How to Calculate the Cost Of Goods Sold (COGS)
For restaurants and cafes, the cost of goods sold (COGS) is easily one of the most important metrics to measure and track. Simply put, it’s defined as how much it costs for you to produce a menu item given a specific period of time.
The reason COGS is paramount to a restaurant/cafe business is entirely because it’s tied to profit margins, revenue, inventory. Businesses with little to no inkling of how they’re handling their COGS often find themselves in a pickle because they’re unaware of their restaurant/cafe’s financial health and performance. Knowledge of how to calculate COGS is essential to stay in control of finances. It’s not difficult, just a little bit of help on the formulas and you should be good to go.
What exactly is COGS?
The widely known definition of COGS is the total cost of all the ingredients that a restaurant/cafe uses to create menu items, given a time period.
Industry-wide, an estimated one-third of a restaurant/cafe’s gross revenue is dedicated to paying off COGS. This COGS alongside other spending areas like staffing, utilities, rent, etc are subtracted from your restaurant/cafe’s gross revenue to work out your net profit.
Since the cost of produce fluctuates with the availability of them during certain seasons, etc, COGS will definitely be affected by changes as well. Best practices come with being vigilant when it comes to COGS patterns, monitoring them in a routine manner, and being able to make efficient business decisions with this information.
To calculate your COGS, you will require the following for a determined time period:
Beginning inventory: This is how much you have in terms of the value of inventory you have leftover from the previous period (depends on how you classify your given time period: day, week, month, or year).
Purchased inventory: The value of inventory purchases you make for this time period (as determined before).
Ending inventory: Calculated based on the value of the inventory you have that is leftover.
Example of how to calculate COGS
Assuming you want to calculate your COGS for the month of May. You started off with $4,000 of leftover inventory from April (aka beginning inventory). This leftover inventory supposedly included salmon, beef, fruits, garnishes, and vegetables.
During the month of April, you found out that you were running out of ingredients so you had to restock and buy $2,000 worth of food inventory (purchased inventory). As such, you ended April with $500 worth of food inventory (ending inventory).
COGS = ($4,000 + $2,000) – $500
COGS = $5,500
Hence your COGS for the month of May was $5,500.
6 ways to lower your COGS
To put things simply: the lower your COGS, the higher your restaurant’s profit margins. Regardless of whether you’re operating a single outlet cafe or a chain of restaurants, it is always key to find methods to lower your COGS without sacrificing food quality or jeopardizing the customer's dining experience.
Here are 6 ways to control your COGS:
Having daily food prices data at your fingertips
Compare supplier prices and quality
Keep a close eye on inventory
Buy in bulk
Reduce food waste
Reworking menu engineering
1. Have daily food prices data at your fingertips
We can’t emphasize how important this data is. Knowing how much your food prices are on a daily basis gives you so much information and power to make efficient business decisions. Equipping yourself with the knowledge on whenever food prices are high or low and when they’re increasing or not, gives you a multitude of options that can influence the way you handle your restaurant/cafe business.
Having an overarching view of pricing data enables you to basically do everything that we’ve mentioned from point 2 to point 6.
Use a solution like FoodRazor to easily track your food prices or manually do so through comparing spreadsheets. Being vigilant in this aspect creates more opportunities and areas to reduce costs like menu engineering, changing suppliers, buying in bulk, etc. At the same time, you will have greater visibility on your business' current financial health.
2. Keep a close eye on inventory
Again another big aspect that causes many headaches for restaurateurs. You won’t know exactly how much inventory and food supplies you require unless you closely track each menu item’s sell-through. An interesting thing to note about COGS is that regardless of how many you’ve sold, you can still incur a high COGS. BUT, being careful not to over-purchase stock, and only buying the average needed to sell, can really help you to minimize additional costs and wastage.
Poor inventory management is a hurdle that all restaurateurs have to learn to overcome. If your establishment has yet to implement proper back-of-house workflows or procedures in place, you could be losing lots of money due to inventory spillage. Careless portioning, over-ordering, food waste and staffing theft can take a huge toll on your restaurant's COGS.
Look at your current sales reports and calculate how much food supplies you need to meet the demand for your menu items. Match this with how much you’re spending on ingredients and you’ll be able to tell if this is properly balanced or if you’re spending too much.
3. Buy in bulk
Some suppliers offer special prices and discounts to restaurants that bulk purchase their goods. Do take note: When purchasing non-perishables (food with a long shelf life) or ingredients that your restaurant sells quickly (menu items with a fast turnover), purchasing in bulk is a very effective way to get what you need at low prices and lowering your COGS.
A common concern for purchasing food in bulk is that the freshness of food, as well as storage space, could be compromised, since not every establishment has a big enough storage area to keep 1,000 pounds of chicken or have a fast enough turnover to avoid food waste or spoilage. Always ensure that you only purchase the volume that has a guarantee that they can be sold prior to spoiling.
4. Compare vendors
Restaurants can’t do without their suppliers. When working with suppliers, it’s pivotal to see whether one’s food quality and pricing matches up against another. It’s in the best interest of any restaurateur to compare the pricing of various vendors. If one is offering a cheaper price than another and can assure similar food quality, why not consider switching?
How this comparison can be done depends largely on whether you have a system in place generating reports based on how much volume you are purchasing per supplier and how much you are spending on them. This could be in the form of invoice management tools to look at the overall volume and amount spent and even down to product item level per supplier. If your restaurant has yet to adopt such technology, you could manually create spreadsheets and compare them as well, though it might be a little more tedious with the formulas and data-entry.
5. Reduce food waste
Regardless of how accurately you are tracking your inventory, there will always be food waste and it is always a big contributor to high COGS. While food waste cannot be entirely eliminated, it can be minimized.
For instance, if you have produce that is turning bad soon, look for alternative creative methods to incorporate them in other forms or in other menu items to create special seasonal dishes. This could be a promotional piece as well for your establishment and you could pump up marketing efforts based on that.
6. Consider reworking your menu engineering
Your menu’s design has a huge impact on what kind of menu items your guests may order. Right from the kind of layout you choose to the colours used for the menu and the description of each food item, they all play a great role in guest’s decision-making.
Menu engineering is essentially strategically designing a menu to encourage guests to purchase high-profit margin menu items. Creating a menu using menu engineering tricks, restaurants can indirectly influence which items customers are drawn to with one look, increasing sales of the menu items that can rid away razor-thin profit margins.
It doesn’t matter what type of establishment you run, the main goal of achieving the ideal balance between COGS and food quality is inherently crucial for the profitability of your business in the long run.
With the points we made earlier, controlling your spending on COGS is well within your means. Regardless of whether you work with cheaper vendors, buy in bulk to obtain highly discounted pricing, or even revamp your menu items, there is a multitude of options to lower your COGS and increase profit margins.
These tasks can get even easier with the adoption of technology to handle the tedious number-crunching. While you carefully plan and pay attention to the details of each report generated, know where you’re spending the most on, and pinpoint where to tackle, greater profits are coming your way.