Il-Kċina tal-Port: A Profitable Restaurant That Cannot Pay Its November Tax Bill
Il-Kċina tal-Port is a 40-cover restaurant on the seafront. Revenue is €560,000 a year, but 72% of it is earned between May and September. Cost of food and drink is 34% of revenue. Annual fixed costs are: wages €168,000, rent €42,000, utilities €26,000 and other overheads €18,000. A bank loan is being repaid at €1,150 a month.
At the end of September the business held €38,000 cash. The owner has projected a net cash outflow of about €4,500 a month for the six winter months, before loan repayments, and must also pay €22,000 of VAT and provisional tax in November. A hotel contract worth €60,000 a year, signed in June, is paid 60 days after each month's invoice.
The bank has offered either a €50,000 overdraft at 7.5% a year, repayable on demand, or a five-year €40,000 loan at 5.2% with a personal guarantee. The owner is also considering shortening kitchen hours in January and February.
1. Calculate the gross profit margin, the annual profit before tax and the annual break-even revenue. Using the seasonal split, show whether an average low-season month covers its share of fixed costs.
Read the worked answer
Margins
- Revenue €560,000; cost of sales 34% = €190,400; gross profit = €369,600 → gross margin 66%
- Fixed costs: 168,000 + 42,000 + 26,000 + 18,000 = €254,000
- Profit before interest and tax = 369,600 − 254,000 = €115,600 (20.6% of revenue)
- The loan repayment of €13,800 a year is a cash outflow, not a cost as presented; only the interest element is a cost, and the case does not split the two. State that assumption.
Break-even
Contribution per €1 of revenue = 0.66, so break-even revenue = 254,000 ÷ 0.66 = €384,848 a year, or €32,071 in an average month.
Seasonality check
- High season (5 months): 72% × 560,000 = €403,200 → €80,640 a month. Contribution = €53,222; less fixed €21,167 = +€32,055 a month.
- Low season (7 months): €156,800 → €22,400 a month. Contribution = 22,400 × 0.66 = €14,784; less fixed €21,167 = −€6,383 a month.
- Reconciliation: (5 × 32,055) − (7 × 6,383) = 160,275 − 44,681 = €115,594, which matches the profit figure above.
Interpretation
For seven months of the year the restaurant does not cover its fixed costs; the summer carries the winter. That is why a business earning €115,600 can still be short of cash, and exactly why adding fixed cost with a loan would deepen the winter hole.
2. Prepare a simple cash forecast from the end of September to the end of March and explain, using at least three specific features of this case, why a profitable business can run out of cash.
Read the worked answer
Cash forecast
| Item | € |
|---|---|
| Opening cash, end September | 38,000 |
| Winter trading outflow, 6 × 4,500 | (27,000) |
| Loan repayments, 6 × 1,150 | (6,900) |
| VAT and provisional tax, November | (22,000) |
| Closing position, end March | (17,900) |
The account is overdrawn by about €18,000 even before the owner takes any drawings, and before any equipment failure. A prudent facility is therefore €25,000–30,000, not €18,000.
Why profit is not cash
- Timing of receipts. The hotel contract is worth €60,000 a year, €5,000 a month, but is paid 60 days after invoice. At any moment about €10,000 is owed to the restaurant. The sale is in the profit figure in month one; the cash arrives in month three, in the middle of winter when it is most needed.
- Lumpy payments. VAT and provisional tax of €22,000 falls due in one month, in November, when trade is already weak. Tax is accrued evenly in the accounts but paid in a block.
- Seasonality of revenue against fixed costs. Rent, wages and utilities keep running through the low season while revenue falls to €22,400 a month. Profit is measured over the year; the bank balance is measured every day.
- Loan repayments and drawings. The capital element of the €1,150 monthly repayment reduces cash but not profit, and the owner's drawings may not appear as a cost at all.
The exam point: profit is an accruals measure, cash flow is a timing measure, and a highly seasonal business can be profitable and insolvent in the same year.
3. Recommend how the owner should finance the winter gap and whether the kitchen hours should be shortened. Justify your choice against the alternative and consider the risk the owner is being asked to carry.
Read the worked answer
Overdraft option. A €50,000 overdraft at 7.5% costs interest only on the amount drawn. If an average €20,000 is drawn for six months, interest is 20,000 × 7.5% × 0.5 = €750. It matches the problem precisely: a temporary, seasonal timing gap. Its weakness is that it is repayable on demand - the bank can withdraw it precisely when trade is poor, and it will usually require a personal guarantee or a charge anyway.
Loan option. €40,000 at 5.2% over five years costs about €2,080 of interest in year one on the full amount, with repayments of roughly €760 a month. It is cheaper per euro borrowed and cannot be recalled, but it hardens fixed costs by about €9,100 a year - in a business whose problem is that seven months do not cover fixed costs. It also means paying interest on roughly €20,000 that would sit idle.
Shortening kitchen hours. This attacks the wrong cost. The winter shortfall is driven by fixed costs (rent, core wages); cutting hours only saves cash if shifts are genuinely removed rather than trimmed, and it reduces the contribution that is already too thin. The better winter move is to raise contribution per cover - a shorter, higher-margin winter menu, private events and Christmas bookings - rather than to shut the door earlier.
Recommendation
- Take the overdraft, but negotiate €30,000 rather than €50,000: enough to cover the €17,900 deficit plus a €10,000 buffer. Interest cost is trivial against the risk of bouncing the tax payment.
- Attack the causes: ask the hotel for 30-day terms (frees about €5,000), and ask whether the VAT can be paid by direct-debit instalments.
- Take the five-year loan only if it funds something that earns in winter - a covered, heated terrace or an events room - in which case the loan is an investment, not a subsidy for a seasonal hole.
The judgement to reward is the one that matches the duration of the finance to the duration of the need, and recognises that the personal guarantee transfers real risk to the owner's family home.