This is not another article telling you to order shredded carrots instead of shredding them in-house. Instead, we will show you how to use your financial data to achieve the ideal cost of goods sold (COGS) that will guarantee profitability in three steps if your other KPIs are in order. First, we’ll show you the numbers you need to monitor weekly; then we’ll discuss menu pricing; and finally show you how to detect and avoid spoilage and waste, the main cause of excessive food costs in many restaurants.
Step 1: Use Financial Data to Track Prime Costs Weekly
To reach your ideal COGS, start with your current food cost as a percentage of sales. The ideal food cost as a percentage of sales differs for every concept. There is no rule of thumb. The ideal food cost as a percentage of sales is the percentage that yields a prime cost (cost of goods sold plus labor) that doesn’t exceed 60% of sales for a quick-service restaurant and 65% for a full-service restaurant. Cost of Goods Sold (COGS) or Cost of Sales includes food, soft beverages, liquor, beer, wine, and paper (in a quick-service restaurant only) costs. High labor costs might be acceptable if offset by lower cost of goods sold, and vice versa. For example, in many upscale casual full-service concepts, the food cost is lower but offset by a higher labor cost. In quick service, the food and labor costs might be more balanced.
While looking at ingredient prices, vendor invoices, labor hours, and other numbers in isolation is important, they don’t tell the whole story. This is why looking at COGS and labor combined in the same report every week is important. Waiting until month/period-end to review these numbers is too late. With constant visibility, you can adjust operations more frequently and quickly. There is no excuse not to track prime costs at least weekly – especially when software like MarginEdge, can automate most of it for you.
You need to ensure prime costs are accurate as well. Measuring labor is straightforward, but measuring COGS requires your bookkeeper to ensure all purchases have been captured, and were accurately coded to the right bucket. The only reliable way to ensure all purchases have been captured is to request statements from all vendors and reconcile those statements with invoices at the restaurant. If you’re not doing this, your COGS is likely inaccurate, and you are basing important decisions on invalid or incomplete data. Reconciling invoices results in accurate financials and helps catch errors, unissued vendor credits, and fraudulent orders. The work is well worth the investment. Contact us if you need help with this.
Although there is no rule of thumb, here are some industry averages from RestaurantOwner.com for COGS to help you identify whether COGS is acceptable relative to labor costs:
*assumes an 8-ounce cup, some cream, sugar, and about one free refill)
**Assumes mainstream domestic beer; cost percentage of specialty and imported bottled beer will generally be higher
***Generally, the higher the price per bottle, the higher the cost percentage.
If COGS seem high relative to industry averages, or the distribution between prime costs seems unbalanced or unprofitable due to high COGS, there may be a COGS problem. You can spot COGS problems by knowing and understanding your COGS targets. We will show you how to identify and fix these COGS problems by showing you how to identify and compare actual vs. theoretical COGS in step 3, below.
Step 2: Cost Out Your Menu
To determine your ideal COGS, you must cost out your menu.
Ideally, this should have been done before opening and adding items to the menu. To cost out your menu, you must create a menu costing sheet that calculates the quantity and cost of each ingredient from the inventory required to produce that item. Add the total cost of these ingredients to arrive at the menu cost of producing that item. The food cost percentage is the total cost as a percentage of the menu sales price for this item. You don’t want to release a menu item that will not be profitable unless it is a loss leader (an item sold at less than cost to encourage customers to stay or return, generating other profitable sales). Pro-tip: don’t have too many loss leaders!
Step 3: Compare Your Actual Food Cost to your Theoretical Cost
This is where we lose most operators. They have costed out their menu, so they have a general understanding of what their overall COGS should be as a percentage of sales, however, they’re still unable to understand where the variances are. This is when comparing actual COGS to theoretical COGS comes into play. This is a process that national chains follow, and if you want to compete in this high-cost environment, you might want to consider implementing the same.
Pro-tip: this might only be realistic for some concepts; it might be unrealistic for concepts with menus that change frequently because it will require using recipe cards.
Your ideal COGS, or theoretical COGS, is the cost expected for a given sales mix over a period, assuming the current cost of ingredients, proper portioning, and normal waste and yields. It is calculated by taking each menu item sold in the POS and multiplying it by the cost of that menu item using the most recent ingredient prices from the recipe card. As the cost for ingredients changes or the sales mix changes, so will the ideal cost.
Now that you know your ideal (or theoretical) cost, you can compare it to your actual cost and identify variances. Actual costs are usually what most people look at because they’re the final and actual COGS reported on the P&L or prime cost analysis. By identifying variances between your theoretical and actual COGS, you can identify and fix problems. The goal is to understand the reason for the variance and try to mitigate it. For example, if your sales mix should yield a 30% food cost according to your recipes and theoretical food cost, and your actual food cost is 34%, then you have a variance of 4%, which is drastic and should be resolved. I call this a drastic variance because a 4% variance is an additional $80k in yearly expenses for a $2m/year restaurant! A COGS variance alone can put a restaurant out of business if left unaddressed for too long. A lower variance indicates that the COGS are efficiently and effectively managed. The variance is rarely zero, but a greater than 1% is too high. It’s best to do this comparison on a weekly basis to catch and investigate issues before they have a serious impact.
Comparing actuals vs. theoretical COGS is highly effective because it helps identify the following problems:
- Receiving problems
- Unissued vendor credits
- Unrecorded sales (giving away inventory without recording a comped sale)
- Improper portioning
- Inventory errors
- Accounting errors (COGS not being coded correctly, etc.)
After identifying the issues, you may need to implement better controls to meet the theoretical cost targets. This might include segregating duties between purchasing, receiving, and bill pay, or internal standards for purchasing and portioning.
Theoretical COGS considers ingredient price fluctuations. Therefore, if an ingredient price increases or decreases, it will not affect your variance since your theoretical cost will also increase or decrease. If your actual COGS is on target with theoretical COGS, and your COGS is still high, you may need to increase prices, re-engineer your menu and recipes, or renegotiate with vendors.
As you can see, reviewing your actual COGS as a percentage of sales is the first step, but it doesn’t tell you everything you need to know. If your COGS is 25%, you might think that’s good, but there might be an actual vs. theoretical variance of 2.5% that you don’t know about, which is a huge leak in your P&L.
Ideal COGS Yields Success
By using your financial data, you can achieve ideal COGS and ensure your restaurant is profitable. Implementing a cost-controlling and reporting system may sound unrealistic given your staffing level, systems, and resources, and it may be if you are a farm-to-table concept with an ever-changing menu. However, a tool like MarginEdge paired with the right restaurant accountant and bookkeeper can automate and streamline most of this process, empowering you with the same financial data as national chains. Don’t hesitate to contact us or schedule a discovery call to see how we can help you get in the rhythm of accurate, consistent, and timely prime cost reporting.