Prime Costs are key indicators of your restaurant’s financial success. In another blog post, we answered the most common first question: “What Should Prime Cost Be in a Restaurant?” In this article, we address the second-most-common question regarding prime costs: Do we use gross sales or net sales in prime cost reporting?
Gross Sales vs Net Sales
Let’s first establish what amounts are included in gross sales versus net sales. Gross sales include food, beverage, wine, beer, and merchandise sales, plus any other operating income, without any reductions for discounts and comps. Net sales include food, beverage, wine, beer, and merchandise sales, plus any other operating income, after reductions for discounts and comps. Net sales are typically presented by net sales category, such as net food sales. For example:
Gross Food Sales = $5,000
Food Discounts/Comps = ($200)
Net Food Sales = $4,800
Prime Cost Formulas
As a refresher, here is the prime cost formula:
Prime Cost = Total Cost of Sales or Cost of Goods Sold (COGS) + 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 or Cost of Goods Sold (COGS) + 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 on whether you are a full-service or quick-service operation. Full-service restaurants should aim for at least 60-65%, ideally around 55% (best-in-class). Quick-service restaurants have average prime costs as a percentage of sales in the 55-60% range, ideally about 50% (best-in-class). Full-service restaurants operating at 65% and quick-service restaurants operating at 60% will typically produce a modest profit and sometimes break even, depending on how other costs are managed relative to sales. For more information about ideal prime costs for your restaurant, check out our full article here.
Notice how those percentages between ideal and modest profit 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 astray, as you’ll see below.
Using Gross Sales or Net Sales in Prime Cost Reporting
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 the composition of your comps and discounts. If your comps and discounts are mostly for promotions, friends, family, and employees, gross sales might be a better approach. If your comps and discounts are predominantly due to back-of-house and front-of-house errors, net sales might be a better approach. This is not a hard rule, it’s more about what helps you make better decisions. Let’s dive in.
When Gross Sales Produce an Accurate Prime Cost Percentage
Using gross sales to evaluate prime costs is helpful when your comps and discounts are due to advertising, promotions, employee meals, friends, family, etc. For example, in your full-service restaurant, you sell a plate that costs you $27.50 in COGS and labor. You usually sell this plate for the menu price of $50, giving you a prime cost percentage of 55% (food and labor of $27.50 / $50.00 gross sales, aka sales price before discounts/comps = 55%). This plate is perfect for your restaurant and gives you your ideal prime cost percentage.
One week, you hold a special promotion, 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. This dish’s prime cost percentage for that week is 68.8% (food and labor 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, but this is a temporary promotional/marketing expense that should be reflected in the marketing section of the P&L, not as a reduction in sales.
The same principle applies to comps and discounts provided to friends, family, and other promotional discounts, such as happy hour. For example, say you comp all law enforcement or military customers 50%. That could impact your prime cost percentages, even though nothing has changed from a kitchen and/or labor management perspective.
If you lower your sales due to promotional comps and discounts, your prime costs may be overstated, indicating labor or COGS management issues. But in reality, you have a comp and discount issue that should be highlighted in the marketing section of your P&L!
When Net Sales Produce an Accurate Prime Cost Percentage
If your comps and discounts are predominantly due to back-of-house and front-of-house errors, net sales might be a better approach to evaluating prime costs. For example, servers ringing in the wrong item, or cooking steak well done when ordered medium. Or, assume your servers are frequently comping a particular plate by $10 because it takes a little longer to prepare and deliver to the table than the rest of the meals. Using net sales in these scenarios to calculate prime cost would more accurately pinpoint labor and COGS issues. Or, perhaps, you have a cocktail spill comp button in your POS. Netting cocktail spills against your liquor sales will indirectly provide a clearer picture of higher prime costs, as the spill should be treated as a prime-cost inefficiency.
When comparing your financials in other restaurants and industry averages, it’s generally accepted to use net sales because your restaurant’s performance includes comps and discounts. Not lowering your sales by comps and discounts may artificially increase your revenue and not provide an accurate representation of your true sales. At The Fork CPAs, we typically assess sales per square foot and occupancy costs as a % of sales to determine whether a restaurant is generating sufficient sales for the space it’s in. If the sales are overstated, these KPIs can be misleading.
Gross Sales vs Net Sales from Prime Cost Comparison
The P&L below shows how prime cost percentages differ using the same financial data.
Separate Cost Accounting and Financial Accounting
A happy medium and potential solution to marry the benefits of both gross and net sales reporting is to prepare your financial statements using net sales and your weekly prime cost reports using gross sales, or vice versa. At The Fork CPAs, we maintain our general ledger using net sales, but in our third-party reporting system, we present the data in multiple formats so we can analyze and prepare the financial reports using both approaches. Alternatively, you can separate the data points in your POS into comps and discounts for poor service, food quality, drink quality, promotional discounts, friends and family, etc. By separating the data points, you can map them to the appropriate accounts on your P&L and/or prime cost reports. For example, spilled cocktail comp would offset liquor sales, while a friends-and-family discount would show up as a marketing expense.
At the end of the day, the goal is to help you make informed and meaningful decisions, and you should have the tools and professional accounting services to allow you to make those decisions. If you’re required to follow GAAP, you may be required to report sales on your financials using the net sales approach. However, that doesn’t mean your internal cost accounting reports need to be on the same basis.
Still have questions about prime cost reporting or percentages?
Once you figure out the prime cost components, the rest falls into place. If you need help setting up your financials, making sure they’re correct, or learning more about reading KPIs like prime cost, sit down with us!
