The nature of the cafe business

The first thing you learn about buying an existing small cafe is how there is a disconnect between the information on paper and the true performance of the business. And that's because owner operators of small cafes are invariably operating a part cash, part official business. That is, they only are reporting a percentage of their true revenue. The rest is disappearing out of the till as cash.

We know this for a fact - it's such an ingrained and accepted practice the business brokers representing the cafe owners even speak openly about the 'cash ratio'. One broker we're negotiating with spoke about how it would be our decision to choose a cash ratio - 50%, 60% - eg what percentage of the takings would be officially reported.

They even cover off the situation where, because the books don't reflect the true takings, a potential buyer might be nervous about paying the asking price. So they offer 'trial periods', whereby the sales contract will include a get out clause if takings don't hit a certain level.

It's not hard to pick a cafe that's under-reporting takings, the signs:

- The paperwork from the broker is minimal or non-existant (they don't want to have to provide a signed off Vendor's Statement certifying the revenue)

- If you are provided with some financials, the ratios will be off. Here's how you tell:

A cafe is advertised for sale. The ad says the takings are $4,500 a week, with 10kg of coffee being sold. The you receive the financials and they show a gross revenue for a year of $150,000 - and a cost of goods vs revenue ratio of 40%.

Start doing the maths. For a start $4,500 a week = $234,000 a year. 10kg of coffee makes around 1,200 cups of coffee, say at an average of $2.50 retail. That's $156,000 just in coffee sales alone for a year.

And cost of goods at 40%! Should be around 22-25% maximum.

When I first realised this was the situation my ethical business bones started to ache. How come the tax office doesn't start in on these people - we've run businesses for 15 years, and we've always run our accounts above board. So while we've been paying taxes, these guys have been evading taxes.

Then I considered the cash chain. Whilst the cafes can't pay cash for some products - for example, buying in drinks from major suppliers like Coca Cola, they do buy a lot of fresh food - fruit and vegetables for example. These are often distributed by small businesses - basically a bloke with a van who looks after a small group of cafes. He goes to the markets early in the morning, purchases the orders, the delivers them out to his customers, the cafes.

The cafes often pay cash to the distributor. Who in turn is quite likely paying cash to the market stall holder. And there's no tax disadvantage. Because there's no Goods and Services Tax on fresh food. So no input credits to claim for the cafe owner. Or the distributor, or the market stall owner.

Thus you get a cash driven supply chain. Some sales are reported on the books - enough to keep filing Business Activity Statements. And a decent percentage are not.

If the tax office got involved their first point of investigation would be requiring the cafe owners to hand over their cash register till rolls, and reconciling these with the BAS filings. If the cafe owners have not been careful to not ring up all their sales whilst sticky fingering cash out of the till, there will be a discrepency.

The tax office seriously does not like you mis-reporting, and evading tax. And they come down hard. They are the one creditor your NEVER piss off in business, because they'll close you without compunction. And that's what'll happen to the small cafes if they get caught. And the distributors. And the market stall holders. Only problem - big bunch of businesses will close, and people out of work.

It reminds me of the big debate during the introduction of the GST back in 1999-2000. Originally the GST was to apply to everything. But after much public outrage, the government backed off and did not impose GST on fresh food. Their argument in support of taxing fresh food was that the GST could be a powerful tool to counter the cash black market. But creating exceptions - eg fresh food - would severly compromise the effectiveness. Now I see they were right.