If you’ve spent much time analyzing your restaurant’s financials, you have already been told or learned that your prime costs are key indicators of your restaurant’s financial success. Because we answered the first most common question “What Should Prime Cost Be in a Restaurant?” in another blog, in this article we address the second most common question regarding prime costs: Why do we use gross sales in prime cost reporting?
Gross Sales vs Net Sales
Let’s first establish what amounts are included in gross sales, versus in net sales. Gross sales are strictly the positive revenue amounts resulting from your restaurant’s operations. This is food sales, beverage sales, and any merchandise sales, without any reductions from discounts, specials, comps, or commissions. Net sales are the positive revenue amounts netted against or reduced by discounts and special promos, comps, and commissions.
Prime Cost Formulas
As a refresher, here is the prime cost formula:
Prime Cost = Total Cost of Sales (Food Cost) + Labor Cost + [Paper Cost for Quick Service Restaurant (QSR)]
Additionally, you need to know what your prime cost percentage is – or, how your costs compare to your actual sales:
Prime Cost Percentage = (Total Cost of Sales (Food Cost) + Labor Cost + [Paper Cost for QSRs]) / SALES
What Should Prime Cost Be in a Restaurant?
The first question we usually get about prime costs and prime cost percentages is, “What numbers are good/indicate success?” The answer depends a little bit on your restaurant’s service type: full-service versus quick-service. Full-service restaurants should be looking for at least an average of 60-65%, and ideally, right around 55%. Quick-service restaurants with average prime costs as a percentage of sales are in the 55-60% range, and ideally about 50%. Full-service restaurants operating at 65%, and quick-service restaurants operating at 60% are usually considered “in trouble.” For more information about ideal prime costs for your restaurant, check out our full article here.
Notice how those percentages between ideal and “in trouble” only differ by about 10%? That is why it’s super important to make sure you’re capturing and using the correct financial data, so that you’re not making decisions based on bad information. Using the wrong type of sales number can lead you very astray, as you’ll see below.
The Case for Using Gross Sales
The second question we get about prime cost is, “Should we be using gross sales or net sales in prime costs reporting?” The answer depends on what information you’re evaluating. For purposes of evaluating food and labor budgets, or for determining if your menu pricing is appropriate, we recommend using gross sales. The reason we use gross sales is that we are analyzing the costs of products sold (food, beverage, and labor) compared to the sales of those products, to evaluate profitability. Without this starting point, you cannot evaluate where any issues with profitability are originating. Let’s walk through an example.
How Net Sales Can Produce Inaccurate Prime Cost Percentage
In your full-service restaurant, you sell a plate that all ingredients included and prepared costs you $27.50. You normally sell this plate for the menu price of $50, giving you a prime cost percentage of 55% (food of $27.50 / $50.00 gross sales aka sales price before discounts/comps = 55%). For your restaurant, this plate is perfect and gives you your ideal prime cost percentage.
One week, you hold a special offering the same plate for $40 instead of $50. This $10 discount is available all day, all week, and for that week is the most popular plate. For that week, this dish’s prime cost percentage is 68.8% (food cost of $27.50 / $40 sales price after discounts/comps). The prime cost percentage including the discount is far from ideal, and would even indicate trouble! But is the original pricing wrong? No, the original pricing, for that dollar cost, is spot-on.
The Wrong Data Leads to the Wrong Decisions
This is especially important when evaluating how your restaurant’s team controls prime costs. Let’s say you set kitchen management bonuses to kick in when prime costs are below 57%. Under the printed menu prices, according to the costs the kitchen staff has incurred, they are mastering controllable costs with a prime cost percentage of 55% using gross sales. But if you used net sales – which includes comps and discounts that your team cannot control – your team would be unfairly unrewarded at the discounted rate of 68.8%.
Additionally, if you’re only using net sales to calculate your prime cost percentage, it may be because you’re not tracking your comps and discounts separately on your P&L – which can lead to drastic misunderstandings in how your restaurant is faring. Using the same figures as the example above, assume that your servers are always comping that plate by $10 because it takes a little longer than the rest of the meals to prepare and deliver to the table. If you examined that prime cost percentage using the net sales as the denominator, you would very likely decide to cut the plate from the menu entirely, or make drastic changes to alter it. This is a problem because the issue is not with the dish’s cost or pricing but with the servers’ training and comp management. By looking at the prime cost percentage using the gross sales, you’d know to look elsewhere, digging into the comps and discounts.
The Case for Using Net Sales
However, there are certainly cases when using net sales to evaluate prime costs is more beneficial. When comparing your financials in other restaurants and industry averages, it’s generally accepted to use net sales, because your restaurant’s overall performance does include comps and discounts.
Besides comparing your performance to other restaurants and industry averages, calculating your prime costs using net sales also gives you a better understanding of your restaurant’s overall actual performance with discounts, comps, etc. You may also choose to use net sales including things like commissions – often represented on the P&L by a negative line item in the revenue section along with comps and discounts. This method of analysis helps you pinpoint issues with your bottom line, such as if your comps and discounts are too high, your occupancy is too low, etc.
Gross Sales vs Net Sales from Prime Cost Comparison
The P&L below shows how prime cost percentages differ using the same financial data.
Still have questions about prime cost percentage?
Once you get prime cost components figured out, the rest falls somewhat into place. If you need help figuring out how to set up your financials, making sure they’re correct or want to know more about reading KPIs like prime cost, sit down with us!