Prime Cost: The "Secret" P&L Item That Can Kill Profitability

Would it surprise you if I told you that your food and beverage (or restaurant) P&L doesn't explicitly state the single most important directly manageable financial data element that can make or break your operation?  It's true.  Food sales has its own line.  Restaurant Supplies has its own line.  Even the pencil on your desk has its own P&L line (Office Supplies or General & Admin).  But the most important P&L, or Income Statement, data element that is largely responsible for determining profit or loss for food and beverage operations doesn't usually have its own line...it has to be calculated.  It's called prime cost.

Simply put, prime cost is the difference between you revenue and key operating expenses listed on your Income Statement.  To figure out your prime cost, add all of your cost of sales to all of your payroll expenses including payroll taxes, benefits, etc. and subtract that figure from your gross sales. Simple as that. 

Labor and cost of goods, the two expense elements of prime cost, are two of the most controllable expenses for any F&B operation and a small movement up or down can mean the difference between operating at a profit or a loss.  Thus, it is critical that management monitor these expenses frequently.  I suggest monitoring labor daily (broken down by day part) and cost of goods weekly.

Let's take a closer look at prime cost and you'll quickly see that the pursuit of profitability usually hinges directly on the manager's ability to manage prime cost.

The formula to calculate prime cost is:

Prime Cost = Revenue - (Cost of Goods Sold + All Labor Costs)

Here's an example:

Prime Cost Calculation
Sales	$      100,000
COGS Expense	$        30,000	30%
Salaried FOH Labor	$          3,750	4%
Hourly FOH Labor	$          6,800	7%
FOH Payroll Tax & Benefits	$          2,300	2%
Total FOH Labor	$        12,850	13%
Salaried BOH Labor	$          3,450	3%
Hourly BOH Labor	$        12,500	13%
BOH Payroll Tax & Benefits	$          2,700	3%
Total BOH Labor	$        18,650	19%
Total Labor Cost	$        31,500	32%
Prime Cost	$        61,500	62%

In this example, we can see that subtracting the COGS and all labor expenses from the sales figure results in a prime cost dollar figure.  Prime cost is expressed as a percentage, so in this example the prime cost is 62% of sales.  This is within a normally acceptable range. 

However, since we split out labor by front of the house and back of the house, we can clearly see that an excessive amount of labor is being spent on kitchen help (Hourly BOH Labor is 13%).  The astute manager will notice this right away and make necessary adjustments to further increase financial efficiency.

You already know that the cost of goods sold and labor comprise the largest expense for a hospitality operation.  But the good news is that since these are two of your most controllable costs, by tracking your prime cost on a regular basis you will be able to make immediate adjustments rather than waiting for the end of the month when inventory is counted.  By actively managing prime costs on a daily basis, managers will see dramatic improvements to the bottom line profits.


How To Get Started

If you haven't done so already, you should gather together your last 12 months of P&L statements and trend your prime cost percentage.  Use this number as your benchmark to evaluate your improvement as you move forward.  A restaurant's prime cost will vary widely based upon the type of restaurant (quick serve will be less than full service) but industry averages range between 55-70% of gross sales.

In order to be nimble and make necessary adjustments to effectively manage prime cost on the fly, accurate record keeping and reporting revenue, labor expenses and inventory is absolutely critical. If you aren't already reporting your daily sales and labor expenses on a daily basis then you should start doing so today!  Be sure to break your daily labor into front of the house and back of the house categories to further refine your labor expense intelligence as we did in the above example.  Not managing your revenue vs. labor expense on a daily basis is the fastest way to poor financial performance. 

Inventory is a bit more time consuming, so most operations conduct inventory on a weekly basis.  This means you won't be able to create a true prime cost any more frequently than weekly, but this is OK as long as labor is being managed on a daily basis in relation to sales.  By the way, you may think taking inventory on a weekly basis is way too frequent.  But some well known restaurants conduct a weekly inventory of all goods and a daily inventory of all expensive proteins (fish, beef, lamb, etc.).  That's right.  Daily.  Those restaurants have a firm handle on both their inventory and their prime cost.

Once you've bench marked your prime cost, communicate this piece of data with your management staff.  Explain what it is and why it is important.  Then set a plan in place whereby your expectations that sales, labor and inventory numbers are consistently and accurately collected so every manager can then be held accountable for doing their part to improve your overall prime cost.  With this one critical piece of operational data front and center in the minds of all managers (both front and back of the house), you'll be positioned to add another percentage point or two to the bottom line.

It's amazing that a critical financial measure that has such a huge impact on your hospitality operation's profitability isn't on your P&L in bold neon ink.  But with this Hospitality Gem, you'll know how to use it to boost your profitability.

Was this prime cost  explanation helpful to you? Were you able to use this Hospitality Gem in your food and beverage operation? I would love to hear how you got along with this Gem so please leave a comment below or feel free to contact me at davidknight825 @ yahoo.com with your comments, queries or feedback!