Someone once told me that restaurants have the most complicated business model because it is the only business in which you bring in raw product, manufacture that product and have a sales force on premise to sell that product. I had never thought of my business as both a manufacturing and sales business. But when I finally did, much of the financial reality I was keeping up with clicked into place. I needed financial literacy from a manufacturing and sales perspective.

The purpose of monitoring your financial health is to provide you red flags or variances from the normal or expected for problems you need to fix.  If your food cost goes up it’s time to review purchases, prices, waste, ‘shrinkage’ (theft). If alcoholic beverage cost goes up it’s time to review purchases, prices, waste, ‘shrinkage’. If your labor costs increase it’s time to consider your scheduling, your hourly wages and, yes, shrinkage.

Breaking costs out into specific categories allows you to pinpoint the areas which need your attention.

Understanding your Profit and Loss (P & L) Statement, also known as the Statement of Activities:

Prime Costs are the two major cost items in a restaurant, food and labor. The prime cost ratio (food + liquor + payroll / total sales) should remain around 60% of total sales. Obviously, a lower prime ratio is better but there is a point that if it’s too low you may be sacrificing food quality or service or charging too much for your product.

Food Cost is the actual amount that food cost you to resell. Because you are manufacturing a finished product from raw product you can expect some waste but controlling that waste is important.

Beverage Cost for liquor, beer, wine – maintain a separate inventory value and calculate cost just like you would food cost.

Cost of Goods (COG) is the cost of all ingredients including food and beverage. This is the cost of all the goods you sell direct to the public. You must do inventory in order to calculate food cost correctly. Emphasis: You cannot calculate food cost correctly without taking a full inventory. Here is the formula for calculating your cost of good sold: (beginning inventory + purchases – ending inventory / total sales). If this cost goes above 35% something has gone wrong. The average COG cost for fine dining is 35% and for quick service it is 25%. If you are having a difficult time getting this cost controlled I would suggest a daily or weekly inventory of your high end items – steaks, seafood and other meat products – and calculate a daily food cost for those items.

Operating Costs are the expenses related to the operation of your restaurant. These can be fixed or variable costs such as rent, utilities, marketing, office expense, insurance and of course payroll and food.

Gross Profit is the difference between your total sales (net income) and total operating costs (expenses).

Profit Margin – Your profit margin is the net income divided by the sales giving you a percentage. In restaurants a 5% to 10% profit margin is considered normal.

Understanding your Balance Sheet – Your balance sheet is a statement of financial position this is what your bank or mortgage holder will look at first and is often the least understood by restaurateurs.

A very quick look at the information you need from your balance sheet is that this is the difference between your assets and your liabilities. What you own and what you owe.

One calculation I learned early on was how to calculate the Quick Ratio: this ratio is calculated by dividing the current assets by the current liabilities giving you a ratio. The ratio should be 1:1 or better. Another way to look at this is subtract your current liabilities from your current assets. Is there money to pay your bills with some left over?

If you don’t understand what a balance sheet is telling your banker, you need financial literacy.  And of course, I hope this goes without saying, you should have a good bookkeeper or I would suggest a CPA. You need someone independent of your organization looking at your books. It’s too easy to lose track of your restaurant if you don’t have someone else responsible for the numbers. It’s also hard to get a loan if you don’t have a credible set of financial statements.

We hope this article was helpful. Please leave a comment below if you think you can help other, maybe newer restaurateurs with financial literacy. We learn better when we learn together. Thank you.