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!

The Restaurant P&L Explained

There are many aspects to restaurant management that present everyday challenges, but understanding the restaurant P&L makes the job a bit easier.  One of the most difficult management responsibilities is balancing the mandate of providing excellent guest service with the requirement of serving a quality product while maintaining bottom line profitability as measured by the P&L.  Even though those core objectives seem to be constantly tugging in opposite directions, a great restaurant manager can pull them together and operate a successful organization. 
 

On the financial side of the business, understanding the restaurant P&L, also called an Income Statement, and knowing what the numbers actually mean is absolutely critical.  Once the restaurant Income Statement is mastered, managing revenues, expenses and cost controls becomes second nature.  Then, when the financial management of the business is solidified, the management team can then focus on other critical elements of restaurant operations such as service and product quality.

If you are managing a corporate or chain restaurant, your financial reports are likely in-depth and detailed.  They might include projected P&L forecasts, sales log summaries, a balance sheet, an operational budget, tax burden reports, individual unit sales (vs. other location sales), a statement of cash flow, corporate performance reports (shareholder value), controllable costs reports, etc.  For smaller operations and independent operators, financial reports are a bit more simple and are basically broken down into three basic categories: Revenue, Expenses and bottom line profit.

So let's get to it. What is an Income Statement, why is it important and how does a manager read it?

The Income Statement tells the story of whether an organization made a profit or not. It has the following basic elements:

     * Revenue

     * Cost of Sales or Cost of Goods (COG)
     * Expenses
     * Profit or Loss

In simple terms, the P&L is calculated as:

Revenue - (COG + Expenses) = Profit or Loss

Don't be fooled into thinking that understanding the Income Statement is as simple as making sure the number at the bottom of the page (the profit or loss number) is a positive number indicating a profit was generated.  Understanding the details of the P&L will paint a picture as to what exactly is happening in the business and where financial improvements can be made.  And becoming familiar with the data trending within specific categories can alert the astute manager that some element of the business may be wrong such as over serving portions (both food and beverage), theft or data entry errors.

Let's examine this sample P&L from a Fictitious Fabio's Restaurant.

 

 

Income Statement

Fictitious Fabio's Restaraunt

Month ended January 31, 2099

Sales
Food	$      710,321		70.0%
Beverage	$      237,544		23.4%
Other	$        67,324		6.6%
Total Sales		$ 1,015,189	100.0%
Cost of Sales
Food	$      227,451		32.0%
Beverage	$        59,444		25.0%
Other	$          2,475		3.7%
Total Cost of Sales		$    289,370	28.5%
Gross Profit		$    725,819
Controllable Expenses
Salaries & Wages	$      315,946		31.1%
Employee Benefits	$        80,155		7.9%
Restaurant Supplies	$        14,355		1.4%
Repairs & Maint	$        11,345		1.1%
Advertising	$          4,342		0.4%
Other Expenses	$        16,242		1.6%
Total Controllable Expenses		$    442,385	43.6%
Income Before Occupancy & EBIDA		$    283,434
Other Expenses
Occupancy Costs	$        73,541		7.2%
Interest	$        37,641		3.7%
Depreciation	$        62,134		6.1%
Total Other Expenses		$    173,316	17.1%
Restaurant Net Profit		$    110,118	10.8%

In order to more easily understand the Income Statement, let's break it down and discuss each section individually.

Header:

For single unit operators, you'll only be interested in the date as the Income Statement could cover a one month period, a fiscal quarter or a full year.  Multi-unit managers and Food and Beverage executives will also need to note the restaurant name as there may be multiple outlets being reported.

Sales:

The first data category on any P&L will be sales.  This sample P&L for Fictitious Fabio reports sales for three categories; food, beverage and other.  If your operation sells T-shirts, hats, souvenir cups or any other non food and beverage merchandise, these sales are typically reported in their own separate categories.

One element of this P&L that I'm not crazy about (even though I created it) is that there is no detail within the sales categories by which a manager can easily see trends and trouble spots within the sales numbers.  For example, if Fictitious Fabio's served breakfast, lunch and dinner then it would be valuable to have those day parts reported as individual P&L elements within the sales category.  The same applies to the beverage data item.  It would be important to break the beverage sales down to non-alcoholic, beer, wine and liquor to effectively paint an accurate picture of where sales are coming from while revealing weak points in the operation.

Cost of Sales:

The Cost of Sales category shows how much money was spent to purchase goods that are to be re-sold.  These reported categories should match the product type breakdown as listed in the above Sales section.  This is important because, in food and beverage operations, it is critical to accurately calculate the cost of sales (sometimes called Cost of Goods) as a percentage of the sales of that particular category.  In Fictitious Fabio's example P&L we can see that the cost of sales for food was divided by the revenue generated from the sale of food only.  The same is true for the beverage and other categories as well. This allows the manager to spot sales trends as well as trouble spots such as over purchasing.

Gross Profit:

The Gross Profit is simply how much money was generated less the amount of money spent to purchase those goods that were sold.

Controllable Expenses:

These are operating expenses that are under the direct control of management.  These expenses must be watched closely on a daily basis to ensure profits are maximized and include items such as labor, supplies, repair costs, etc.

Income Before Occupancy & EBIDA (Earnings Before Interest Depreciation and Amortization):

This number is simply a statement of how much cash the business generated.  It is calculated before considering occupancy expenses and before any accounting rules for interest, depreciation or amortization are applied.

A simple example would be if your business only sold banana muffins and you only sold one muffin for the reporting period.  If you sold that muffin for $1 and your controllable expenses were $0.40 then your true cash generated (EBIDA) would be $0.60.

Other Expenses:

This category completes the expenses picture by adding in all other expenses that are not related to cash flow such as interest paid on loans, depreciation charges for owned equipment or amortization costs for purchased real estate.

Net Profit:

The bottom line subtracts all expenses from all revenues to answer the all important question of whether or not the business was profitable for that particular reporting period.

OK, that all sounds simple enough, right?  So why can't I just grab my P&L and just look at the bottom line to see if I made a profit or not?  Isn't that the ultimate goal?

Well, I'm glad you asked.  Yes, of course profitability is the goal, but understanding the Income Statement and how it tells the story of your everyday business operations is incredibly important.  Tying together the daily record keeping and the monthly P&L can tell stories that could mean the difference between operating at a loss or turning a profit.

Here's an example.

Fictitious Fabio reported a food cost of 32.5% on their Income Statement.  The manager notices this is a pretty high number since her food cost is normally in the 28% to 29% range on a consistent basis.  After doing some investigative work, she realizes that a case of filet mignon was ordered but not delivered since the vendor was out of stock that particular day.  Then the chef submitted second order the next day but somehow both charges found their way to the accounting department when only one order was actually delivered.  

 

Aha! Mystery solved, right?

Well, no because given that the overall food sales $710,321, one case of filet mignon wouldn't cause her food cost to jump by such a large margin.  Something else must be amiss.

Further investigating revealed that, although Fabio's doesn't normally host weddings, the town mayor had a huge wedding at the restaurant to the tune of $60,000 which was accidentally posted to the "Other" sales category.  Ahhhhh, that makes sense because a 6.6% COG for merchandise sales seems way too low.  Once that revenue was re-classified, the numbers started falling in line with the norms.

If the manager didn't understand each particular category of the Income Statement, she might not have realized errors were made which could have affected her bottom line P&L performance, especially if revenue wasn't recorded at all for a particular day, a shift or even a single event.

A tremendous amount of business intelligence can be ascertained by effectively managing the P&L and the data that makes up the P&L numbers.  A good manager will understand everything about the P&L and daily operations to be able to manage category sales, per person averages (PPA or also called guest average), server sales effectiveness, check averages, etc.

Was this P&L 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!

Does Socially Responsible Food and Beverage Operations Matter To Your Guests?

When it comes to "green" consumerism and social responsibility, your guests are becoming more knowledgeable of current environmental issues and if it hasn't affected your food and beverage business yet, rest assured it soon will.

When I was an undergrad at UNLV's College of Hotel Administration, facilities management one of the required courses.  To be perfectly honest, it wasn't one of my favorite courses, but I found the in-depth studies in Leadership in Energy and Environmental Design (LEED), sustainability and social responsibility particularly interesting.  At the time I really didn't see the correlation between "green" strategies and food and beverage until I realized that being environmentally conscious is actually a state of mind and personal preference that manifests in consumer behavior as more and more consumers are demanding hospitality operators to act in a more socially responsible manner. 

Close your eyes for a moment and formulate a mental image of what you believe the average environmentally conscious person might look like.  If your image is of a hippie in bell bottom jeans and a tie died T-shirt or a grunged out anarchist, then your perception is severely outdated.  Earth friendly ideals and sustainability efforts are now embraced by the average consumer as they are quickly becoming more educated due to ease and speed of information sharing in today's wired and social media world. 

A 2007 McKinsey & Company global survey of 7,751 consumers in eight major countries found that 87% of international consumers who participated in the survey are concerned about the environmental and social impacts of the products they buy. (Sheila Bonini, Greg Hintz, and Lenny Mendonca, “Addressing Consumer Concerns About Climate Change,” McKinsey Quarterly, March 2008).  While being "concerned" about the social responsibility of products doesn't necessarily translate into consumer action such as choosing one brand over another, it is important to realize that 87% of consumers, and presumably your guests, are environmentally aware.  That's a staggering percentage.

Earth Sense LLC published a finding that 56% of consumers will "buycott" (either purchase or boycott) products based upon their "environmental reputation" (Amy Hebard, Ph.D. and Wendy Cobrda, Ph.D., "The Corporate Reality of Consumer Perceptions", 2009). That's a large number that is only growing larger as consumers become more environmentally conscious.

This attitude is being reflected in consumer choices in the food and beverage industry.  More directly to the point, the National Restaurant Association reports that 41% of restaurant consumers stated they are likely to make their choice of restaurant based upon whether or not they perceive that restaurant to be environmentally friendly and 55% said they would choose a restaurant that offered organic, locally grown or environmentally friendly grown food (2012 Restaurant Industry Forecast).

 Sustainability of food sources, guests' focus on eating healthier foods and avoiding particular ingredients such as foods containing gluten are currently strong food and beverage consumer trends.  Restaurant consumers are asking more questions now.  It is common to hear questions such as "Is this sea bass from Chile?" (knowing Chilean sea bass is over-fished) or "Is this farm raised salmon or wild caught?".  Guests are also seeking locally sourced meats, seafood and produce where possible with the knowledge that the ingredients will be more fresh and will have left less of a carbon footprint by eliminating unnecessary transport.

But, food and beverage operations have been slow to adjust to consumer environmental demands for a variety of reasons.  Cost is the most obvious reason as some earth friendly food items, such as organic fruits and vegetables, can be much more expensive to procure.  But this doesn't have to be a show stopper.  Bear in mind that consumers want fresh ingredients and although purchasing fresh ingredients does require more preparation work, it is often less expensive, healthier and more flavorful than pre-packaged foods.

Food and beverage operators shouldn't be so short sighted to believe that being earth friendly is all about food, because it isn't.  Croc's, a restaurant in Virginia Beach, Virginia is a 125 seat restaurant that has gone "green" with the help of a state grant and has attracted new guests because of their earth friendly approach to doing business.  The green business practices they have adopted includes recycling, the reduced use of disposable items, grease recycling, eliminating styrofoam, energy conservation and utilizing local and sustainable ingredients.  As a result, costs are down and revenues are up.  That's a recipe for success.

So if your food and beverage operation hasn't already adopted "green" initiatives, the time to do so is now.  You will be doing your part to protect the environment while giving your market exactly what they are asking for; fresh, locally grown, and sustainable food.  Market your initiatives to spread the word that you are doing your part and you may soon be tapping a "fresh" new market segment you may currently be missing.

So go ahead and give this Hospitality Gem some consideration. Try out some "green" ideas and begin transforming your food and beverage operation for the better.  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!