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The Problem with Cash-on-Cash Return

Greg Williams
Greg Williams LinkedIn

CEO & Co-Founder, Veloflo

What’s the problem with Cash-on-Cash Return? Surely there isn’t one! What’s not to like!? Well, the preferred metric for many multi-unit operators and investors has its limitations. This article outlines the most common measures of Unit-Level Return-on-Investment (ROI), explores their pros and cons, and recommends the appropriate contexts for using each. The TL;DR? Cash-on-Cash Return is fine for high-level discussions and benchmarking, but IRR is best for underwriting new units.

Cash-on-Cash Return

Cash-on-Cash Return is probably the most commonly used shorthand for Unit-Level ROI amongst multi-unit operators and investors. It equals your Four-Wall EBITDA divided by your Net Investment (capital expenditures net of tenant improvement allowances, pre-opening expenses, and working capital at a unit level).

Pros

  • Widely used and easily benchmarked
  • Intuitive to calculate and (loosely) interpret

Cons

  • Decision around when to include units in the calculation (i.e., at what point of their maturity) can significantly impact the outcome
  • An incomplete metric because it does not account for the full history of a unit’s cash flow (it typically uses L12M EBITDA at a specific point in time)

Best Uses

  • Discussions with Boards and investors (for easy benchmarking/comparison, even though those comparisons may not be fully valid)
  • Back-of-the-napkin calculations to quickly decide if a potential new unit ‘pencils’

Payback Period

Payback Period is another favorite of multi-unit operators and investors. It measures the number of months or years it takes for the cumulative Four-Wall EBITDA of a unit to equal the Net Investment.

Pros

  • Ensures financial discipline as it accounts for the early cash flows of a unit (often a less profitable “ramp period”)
  • Intuitive to calculate and (loosely) interpret

Cons

  • Favors more conservative decision-making (i.e., units that will payback quickly but aren’t necessarily projected to have the highest overall return)
  • Expressed in months or years, rather than a rate of return

Best Uses

  • Discussions with Boards and investors (for easy benchmarking/comparison, even though those comparisons may not be fully valid)
  • Back-of-the-napkin calculations to quickly decide if a potential new unit ‘pencils’

Internal Rate of Return (IRR)

IRR is also widely used by multi-unit operators and investors but less frequently in discussions about company performance and benchmarking than Cash-on-Cash Return or Payback Period. In this context, IRR is the discount rate that makes the net present value (NPV) of the cash flows of a unit equal to zero.

Pros

  • Unlike Cash-on-Cash Return and Payback Period, it is not biased by the time period used in the calculation—it takes into account all the cash flows of the unit
  • Expressed as a rate of return and easy to compare to other investments

Cons

  • Requires forecasting future cash flows for each unit

Best Uses

  • Underwriting investments in new units
  • Sense-checking investments in new units versus a broader landscape of investment opportunities

Net Present Value (NPV)

NPV rarely makes it into Board decks or S-1s but can help operators prioritize between potential new projects. NPV is the sum of all the discounted cash flows of a unit, minus the Net Investment.

Pros

  • Similar to IRR, it avoids “time period bias”
  • Expressed in a dollar value, making it useful for prioritizing between projects when non-financial resources (e.g., a team’s ability to open a certain number of units) are constrained

Cons

  • Requires aligning on a discount rate (e.g., the project’s WACC—weighted average cost of capital)
  • Highly sensitive to assumptions for larger, lower ROI projects