Trailing Twelve-Month Liability Turnover
To bring you back to Trailing Twelve-Month Liability Turnover – remember it’s the number of days of next month’s sales needed to cover any working capital deficit. To calculate the TTM LTO, working capital is divided by average daily sales. This results in the number of liability turnover days, either positive or negative.
If you have positive working capital, this equates to negative days, meaning you have more than enough working capital to cover your current monthly debt payment and pay your current liabilities. If you have negative working capital, this equates to positive days, meaning you have to borrow from next months’ sales to pay your current obligations.
How Business Choices Affect TTM LTO
When cash flows are not sufficient to cover the debts and personal needs of the owner, working capital suffers because savings are used to manage the shortfall. Alternatively, a business that must hold off paying bills until they have deposits from the following month. These situations results in an increase in liability turnover.
The best way to improve TTM LTO is to maintain a positive working capital in the business at all times. This can be accomplished by operating the restaurants with a cash flow coverage ratio of more than 1.0 and retaining the excess cash flow in the business. (We’ll discuss cash flow coverage ratio tips in more details in upcoming articles.)
READ MORE: Understanding and Managing Financial Ratios for McDonald’s Franchisees
Can You Have too Much Working Capital?
Yes you can if it’s sitting idle and not working for you. Take a balanced approach with your cash reserves – strive for $50,000-$75,000 of working capital per restaurant to enable your restaurants to smoothly fund the three payroll months, rainy day expenses or any unexpected reinvestments or opportunities.
During the onset of the COVID pandemic, excess cash was warranted since there was a lot of uncertainty about future results of operations, but as the risks began to subside, the need for excess cash reserves has waned. As a result, you may want to consider talking with your financial advisor or CPA about putting cash reserves to work for you by investing them in a way to obtain an acceptable return on your assets while minimizing any investment risk.
Concannon Miller’s clients receive full FVA reports every month so that they are always up to date on their financial viability standing. Are you looking to be better informed? Contact us to find out more.
