Calculating your restaurant labor cost percentage is essential to running a successful restaurant. The labor cost percentage is the amount of money you spend on employee wages and benefits as it compares to your total sales.
This number is significant because it tells you how much profit you’re making on each dollar that comes through your door. If your labor cost percentage is too high, it means that you’re losing money every time a customer buys food or drinks at your restaurant. This can lead to lower profits and eventually force you out of business if you don’t act fast to resolve these issues.
Let’s explore how to calculate your labor cost percentage and reduce the labor costs in your restaurant.
What Are the Operating Costs of a Restaurant?
A restaurant’s operating costs are the expenses necessary for a business’s day-to-day operation. A restaurant’s operating costs fall into two main categories: variable costs and fixed costs. Variable costs are those that change due to changes in business volume or sales revenue. Fixed costs remain the same regardless of how much you sell.
The average restaurant cost varies greatly depending on location, type of food served, and other factors.
Restaurant Fixed Costs
Restaurant fixed costs are expenses that remain the same regardless of how much business you do. The biggest one is rent or mortgage payments, followed by salaried payroll and utilities (such as heating and air conditioning).
In addition to these three major categories, there are several more minor fixed expenses that you’ll have to pay regularly:
Insurance. A good insurance policy protects your business from losses due to theft or damage caused by fire or other disasters. You also need workers’ compensation insurance if you have employees working in your restaurant.
Interest on loans. If you own the building where your restaurant is located or have borrowed money to finance your restaurant’s build-out or remodeling, you must make monthly payments on those loans.
Restaurant Variable Costs
Variable costs are those that change with the volume of sales. They include items such as food, beverages, and hourly labor. These costs will vary depending on how many customers are served on any given day or week. For example, if you have ten tables (or 40 covers) occupied at lunchtime but only five at dinnertime (20 covers), your labor costs will be higher since you will need more resources, e.g., food and drinks, to serve your customers.
The most ordinary restaurant operating costs are food, beverage, and labor (widely known as your prime costs). However, other expenses can have a significant impact on your bottom line. Here are some of the most common ones:
Food costs. Food costs represent the percentage of gross sales that goes toward purchasing ingredients used to prepare your meals. These costs include the price you paid for raw materials and any labor involved in receiving, receiving, and storing them before they’re used.
Beverage costs. Beverage costs include the amount spent on alcoholic, non-alcoholic, and other beverage inputs (lemons, mixers, etc.). You should consider ice in this category as well if you do not have the onsite equipment to produce it.
Utilities/supplies. Utilities include electricity and gas for cooking purposes and lighting and heating/air conditioning costs associated with providing service to customers indoors or out on your patio or deck area if applicable. Supplies include paper napkins, plastic cutlery, and other similar items needed for serving food to your guests.
Labor costs. Labor is one of the most significant expenses in any business, but especially so when it comes to restaurants due to their nature as a labor-intensive businesses.
What Makes up Labor Costs?
Labor costs are one of the most significant expenses for any restaurant. And they can also be one of the most difficult to calculate.
Labor costs are the wages and benefits paid to employees, including hourly and salaried staff. It includes payroll taxes, health insurance premiums, unemployment, and workers’ compensation insurance premiums.
Labor costs include:
Wages and salaries. This includes hourly wages, tips, and bonuses paid to employees. You can also include payroll taxes and benefits costs, such as employee 401(k) contributions or health insurance premiums.
Employee benefits. These include life insurance, disability insurance, worker’s compensation, and other fringe benefits that employers provide.
Employee turnover costs. These are expenses related to hiring and training new employees, including recruiting fees and employee training programs offered by industry associations or state agencies.
When calculating labor costs in your restaurant business plan, you’ll want to include these items to know exactly how much money you’re spending on payroll each month or year.
How to Think about Labor Costs
Labor costs are an essential part of any restaurant management. When operating a small- or medium-sized restaurant, you must understand precisely where your money is going. By breaking down your labor costs into different categories, you’ll see where you might need to cut costs or make adjustments to increase profits.
Front of House
The front of the house refers to employees who interact with guests directly, such as servers, bartenders, and hosts. Front-of-house labor costs can vary wildly depending on the number of employees and the type of service they provide. For example, if you have a more formal dining setting with two servers per table, this contrasts with a more casual dining experience where one server may have ten tables.
Back of House
Back-of-house restaurant costs are the expenses incurred by the restaurant to run the restaurant. The back of the house refers to the kitchen and the production of foods that tend not to be visible to customers. These include food, beverage, and labor costs.
The most important thing to remember about a restaurant’s back of the house is where the production happens, the making of the goods to be sold to the customer. The front of the house is where you sell food and beverages, but it’s the back of the house that makes sure those items are properly prepared and delivered.
Management & Administration
For larger, more complex operations, you will have administrative or management staff as well. This tends to be a general manager or assistant general manager. Other roles will roll into this bucket of costs but vary depending on your business structure.
Per Plate Inputs
If you’re running a restaurant, you need to know what goes into every meal you serve to ensure your business stays profitable. Here is a look at some of the back-of-the-house costs involved with preparing food for customers:
Food costs. Food costs represent how much you spend on ingredients, such as meat, poultry, and seafood. These ingredients are then used to create menu items from appetizers to salads and main courses to desserts. Food costs include other supplies used to prepare meals, like raw ingredients such as sugar, flour, spices, and so on.
Labor costs. Labor costs include wages paid to employees in the kitchen and prep area at your restaurant. Labor costs include payroll taxes such as Social Security and Medicare taxes, unemployment insurance taxes, and workers’ compensation insurance premiums.
How to Calculate Labor Cost Percentage
Labor is a large part of every business’s expenses. By knowing your labor cost percentage, you can determine how much your company spends on labor and how much it makes in profit.
You can also set targets, improve on those targets and improve profitability quarter after quarter.
There are a few ways to calculate labor cost percentages. We’ll be diving into two labor cost percentage formulas in particular: labor as a percentage of sales and work as a percentage of total operating costs.
Labor as a Percentage of Sales
Labor cost percentage based on sales is the most common formula. Here’s how it works:
- Determine your restaurant’s labor cost. This cost includes all the money the business has to pay its employees throughout the year.
- Determine your restaurant’s revenue. Revenue, in this case, is your gross sales: the amount of money your business generates before comps, discounts, or other deductions. You can find this number in your POS system dashboard. Remember, sales tax is not revenue; this is simply money you are holding for the government – do not count this as part of your gross revenue.
- Divide your restaurant’s labor cost by its annual revenue. For example, if the restaurant paid $200,000 a year to its employees and brought in $1,000,000 a year in sales, divide $200,000 by $1,000,000 to get 0.2.
- Multiply by 100. This final number is your restaurant’s labor cost percentage. In this example, it is 20%.
Use this formula to determine your labor cost percentage based on revenue.
Use Labor as a Percentage of Sales Weekly
Labor as a percentage of sales is the most powerful metric weekly. This allows us to see how the business is performing in real-time, what levers we have to make adjustments during the slow season, or if other factors are driving this metric positively or negatively.
Restaurant Labor as a Percentage of Total Operating Costs
Labor cost percentage can also be calculated relative to total operating costs. In this case, the steps are only slightly different.
- Determine your restaurant’s annual labor cost. This cost includes all the money the business has to pay its employees throughout the year.
- Determine your total operating costs. Total operating costs are the total cost of making business, not just sales, but including costs for marketing, rent, food, drink, and other expenses.
- Divide labor costs by total operating costs. For example, if labor costs $18,000 per month and the total operating cost is $30,000 per month, divide $18,000 by $30,000 to get 0.6.
- Multiply by 100. This final number is your restaurant’s labor cost percentage. In this example, it’s 60% of the total cost of doing business.
Use this formula to determine your labor cost percentage based on total operating costs.
Restaurant Labor Costs by Hours Work
Calculating your labor costs by hours worked is a way to segment your staff into different operational groups, such as servers, bartenders, kitchen, and dish room employees. The point here is to quantify the cost per hour for each group.
For example, say you have five cooks, each working 40 hours per week, and are paid $20 on average. Here’s the formula for calculating cost by hours worked for this cohort:
Average cost per hour of work = (Weekly hours worked by group x Average hourly wage) / 52 weeks in a year.
Five cooks x 40 hours each = 200 weekly hours worked by a group
200 hrs/week x $20 avg hourly wage = $4000
$4000 total wages per week / 52 weeks in a year = $76.92
After dividing by 52 to get the average over the year, restaurant labor costs for the cooks at this restaurant are $76.92 per hour worked.
This is a powerful tool to compare similar restaurants or concepts and set benchmarks for your restaurant group as a whole.
What is an Ideal Labor Cost Percentage?
Based on my experience, labor costs should come in at less than 30% of revenue, and food and labor costs should be less than 60% of the revenue. Fine dining, however, may have higher labor cost percentages than fast-casual eateries.
These numbers are not hard and fast; they depend on your specific situation but are a good rule of thumb for the average operator.
The best way to lower labor costs is to eliminate excess overhead. A company’s overhead includes all expenses unrelated to the production of goods or services.
When lowering labor costs, one of the first things you need to do is take a hard look at your current payroll. The first step in reducing your labor costs is to ensure the ideal organizational structure. Make sure you have structured your salaried and hourly employees in the best way to run your business. Sometimes our ideal structure and current structure are worlds apart.
Here are some ways you can reduce your overhead and save money:
Reduce staff. If you have too many people on your payroll for a given shift, it may be time to rethink your scheduling. If you have too many salaried employees, it may be time to rethink your organizational structure and reduce headcount.
Reduce hours. Sometimes we set restaurant hours when we are over-idealistic. Perhaps your business does not have a strong lunch following, or Sunday brunch just isn’t taking off. It’s important to rethink our hours, so they align with our business and profitability goals.
Increase sales. They say that rising tides lift all boats; this is the same for the restaurant industry. If your labor costs are high, but you can’t find anywhere to cut, it likely means you need to get more people in your restaurant. Rethink your marketing approach, make your brand more approachable, and do what it takes to increase sales.
Guest post written by Zachary Weiner, who provides part-time, interim, and special project CFO services to the restaurant and hospitality industry for Restaurant Accounting. Zac has also published QuickBooks for Restaurants A Bookkeeping and Accounting Guide: A Must-Have QuickBooks Guide for Restaurant Owners and Operators. For more information about restaurant labor costs, grab a seat with the Fork CPAs or schedule a call with Zac.