The other scenario
What if you missed out on the RRF? As noted before, the first thing to realize is you’re not alone. This is going to be a crowded pool. And while (hopefully) more aid will come, similar to how the PPP had multiple rounds, it’s hard to count on that before the ink dries.
Sarah O’Sullivan, Accounting Director at LeaseQuery, shared some thoughts with QSR on where operators can go from here.
The question on the minds of operators now is what’s next? The National Restaurant Association and others are lobbying to replenish the RRF. But it’s hard to count on that. And nobody knows the timing. So what would be your advice to operators left out of this program, especially those who were banking on it?
It’s no surprise that the restaurant industry was hit hard by the pandemic. While the RRF provides benefits for those that have access to it, there are other things that restaurant operators can consider right now outside of that program.
One benefit of the new lease accounting is that companies are gaining a better understanding of their lease portfolios, helping them to identify inefficiencies and opportunities for cost savings. Lessees across many industries worked with lessors over the past year to negotiate new lease terms and rent concessions. The restaurant industry in particular saw a lot of rent concession activity.
The pandemic has impacted lessors as well as lessees. Now more than ever, restaurant operators are in a position to leverage this to their benefit and might find that their lessors are willing to renegotiate lease terms to the advantage of lessees.
Let’s talk about liabilities. Restaurants saw a 3,992 percent increase on their balance sheets after implementing the new lease accounting standard, per LeaseQuery’s recent data. Walk us through what that means, and why it’s critical.
By far the most significant and immediate impact of the new lease accounting standard is the fact that all operating leases are now reflected on the balance sheet. These operating leases will no longer provide the off-balance sheet benefit for companies that they once did. Industries that have historically relied heavily on operating leases are seeing significant increases in total liabilities on the balance sheet due to the adoption of the new accounting rules.
The new standard has brought transparency to lease accounting and financial statement users such as banks, investors, and creditors who will now have more information than ever before about the extent that restaurant operators are relying on operating leases and the amount of future lease payment obligations currently committed to these arrangements.
It is critical for restaurant operators to understand their entire lease portfolio as it will be up to them to make sure their banks, investors, and creditors understand how the new lease liabilities impact their business and operating models.
What are some actionable insights restaurants can take, such as centralizing lease data and creative lease design?
While the new lease accounting standards are causing a significant impact to the financial statements themselves, they also are providing lessees with benefits that might not immediately be obvious.
In addition to prompting more centralization and organization of lease data, companies are also gaining a better understanding of their lease portfolio, which is helping them make important financial decisions.
For example, companies are now able to more easily and quickly answer questions about their lease activity such as what types of leases make up the majority of rent expense, what leases should be renegotiated, and what leases have reached their expiration date but have continued on month-to-month arrangements at higher costs.
Furthermore, companies often find that having a centralized listing of active leases has assisted with building budgets and forecasts for future years. By enhancing their lease understanding and analysis, companies are better equipped to make procurement decisions.
Where do ghost kitchens and new delivery service options fit in?
The pandemic forced consumers to stay home and change their spending habits, but it also exposed them to the ease and convenience of online food ordering and delivery. As the world continues to emerge from the pandemic and economic downturn, consumers are returning to their previous routines and increasing face-to-face transactions.
However, it’s clear that the demand for food delivery services isn’t going away. Restaurant operators that plan to continue the use of ghost kitchens and delivery services going forward are faced with new procurement and leasing decisions. Some restaurant operators may decide they no longer need as much in-person retail space and instead increase their use of smaller locations that are dedicated solely to delivery transactions.
Strategic changes like these could result in savings on rent expense as restaurants reduce their real estate footprint.
Explain the “one-two punch” that could be facing operators from all of this.
The restaurant industry is currently facing significant changes on two fronts: the economic impact of the pandemic, and the accounting impact of adopting the new lease accounting standard.
Over the past year, the restaurant industry has experienced business closures and changing consumer habits, resulting in negative effects to financial performance. Add to that an average increase to liability balances of almost 4,000% due to the new lease accounting rules and the industry is having to juggle a lot of major challenges at once.
With the new lease accounting standard, companies are building knowledge and expertise in their lease portfolios, allowing them to better understand current financial performance and consider future leasing decisions with more detail and preparation.
Restaurant operators can leverage this detailed lease knowledge as they consider new and changing business strategies to mitigate the economic slide. By expanding their understanding of their lease arrangements and terms, they have the ability to identify opportunities for cost savings.
The final push by private restaurant companies to adopt ASC 842 is underway. Given that, why is it so important to understand the potential impact to the balance sheet in the restaurant sector?
In general, companies don’t want to be surprised by the financial statement results that come from adopting the new lease accounting standard. Avoiding surprises is particularly important for industries, like the restaurant industry, that historically have operated within a high leverage and active leasing environment.
The bottom line is that adopting ASC 842 is going to increase the liabilities balance on the balance sheet and companies that fully understand their lease portfolio and what that impact is are better prepared to have important discussions with banks, investors, and creditors.
For example, will the increase in lease liabilities change the analysis of certain debt covenant ratios? If so, are there steps companies should take now to discuss these changes with their banks and modify agreements if needed?
The adoption of ASC 842 also requires new and extensive footnote disclosures that bring information about the nature of a company’s lease portfolio and its financial obligations to the forefront. Companies in the restaurant industry will want to be ready to answer new questions about their lease activity and manage both internal and external messaging.
What else should restaurants know?
The best advice is to start the ASC 842 implementation process early. Not only is it a big project to undertake, but most companies find that it takes more time than they initially anticipated.
As public companies have already adopted the new lease accounting rules, there are currently many sources available that help with identifying best practices for implementation that companies still pending adoption should take advantage of.
Adopting this standard requires organization, time, and effort, but it also provides companies with opportunities to better understand and manage their operating costs.
Broadly speaking, what are you most excited about for the industry as we approach summer, the backside of COVID, and beyond?
With the vaccine rollout and the approaching summer months, consumers are ready to amp up their social lives again. The restaurant industry was innovative during the pandemic and found new and creative ways to continue operating and serving customers. It will be exciting to see what new innovations and operating models restaurant operators continue to come up with in the future. The restaurant industry is primed for a boost in business over the next several months as consumers increase face-to-face interaction visiting their favorite restaurants once again and trying out new ones opening up in the market.