When running a restaurant, calculating prime costs are fundamental to success. Making up the majority of a restaurant’s cost of doing business, prime costs determine the difference between a profitable restaurant and a failing restaurant.
As restaurant bookkeepers and accountants, it’s critical to understand what restaurant prime costs are, how to calculate them accurately, and ways to help your client determine what’s best for their business.
What are Prime Costs?
In its simplest terms, prime costs are the combined cost of the product and the people. In other words, it is the sum of the total cost-of-goods-sold (COGS) - including food, beverage and liquor - and the total labor costs – including taxes, benefits and insurance.
Cost of Goods Sold (COGS) + Total Labor Cost = Prime Cost
These “prime” expenses are under the direct control of management and, as such, are otherwise known as “controllable expenses.” A restaurant’s “controllable expenses” represent both the greatest exposure for losses as well as the greatest opportunity to impact profitability.
Therefore, having accurate, timely insight into prime cost and understanding the factors that influence prime cost are critical to all restaurant operators. By itself, however, the sum of COGS and labor is not all that helpful. Instead, we need to look at the Prime Cost Ratio.
Calculating the Prime Cost Ratio
Most often when considering prime costs, what you’re really thinking about is the ratio of the prime costs to what you sold. Knowing what your total spend on controllable expenses is valuable, but what’s more valuable is knowing what your total spend on controllable expenses is compared to your sales.
Therefore, to calculate prime cost ratio, you must divide your prime cost (COGS + labor) by your sales for the same period, typically by week.
(Cost of Goods Sold (COGS) + Total Labor Cost) / Sales = Prime Cost Ratio
Example:
Let’s say you have a restaurant client that operates a casual restaurant concept. Your client’s restaurant generates $750,000 in annual sales revenue. The total cost of the ingredients (food, beverage and liquor) is $232,500 and the total labor cost for the year is $210,000.
To calculate the restaurant’s prime cost, you would divide the sum of the controllable expenses by the sales, giving you your client’s prime cost ratio of 59%.
What Is a Good Prime Cost Ratio
Keeping with the example above, we’ll assume that your client has a 59% prime cost ratio. This is actually a great ratio for a full-service casual restaurant!
However, what might be a good restaurant prime cost ratio for one restaurant may not be the same for another. It all depends on the type of operation, the concept, the menu, etc.
Industry averages for a restaurant’s prime cost typically range between 55% and 70%. Full-service restaurants tend to be higher because of higher quality, and thus more expensive, ingredients, as well as higher labor costs. Limited-service restaurants are typically between 55% and 60%.
As a general industry benchmark, 60% is a good number to keep in mind with half attributed to COGS (30%) and half attributed to labor (30%).
Knowing What’s Best for Your Clients
In order to know what a good prime cost ratio is for your clients, you really have to understand their business and be able to drill down into their numbers.
To do so, you have to capture, catalogue and compare their prime costs from week to week or even day to day. If you were to only look at the data from an annual basis, you would be missing out on how the costs trend from week to week and where the opportunities for improvement are hidden.
Are food costs trending upwards? Are rising wages causing labor costs to increase consistently? How do this year’s numbers compare to the same period last year?
Having the right tools and restaurant management technology in place to capture and aggregate labor, food cost, and sales data in a timely manner is essential to being able to assess and suggest improvements.
If you’re serious about helping your restaurant clients succeed, then helping them set and achieve prime cost targets is critical to your success.
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Webinar: Going Beyond Bookkeeping for Your Restaurant Clients
Author of this article, John Enny, will be presenting a free webinar with Insightful Accountant on May 1, 2019 at 2:00 p.m. Eastern Time, about how xtraCHEF can help you deliver more value to your restaurant clients and go beyond basic bookkeeping. Learn more about this webinar event & how to register here.
More About John Enny: John is the Director of Marketing at xtraCHEF, a cloud-based restaurant management platform built to automate restaurant accounting tasks typically performed by restaurant operators, accountants, chefs and managers.