Restaurant owners and managers need to be acutely aware of their prime costs. This metric provides a snapshot of the percentage of a restaurant's revenue that is being spent on food and beverage costs. It is important to track this metric closely, as it can help identify areas where cost savings can be made.
Today, we'll take a closer look at what prime costs are and why they're so important. We'll also provide some tips on how to keep your prime costs in check. So read on to learn more!
Restaurant prime cost, why this matters?
To make your business as profitable as possible, you need to consider several different factors to become a successful restaurant owner - and this is not just increasing sales. The prime cost is a crucial performance metric for restaurants. A restaurant's prime costs also known as the direct costs are defined as the sum of your product costs (also known as COGS or "cost of goods sold") and your labor costs.
The prime cost of running a restaurant business is the key to maintaining a good profit margin. Analyzing, controlling, and calculating prime cost can help you have a good sense of how you can adjust your budget and make necessary changes to keep your restaurant business profitable.
The following are considered your prime cost if...
Cost of Goods Sold:
- The product/service is sold to a customer
- It comes with every purchase
- It's paid out as salary received by employees for their work
- It's paid out to cover employee-related costs, such as taxes, insurance, and benefits.
Why understanding your prime costs is key
Restaurant prime costs are the total value of all your costs incurred in producing a product or service. Knowing your prime cost number lets you set prices that ensure you'll make a profit, and understand how much you can spend without putting your business at risk.
If you want to make a profit, it is important to understand what your restaurant's prime costs are. This way, you can take steps to reduce these costs where possible. For example, if you know that your labor costs make up a large proportion of your prime cost, you may choose to cut back on staff hours or invest in labor-saving technologies.
Similarly, if food costs are a significant portion of your prime cost, you may seek out cheaper suppliers or review your menu to find ways to reduce food waste.
You should also regularly keep tracking prime costs. This way, you can spot any trends or areas for improvement. For example, if you notice that your prime cost is gradually increasing, this may be a sign that you need to take action to cut costs.
The Differences Between Prime and Conversion Costs
To put it simply, prime costs do not include the production-related expenses that are included in conversion costs. Comparing prime cost to conversion cost is a bit like looking at the cost of ingredients to make a cake versus the total cost of making and then decorating the cake. With prime cost, you would just focus on what it costs to buy the eggs, flour, sugar, etc. needed to make the cake. But with conversion costs, you would also factor in things like the cost of the oven, the cost of electricity to run the oven, your time spent making the cake, etc.
Formula to Calculate prime cost
Below is the prime cost formula to calculate your restaurant's prime cost, which factors in the total cost of goods sold as well as labor costs.
Total Cost of Goods Sold (CoGS) + Total Labor Cost = Prime Cost
To break this prime cost formula down, we will take a closer look at it.
Total Cost of Goods Sold (CoGs)
Every ingredient and product purchased for use in your restaurant is included in the total CoGs. This includes food, beverages, packaging, and cleaning supplies, as well as anything else that is regularly required to get your products to customers.
You can calculate your CoGS using this formula:
Beginning Inventory + Purchases – Ending Inventory = CoGS
The amount of inventory you have at the beginning of a given period is your starting inventory.
The amount of inventory you bought over that time period is your purchase.
Ending inventory refers to the amount of inventory remaining at the end of a given period. Your ending inventory is calculated by taking your starting inventory and adding your purchases, then subtracting the amount of food and beverage used during that time period.
Total Labor Costs
When you're determining how much an employee costs, don't stop at their hourly rate. You also need to factor in things like taxes, benefits, food discounts, and insurance. For example, if you pay an employee $10 per hour, the actual cost is closer to $12 or even $13 per hour when you include those other expenses.
To calculate labor costs, you will need to consider a few factors, such as:
- Wage per hour
- The number of hours you work each week
- How many weeks you are working in a year.
In order to calculate your total labor cost for a certain time frame, you will need to classify it into two: hourly employees and those who have a salary.
To calculate the amount you need to pay your salaried employees, first determine the period you are calculating for. (For example's sake, let's say weekly.) Then, divide their total salary by 52 or ask your accountant for more specific figures.
To calculate your business's hourly wage expenses:
1. Look at the hourly wage of each employee.
2. Add up the number of hours they worked during the same period.
3. Multiply that number by their allocated hourly wage rate; this will give you their total wages for that time period.
Taxes, benefits, insurance, and workers’ compensation:
In order to determine your labor costs, you will need to speak with your accountant. All figures should include payroll tax, benefits, health insurance, retirement contributions, workers’ compensation, and any other employee benefit programs for the specified period. This can be estimated as a percentage of the total payroll expenses.
The restaurant prime cost includes:
Food and beverage inventory, labor, payroll taxes, and related expenses like workers’ compensation and health insurance, employee benefits, as well as disposables.
Here are some expenses that prime cost doesn't account for:
Prime cost does not include indirect overhead costs like allocated factory overheads. Administrative expenses are frequently omitted from the definition of prime cost as well. This often means that most company expenditure, which includes items like the below, does not result in a direct contribution to profit:
- Office and bathroom supplies
- Kitchen equipment and equipment repairs
- Furniture and menu redesigns
- Utilities, signage, and decor
- Maintenance and landscaping
Restaurant Prime Cost Ratio
The prime cost ratio is found by comparing prime cost (the total amount) to your overall food and beverage sales. This prime cost equation will give you the answer as a prime cost percentage:
Prime Cost as a Percentage of Sales = Prime Cost / Total Sales
The percentage of sales will help you understand how much of your sales are going towards your direct costs, which is important to know when making pricing and menu decisions.
If your prime cost is too high, it means that you're not making enough profit off of each sale. On the other hand, a lower prime cost might mean that you're not charging enough for your food and beverage. In either case, it's important to keep an eye on your prime cost percentage so that you can make necessary changes to your menu and pricing.
What's a Healthy Prime Cost and Prime Cost Ratios?
The ideal prime cost and prime cost ratios are different for every restaurant, as they depend on the type of food you serve, your location, and your target market.
Although there is no magic number that all restaurants should aim for, most restaurants in the industry shoot for a prime cost percentage between 60-70%. Most full-service restaurants bring in around 65% of their total sales, a number which is slightly higher than that of quick-service restaurants (55-60%).
A quick service restaurant, like a pizza parlor, for example, might have low food costs. This is due to the fact that their menu offerings are typically less complex and require fewer ingredients than a full-service restaurant. However, their labor costs could be high if they don't use equipment to automate certain processes, like dough-making. In this case, their prime cost percentage would be on the higher end.
While a seafood restaurant has to contend with generally higher food costs for ingredients like shrimp and crab. But they could make up for this by using lower-cost labor, such as via pre-made fish filets rather than cooking whole fish from scratch.
With that in mind, if you're someone who loves seeing numbers and measuring progress, an acceptable food cost is usually between 25%–35% with labor making up 20%–35% of total sales.
Maintaining a good prime cost percentage which is 55% or lower is critical to the success of restaurant operators. Any number higher than 50% means you're cutting corners somewhere, and that will only lead to problems down the road. Your restaurant's health lies in comparing your prime cost regularly, so take some time to understand and calculate your restaurant's prime costs.
6 factors contribute to high prime cost
There are several factors that can lead to high restaurant prime costs. Here are six of them:
1. High food prices
The costs of food and drinks can flux due to seasonal changes or because suppliers raise prices without any specific reasoning. If you're not observing the increases in your raw materials costs, your prime cost could pass a safe limit.
2. High labor costs
Another major expense for restaurants is the total labor costs. This includes employee wages, benefits, and taxes. If you're paying your employees too much or if you have too many employees, this will drive up your labor costs.
3. Poor inventory management
If you don't have an inventory management system, this can lead to wasting stock and higher production costs.
4. Poor cost control
Without careful cost monitoring, you could end up throwing away money needlessly, and as a result, your prime cost will be higher.
5. Lack of economies of scale
If you're a small operation, you may not be able to take advantage of economies of scale. This means that you'll have to pay more for your supplies and ingredients, which will drive up your costs.
6. High menu prices
If you price your menu without factoring in an ideal food cost percentage, then the CoG portion of your prime cost is likely higher than necessary. However, if you start by basing your menu prices on a low food cost percentage, then CoGS will have a solid foundation.
Calculate Prime Cost regularly
Many restaurant owners don't realize that time is of the essence when it comes to tracking prime costs. The sooner you calculate your restaurant's prime cost, the less chance there is of profits slipping through the cracks or putting yourself in the danger zone where 70%+ of businesses fail.
To ensure you have accurate and updated always, it is recommended that you keep tracking prime cost on a weekly basis.
What to do when you have a low prime cost percentage?
There are many ways to keep your restaurant's prime cost low, some of which are listed below. For example:
- Review your menu regularly and update it as necessary. If you want to keep your COGs low, you need to be constantly reviewing your menu. As prices for ingredients change, you'll need to adjust your menu prices accordingly.
- Use a food cost calculator. A food cost calculator can help you determine the ideal price for each menu item. This will take the guesswork out of menu pricing and help you keep your COGs low.
- Keep an eye on your labor costs. If your labor costs are too high, it will drive up your prime cost. Make sure you're not overstaffing your restaurant and that you're paying your employees a fair wage.
- Implement an inventory management system. An inventory management system will help you keep track of your inventory and ensure that you're using all of your supplies efficiently. This will help you save money and keep your costs down.
- Compare prices from different suppliers. Don't be afraid to shop around for better prices on your supplies and ingredients. By comparing prices, you can ensure that you're getting the best deal possible. Switch suppliers if necessary. Monitor your costs carefully. Keep a close eye on your costs so that you can identify any areas where you may be wasting money.
- Offer discounts and promotions. Offering discounts and promotions are a great way to bring in customers and boost sales. Just be sure that you're not discounting your menu items too much or you'll end up losing money.
- Use your POS system to simplify and streamline your business processes. Your POS system can be a valuable tool for managing your restaurant's inventory and costs. By tracking your total sales, you can see what menu items are selling well and adjust your prices accordingly. You can also use your POS to track your inventory and make sure you're not over-ordering or wasting food.
- Purchase portioning wares. Portioning wares can help you control the portion sizes of your menu items and ensure that you're not giving out too much food. This can help in minimizing food waste and save money. Invest in kitchen equipment that will help you save time and money. There are many types of kitchen equipment that can help you save time and money.
- Use scheduling strategies. By using scheduling strategies such as an attendance system, you can ensure that your restaurant is staffed properly and that you're not overpaying for labor. This includes things like using part-time employees and cross-training your staff.
- Use market pricing. Market pricing is a pricing strategy where you adjust your prices based on the current market conditions. This can help you stay competitive and ensure that you're not overcharging or undercharging for your menu items. The best way to keep a restaurant's prime cost low is to monitor your food costs closely.
- Predictive total sales forecasts. Not only does this help you make sound business decisions but also saves you money. Overordering supplies leads to wasted money; conversely, if you under order you'll lose customers.
Tracking prime costs weekly
To determine the food cost component of your prime cost, begin by documenting your daily food and beverage purchases in an invoice log. Each day, post or record invoices on the corresponding worksheet - specifying which amounts go towards which food or beverage account categories.
Product returns or invoice adjustments require credits to be posted, and cash-paid-out transactions for food and beverage purchases need to be recorded. At the end of each week, you will have a comprehensive log of your restaurant's total food, liquor, beer, and wine purchases.
If you want to reduce the time spent on posting invoices, ask your suppliers - especially broad-line distributors - for an invoice per product type. For example, ask for one invoice that only has your food items, and another with cleaning supplies, paper goods, and so on.
Logging invoices into the right accounts will be much simpler when you don't have to manually deconstruct and classify the invoice line items. Also, if you want that degree of detail in your food cost account, most distributors can quickly give you subtotals of your food items by categories such as meat, seafood, poultry, grocery store items, etc.
Use the "Daily Labor Hours" log to calculate hourly labor costs daily for your weekly labor cost report. You can calculate your hourly labor cost easily with a worksheet by listing your employees in the same order as their hours appear on your timekeeping system. Then, post each employee's total hours at the end of every day.
The first thing you should examine on your Profit and Loss statement (P&L)
Because prime cost is so crucial, it's recommended that restaurant owners review their P&L reports with an accountant or bookkeeper. This will help them recognize the prime cost more effectively.
As a restaurateur, it is critical that you focus on your restaurant's prime cost to maintain a profitable business. When you have uncontrolled food or labor costs, this often results in other issues such as inconsistency with food quality, services, or even management practices. If a restaurant can efficiently manage its prime cost, it indicates that the business is managed well overall.