How Startup Operators Get Ripped Off and How to Stop It

EDITOR'S NOTE: Juliette Gust worked her way up from an hourly position at a local restaurant to management positions in various cities. She returned to school and graduated with a hospitality management degree.

There was one subject she dreaded in her professional life: numbers.

Sure, a P&L (profit-and-loss statement) review wasn't too difficult if you focused on food and beverage revenues and expenses, labor costs, and china/glass/silver costs, she says. That said, what is depreciation? What is included in G&A (general and administrative) expenses? What does Net 30 mean and why should I care?

Gust adds, And what the heck is EBITDA? (It is shorthand for earnings before interest, taxes, depreciation and amortization, and it is a useful measure of operating cash flow, but used mostly by large companies with a lot of expensive assets and/or significant debt financing.) According to Gust, forecasting and budgeting was another exercise in frustration. How do I know there will or won't be another massive storm affecting sales at some point next year? What if the power goes out on a Saturday night again? What if my best-selling item's wholesale price skyrockets? What if my best managers resign? How am I supposed to fill out this budget template??

Ironically, after more than 15 years in hospitality management, says Gust, I took a lonely road for a restaurant operations manager; I returned to school for an accounting degree. While there, I majored in forensic accounting and then spent the next 12 years investigating fraud, theft, embezzlement, money laundering, bribery and corruption. Not all of that time was spent working with hospitality businesses, but much of it was.

Gust is not just an accountant. She's an accountant who understands your world. As a result, today I look at restaurant financial statements through a different lens; one that focuses on potential unethical and illegal behavior behind certain numbers, rather than performance management issues.

RS&G asked Gust to review a few fundamental restaurant performance metrics and some tips on how to spot potential employee and vendor misconduct based on those dreaded numbers.

Such misconduct can cost you plenty.

Particularly on those days when you wonder Who can I really trust?- those numbers can be real friends.


By the time you've finished reading this article, you should be able to:
  • Describe the value of surprise cash counts.
  • Identify ways your cost of goods sold can be skewed by theft or sloppy inventory management.
  • Explain the benefits of reviewing your product list counts against what is in your storage.


Revenue Rip-offs

Be vigilant of the relationship between your covers count and check average. Do some of your servers have a consistently higher or lower average check than others? Review their individual table checks at the end of the shift, with particular attention paid to those paid in cash. Look for the following tell-tale signs, including:

  • Are beverage sales being recorded?
  • Are discounts and/or voids properly applied?
  • Are there fewer or more meals and drinks on the check than the number of covers entered?

Check if server tips seem reasonable based on their sales percentage. An excessive tip (e.g. 30% or more) might mean the server is giving away items.

When reviewing transactions at the bar or cashier, a surprise cash count (based on their sales at that point in time) should not result in any excess cash if they are required to keep their tips in a separate location (and they should).

Reviewing tips may also identify instances of tip padding, where servers may increase guest tip amounts from $9 to $19 by adding the 1, for example. This is especially important for guest relations purposes, as a guest may review their credit card statement and notice the tip discrepancy, resulting in a chargeback for you. It could result in a possible fraud alert on your account.

While most transactions today tend to be via credit card, cash is still exchanged in a restaurant, and it has a way of disappearing if you're not careful. Consider surprise cash counts for servers, bartenders, and cashiers, if you use them. Run a sales report and count the cash to compare against the report. The following are poten- tial cash theft schemes for which you might want to be on the lookout:

  • Skimming from cash sales by not entering beverages or other items that don't have to be ordered through the kitchen or bar.
  • Floating drinks or open food/buffet items from check to check: for example, a server can ring up an item. Once the guest pays for it in cash, the server can transfer the item to other guest checks who order the same item. Using this method, a server can ring up one item, but collect payment for that same item several times over.
  • Abuse of gift card promotions, such as buy a $100 gift card, get a $25 one for free. If your server is the only one responsible for informing the guest of the promotion, they may not do so and keep the $25 card to use on other guest checks while pocketing cash.
  • Using coupons or discounts without knowledge of the guest, after the full check amount is paid. This allows the server to reduce the amount of money owed the restaurant, with he or she pocketing the difference.
  • Void or Error Correct functions to provide free items to acquaintances or in hopes of securing a larger tip by providing complimentary items.

Case in Point: A high-volume restaurant identified more than $200,000 in skimmed cash sales due to managers who allowed bartenders and servers to use their point-of-sale system access cards for various requests, but meanwhile, they were being used to void items and pocket the cash from the sale.

Bottom Line Bilking

I won't write about the well-known reasons why COGS (cost of goods sold) may be out of line. You should always ask yourself if food costs are in line with what you budgeted. If you are finding significant overruns, that is not a good thing; however, if your food costs are below budget, that could be a red flag, as well.

Realize that even the best-run kitchens have cost control issues at times. Inventory overstatement is a common scheme that can be used to cover up a wide variety of problems, both mismanagement and fraud.

Did your manager discover that the meat cost was a little high due to poor purchasing? He or she might "add" a phantom case of sirloins to the inventory to bring the numbers in line. Does your budget require (and maybe your manager's bonus depends on) a 29% food cost (as a percentage of total sales), and your manager realizes that the restaurant is running at 30%? He or she can keep counting expired goods in inventory, even though they were thrown out before the last health department inspection.

You should be reviewing your profit-and-loss statement; however, without taking a good look at your general ledger as well, you might not be seeing the whole picture.

Regardless of the sophistication of the inventory technology, you need to roll up your sleeves. There is no substitute for a periodic, in-person count check by someone independent of the function. Checks and balances are critical in every company, large or small.

Review the activity around deliveries. Sometimes cases of filet mignon really do fall off the truck, but not often. Do you know what is actually being loaded off trucks into inventory? An unethical manager can "pay" for items that never make it into your pantry. The money that comes out of your account might just wind up in his or her pockets.

Case in Point: A restaurant inventory list indicated there were 102 units of saffron on hand (among other false counts), and there were actually two.

Procurement Ploys

Dealing with purchasing and vendor selection is an area that is rife with opportunities for fraud and corruption schemes. If you have delegated the purchase of any supplies or vendor relationship management, be sure to monitor the process and products closely, including:

  • Review your vendor master list at least once per month to ensure that you recognize the names and inquire about those that don't look familiar. If your produce cost is increasing, for example, it could be there is a fake vendor that is receiving payments for goods not delivered.
  • Periodically review your product list counts against what is in the storerooms. Is there a case of champagne that will never be sold? 24 bottles of a liqueur not included in any of your drink recipes? 12 bottles of very high-end scotch that won't likely be ordered by your guests? It could be a deal was made to purchase slow-moving product from the beverage vendor in exchange for a kickback or for product delivered to your manager's home.
  • Another area to consider when reviewing your costs is the relationship between the prices you're paying and the quality of the goods received. Are you paying top-dollar for average goods? It could be the vendor is a relative or friend kicking back a percentage of purchase amounts to your manager. Or, it may be that your employee has created his or her own business on the side and has selected that business as one of your vendors. It's good practice to develop a simple conflict of interest policy that requires your employees to disclose any personal relationships they may have with prospective and existing vendors.

Procurement decisions and selection should be thoughtfully considered and consistent. A purchasing policy that outlines specific controls around product and supplier selection is a key control in deterring fraud and corruption. Some specific items to include are:

  • A requirement that a certain list of vendors should be contacted for every purchasing need (I prefer three, but it could be more or less depending on the availability in your market and your personal judgment).
  • Appropriate documentation on the selection process and outcome. The selection of a particular vendor, as well as notes on the losing vendors, should be documented and placed in the vendor file for periodic review. It may not be the best practice to always go with the cheapest vendor as there may be other factors to consider such as quality and customer service, but at least it reduces the opportunity or playing favorites with the vendors that may not have your best interests in mind.
  • Purchasing limits should also be clear, consistent and well documented. For example, a manager or chef may have flexibility with purchases up to $500, but anything beyond that amount requires review and approval by a second set of eyes.
  • Vendor selection steps should also be outlined. Ensure that new vendors are vetted by someone other than the purchaser to confirm that the vendor is legitimate and that they adhere to your food safety and other operational standards.

Case in Point: a restaurant ?sh vendor was selected by a manager due to a close, personal relationship. The restaurant paid higher than market rates for seafood because of the glowing recommendation provided by the manager. After a slew of guest complaints, it was found that the vendor kept ?sh in an unrefrigerated, ?lthy warehouse, and transported it to customers in an unrefrigerated truck.

Another Case in Point: a meat vendor was paid every month for more than a year before the restaurant controller noticed unusual amounts of pork purchases. After investigating, it was found that the vendor didn't exist, nor did the pork. The vendor was a company created by the kitchen manager, who ordered the ?ctitious pork from the fictitious vendor and pocketed the vendor payments.

Can You Afford to Lose 4-5% of Your Sales Each Year?

According to fraud experts and the National Restaurant Association, the typical organization loses 4-5% of annual revenues to fraud. Establishing clear guidelines and policies, ensuring they are enforced, and spending a few hours per month monitoring the numbers in your operation can often save you a significant amount of money.

A Member Resource:

According to a recent Wall Street Journal article, cash squeezed small businesses are facing another threat in this struggling economy - rising employee fraud.

Employee fraud - from check-forgery schemes to product going out the back door, tend to rise during tough economic times, when workers are feeling financial stress in their personal lives.

Even more than many other types of small businesses, restaurants are particularly ripe for the potential of fraud and abuse. What do restaurants usually have in plentiful supplies? Answer: cash, food and alcoholic beverages that are overseen by an owner who is often naturally trusting of others and not well versed in basic business controls.

The audio portion of this webcast is from a live seminar conducted by founder, Jim Laube. He has a diverse 30 plus year career in the restaurant industry and for 15 of those years was a practicing CPA advising restaurant clients on financial and operational issues dealing with cost containment, profit enhancement and improving internal controls.

What You Will Learn:

    • The people and parties most likely to steal from you.
    • Why independent restaurants are particularly vulnerable to fraud and theft.
    • Main reasons people steal from their employers.
    • The best deterrents to prevent fraud and theft. 
    • Employees who should NEVER handle your cash.
    • Essential cash handling controls.
    • Controls that should be present whenever you receive deliveries.
    • Why every restaurant needs an approved vendor list and what can happen if you don't have one.
    • Actual case studies of restaurants who have been victims of employee fraud. Members Can Watch it Today

Ten Financial and Accounting Controls

    • Review your financial statements. One of the best controls in a restaurant is for the owner to regularly review the monthly or four-week profit-and-loss (P&L) statement and balance sheet. As a business owner you must understand what the numbers on these two reports tell you because they reflect the financial result of just about everything that's going on in your restaurant, both good and bad. Not reviewing and understanding your financial statements can make you ignorant of operational problems, fraud and even shoddy accounting practices.
    • It's important to examine your statements in light of past periods, too. Noting an increase in liquor cost, for example, might indicate over-pouring or theft of bottles out the back door; a steady or sharp reduction of liquor sales may reveal skimming of your liquor receipts. Operators who are casual about looking at their financials might never notice the fluctuations in liquor cost and sales mix and therefore remain oblivious to the underlying problems for a long, long time at great expense.
    • Reviewing the balance sheet alerts you to changes in your financial position. Is your cash shrinking even though you're profitable? Why are payables growing; aren't we paying our bills on time? These types of questions come up only when someone, like you, the owner, stays on top of the financials. If nobody asks these types of questions, bookkeepers and accountants can become complacent at best and con?dent about getting away with something at worst.
      You may not know much about accounting and financial matter and may feel a little out of your element when talking to your bookkeeper or accountant about these things but don't let that stop you from asking questions. I repeat: Don't let your lack of understanding of accounting keep you from asking questions.
    • The more questions you ask the more you will eventually understand. And here's a little secret your accountant and bookkeeper doesn't want you to know: When you ask them a question about a number on your financials, they should be able to tell you exactly how that number (or any other number) was arrived at in a very logical and straightforward manner. If they can't, it's a sign that either they don't understand themselves or they are trying to hide something. Either way, it may signal it's time to start looking for a new accountant.
    • Conduct regular physical inventories. What do your employees think when they see you or your managers counting things? The first thing that happens is they notice. Then they start thinking that since management is counting certain items they must be keeping track of them and will know if some are missing. Taking a physical count is a great way to create psychological controls that will influence your employees' perception of what they think they can get away with. When employees never see management count anything, it makes the opposite impression, that you don't have a clue how much of anything should be here and you'll never miss a box of this or a case of that if it happens to walk out the back door.
      Conducting a physical inventory whenever you prepare your financial statements will also result in more accurate food and beverage costs on your P&L and inventory balances on your balance sheet.
    • Owners (not managers) should hand out payroll checks. Depending on the size of your company, you may not be able to do this every time, but it's important that if your managers submit your payroll information for processing, they should not hand out payroll checks. Allowing this to happen can result in managers adding one or more phantom-employees whose pay ends up in their own bank account.
    • Review the bank reconciliation(s). This will not be your idea of a good time but you must have assurance that your bookkeeper or accountant is keeping the bank reconciliations up to date and is not playing games with your cash accounts. Ask questions regarding any adjusting entries, transfers and other reconciling items. Make sure the bank balance on the reconciliation agrees with the actual ending bank statement balance. If something doesn't make sense to you, get your CPA involved immediately. Major red ?ag if your bookkeeper appears hesitant or overly protective of their work.
    • Never sign a blank check. The reason for this is obvious but it still happens in small companies all too often. Blank checks should be securely stored. Unused check stock should always be kept under lock and key. If someone ends up with your blank checks and starts using them, your bank may not be responsible for paying them even though the signature isn't yours.
    • Review the supporting documents for every check you sign. Insist that the purchase order, receiving report, invoice(s) or other documentation is attached to every check before you sign it. Ask questions regarding anything that doesn't look right or you're not familiar with.
    • Bookkeepers and accountants should never have checkwriting authority. One of the foundational principles of good internal controls is to keep people with access to your books away from your assets. When bookkeepers can sign checks they have the ability to easily divert company funds to themselves or others. Because they have access to the books, it's also easy for them to conceal this, possibly for a very long time, even forever.