A deep dive into the Profit and Loss, Balance Sheet, Cost of Goods Sold, and some key financial ratios for restaurant management and how restaurant inventory management impacts it all.
What does my accountant do with our restaurant’s stocktake, and why does it matter?
Year-end, quarter-end, month-end, week-end, or even shift-end, maybe you do all of them or just one of them, but most bars and restaurants endure this exercise at some regular interval. As tedious as counting everything is, I assure you, it’s for good reason.
In this article, I’ll explain some of the top reasons why your accountant wants you to do a stocktake, what they do with it, and how you can benefit too! Before we can really dive in, we need to define a couple of things.
Cost of Goods Sold
Nearly everyone in the industry has heard the bar manager, chef, or general manager talking about COGS, aka Cost of Goods Sold. It’s a key metric in every restaurant operation and essentially means, “How much did the ingredients in this dish (or all the dishes) cost?” you’ll also often hear people talk about food or beverage costs…same thing.
COGS refers to both food cost and beverage costs, and when building a recipe, it is essential information that will guide how you’re going to price an item.
Let’s run through how we calculate the COGS for a gin and tonic as an easy example.
That means the COGS on a Gin and Tonic is $4.97 (I forgot to mention, I’m writing this from Singapore, one of the world's most expensive cities, so your ingredient costs may vary!). If you’re selling your G&T for $16.00 and it costs you $4.97, your COGS is 31.06% ($4.97/$16.00).
Product Group | Specific Product | Product Unit | Cost per Product Unit | Recipe | Recipe COGS |
Gin | Aviation American Gin | Bottle (750ml) | $68.00 | 45ml | 4.08 |
Tonic | Fever Tree | 24 x 200ml | $38.00 | 100ml | .8 |
Lime | Lime | Carton of 10 | $4.00 | .25 of a piece | .10 |
COGS Per Unit | $4.97 |
COGS or Margin is one of the most essential metrics in the F&B industry. One of the trickiest aspects of managing COGS is that it doesn’t stand still, especially not now when suppliers keep raising prices. Once you set the recipe and price, you need to revisit it occasionally to ensure you’re still “good.”
What is a good COGS? It varies from menu item to menu item within a restaurant and from restaurant to restaurant, but the lower it is, the better (as long as quality doesn’t suffer). A good rule of thumb is about 30%, but the industry average is around 30-35% depending on the concept. If you shoot for 30% and end up at 32%, it won’t kill you.
Now, what is COGS to your accountant? It’s the same thing, but within the accounting context, it’s an item on your Profit and Loss. What’s a Profit and Loss…ding…runner!
Profit & Loss Statement aka Income Statement
The Profit and Loss, aka P&L, aka Income Statement, is one of the two most commonly referred to financial statements in business, the other being the balance sheet (we’ll cover that next). At the end of the month, when the accountant is chasing you for receipts, invoices, and payroll info so they can “close the month.” The P&L is one of the reports reviewed by owners and operators worldwide.
The P&L is a summary of how you did in a given period (typically a month), a financial scorecard, and whether you made a profit or a loss. At the top go all the sales (aka revenue), and from that, we deduct your COGS (you know that one now, too!), which gives you your Gross Margin. Subtract from your labor costs, and you get your “Prime Costs” (another great metric you’ll hear around the kitchen, bar, and from owners), and a good target is generally 60%.
After that, you need to deduct all the other expenses to get your “Net Margin”, which, if positive, means you made money, and if negative, means you lost money. A good Net Margin in the F&B industry is 3-5%, which you calculate by dividing your profit by your revenue ($9,920 / $205,000 = 4.8%). Here’s a sample P&L
Revenue | $ 204,929.00 | Ratios |
COGS | $ 69,163.54 | 33.75% COGS |
Gross Margin | $ 135,765.46 | |
Labor Cost | $ 65,372.35 | |
Prime Costs | $ 134,535.89 | 65.65% Prime Costs |
Operating Expenses | ||
Rent | $ 19,000.00 | 9.27% Rent |
Marketing and Advertising | $ 3,750.00 | |
Utilities | $ 5,209.00 | |
Software Subscriptions | $ 1,930.00 | |
Repairs | $ 4,201.00 | |
General Operating Expenses | $ 12,049.00 | |
Music | $ 1,440.00 | |
Insurance | $ 891.00 | |
Licenses | $ 119.00 | |
Interest Expenses | $ 2,850.00 | |
Depreciation | $ 9,034.00 | |
Total Operating Expenses | $ 60,473.00 | |
Net Profit | $ 9,920.11 | 4.84% Net Profit |
The P&L always covers a period in time: a month, a quarter, or a year, are by far the most common periods. It’s the scorecard of how much you brought in and how much it cost to achieve it, letting you know if things are going well or not. But remember, your P&L doesn’t represent your cash flow, something we’ll talk about another day, but by the time you finish this article, you should have an idea of the difference.
Balance Sheet
If the P&L is what you did during a period, the Balance Sheet is what you own on a given day. The Balance Sheet is always a specific moment in time (versus a period of time for the P&L), for example, 31 December 2023. The most common dates when you generate a Balance Sheet are at the end of the month, again this is another part of your accountant trying to “close the books” for a month, which includes finalizing the Balance Sheet.
Like the P&L, the Balance Sheet is broken up into parts; in this case, it’s Assets, Liabilities, and Owners’ Equity.
Assets are things that you own. Buy a new range for the kitchen, that’s an asset and goes onto your balance sheet. The balance sheet is the “what I have” to the P&L’s “how’d I do”.
The most common balance sheet asset categories are Current Assets and Fixed Assets. The best representation of a current asset is cash. Your accountant’s definition is going to be something like “short-term assets that are expected to be converted into cash, sold, or consumed within one year or within the operating cycle of the business, whichever is longer.” For a restaurant, that includes your purchases, like food, wine, beer, spirits, etc. (ie: your inventory).
As for Fixed Assets, I like to think of them as affixed to my restaurant. You may hear people say PPE, or property, plant, and equipment (never forget a restaurant is just a little food factory). These things should have a useful life of more than a year (disregard Stevie, who keeps breaking the blender. It’s still a fixed asset) and require you to depreciate them. Depreciation is your accountant’s way of tracking the wear and tear that equipment incurs (again we’ll do an entire article on it and link to it here).
On the other side of the ledger are categories of Liabilities: Current and Non-current Liabilities. The key distinction here is simply time. Current liabilities are those due in the ordinary course of business, things like supplier invoices, payroll, utilities, etc. but are definitely due within one year. As for long-term liabilities, those have a time horizon longer than 1 year and are best represented by things such as loans, mortgages, lease obligations, etc.
Let’s run an example of how a lease plays out in your balance sheet. Let’s take this example where you have a three year lease at $5,000 per month, a two month deposit, and assume that you’re four months into your lease:
Lease Total Obligation: $180,000 (36 months x $5,000 per month)
Deposit: $10,000 (2 months x $5,000)
Payments Already Made: 4 months into the lease, so 4 x $5,000 = $20,000 paid
Remaining Lease Obligation: $180,000 - $20,000 = $160,000
Out of this remaining obligation, the portion due within the next 12 months is a current liability, and the portion due after 12 months is a non-current liability and your deposit is an asset.
Current Asset: $10,000 (2 months deposit)
Current Liability (Next 12 Months): 12 months x $5,000 per month = $60,000
Non-Current Liability (After Next 12 Months): $160,000 (remaining obligation) - $60,000 (current portion) = $100,000
Thus, after 4 months into the lease, you would have a non-current liability of $100,000 related to the lease. This amount represents the lease payments that are due more than 12 months from your current point in time.
You might be wondering, but what happened to the $20,000 I paid? That would be a great question and we’ll tackle that soon.
Revenue and Expense Recognition: The Matching Principle
One of the things you’ll notice that has been conspicuously absent from this article is any talk of bills, cash (outside of current assets), and payments. All of those ties into the P&L and Balance Sheet, however, they are best to think about in the Cash Flow Statement, the last and, if you ask many a restaurant owners, the most important of the financial statements (we’ll do another article on Cash Flow Statements and link it here).
This article is focused on the accounting for restaurants, and no introductory conversation of accounting would be complete if we didn’t talk about the Accrual versus Cash method. The rest of this article assumes that you’re doing accrual accounting, which is by far the most common nowadays and most accounting software is going to default to that. So what’s the difference?
Cash accounting means that you record any transaction when you pay it, not when you incur the expense. So for example, if you buy a case of red wine in December but don’t pay for it until February (stretching those suppliers a little bit 🙂), it won’t be in your accounting until February and you might not sell all that wine until March. So you’ve got sales from that wine in December, January, February, and March, but you only have expenses in February.
In accrual accounting, we have to deal with things like Depreciation and the Matching Principle. Once you get into it, they both make a lot of sense, but I find the Matching Principle makes more intuitive sense and is the only one relevant today.
The core idea of the Matching Principle is that your revenue and expenses should be tied together in time. Makes sense, right? The cost of that Gin & Tonic’s ingredients should be on your Profit and Loss in the same month when you get the sales for that same G&T. Revenue is matched to expenses.
Here’s the twist. You don’t buy gin 45ml at a time; you buy it by the bottle or case, and the same is true for nearly all of your ingredients. You might pay for 12 bottles of gin in December but only used 8.5 bottles. So how do you account for that? Inventory.
Sticking with our 12-bottle purchase of Aviation Gin in December and 8.5-bottle use. We said that a bottle costs $68.00 and by the matching principle we should have 8.5 x $68 = $578 of Expense on our Profit and Loss for our Aviation Gin. But what happens to the rest of the value of the gin, $238 in this example (12 x $68 = $816 minus 8.5 x 68 ($578) = $238)?
This is where restaurant inventory management comes in to save the day (or the P&L). When you purchase those 12 bottles of gin, you’re actually going to increase a Current Assets account on your Balance Sheet, likely called Inventory, Stock-on-Hand, etc., and then we’re going transfer whatever you used it to your Profit and Loss ending up in the Cost of Goods Sold. How does it get from the Balance Sheet to the Profit and Loss…ding…runner!
Remember that $20,000 in rent you paid in the section before? Yeah, the same principle of matching applies to that, too. When you sign the lease, you have a liability of $180,000, and each month you pay rent, that Non-Current Liability is decreased by the $5,000 in rent you paid, and on your Profit and Loss, you’ll have a Rent Expense for $5,000.
Restaurant Inventory Management, the Balance Sheet, & P&L
We’re coming full circle back to the dreaded stocktake, the accountant’s way of sending your ingredients from the Balance Sheet to the Profit and Loss, magically transforming them from a Current Asset to a Cost of Goods Sold. The outcome is that your revenue (the sales you made from using these ingredients) and your expenses (the cost of those same ingredients) have matched up in time, delivering you the most accurate picture of how you’re performing.
Let’s bring our example together and see what’s happening at every step:
Real Life | Accounting |
November 30th Stocktake shows you have 4 bottles of Aviation Gin that cost you $272 | Balance Sheet - Current Asset - Inventory balance for this product is $272 |
You order 12 bottles of Aviation Gin for a total of $816 in December | Balance Sheet - Current Asset - Inventory is increased by $816 to $1,088 |
Throughout the month you sell, drink, cook, giveaway, or drop 8.5 bottles | Nothing |
December 31st Stocktake shows you have 8.5 bottles of Aviation Gin | Balance Sheet - Current Asset - Inventory is decreased by $578, new balance is $510 |
Profit and Loss - Cost of Goods Sold is increased by $578 |
No cash changes hands, but it impacts your P&L and balance sheet. The cost of the things you sold are recorded in your P&L in the same period you sold them; they “match.”
This is the key accounting rationale for doing stocktakes and inventory management in your restaurant.
Why else should I care about my restaurant’s inventory management?
There’s a number of great reasons: cash management, spoilage, order management, and menu management are just a couple.
Cash Management
Most of us don’t have a rich uncle with an Amex Platinum card to keep us afloat regardless of our success and that’s where cash management comes in. I would venture to guess that big percentage of restaurant failures are due to cash flow issues rather than not having enough customers or good food.
Inventory management is essential to managing your cash. If your sommelier builds out a 100-bottle wine list and keeps two of each bottle in stock, and each one costs $40, you’ve got $8,000 sitting in the wine fridge. That’s not even including the 2 cases of each of your house pours that you have sitting around at any given time (24 x $10 x red, white, rose = $720) add to that the 50 spirits bottles, cases of beer, and it’s easy to find yourself with $20,000 worth of inventory before you even get into the kitchen! You have to pay for these upfront and then wait days, weeks, months, or even years to turn that back into cash.
At the same time, missing out on selling a $400 bottle of wine you bought for $108 because it’s out of stock also hurts. Inventory management helps you know what’s selling and in what quantities so that you can keep just enough stock on hand but not too much. It is a fine line, but one that the best operators are thinking about regularly.
Spoilage
There’s no quicker way to fail than throwing spoiled ingredients in the trash. The worst part is that it’s not just the cost of that cod that went bad, but somebody spent time ordering it, receiving it, preparing it, and throwing it away, and all of those are labor costs, too.
Once you get over the financial cost of spoilage, then you get hit with the environmental aspect as well. You start wondering how much time and effort went into getting that fish from the Atlantic to your restaurant in Kansas City, only to have you pitch it in the bin. Heartbreaking.
Inventory management will help you better manage spoilage because you’ll have insight into what’s selling and what’s not, and you can adjust accordingly.
Order Management
How do you know what to order if you don’t know what you have? Forget trying to forecast what’s going to happen this weekend or next week. To place smart orders, you need to know your current stock levels. Restaurant inventory management can help you order better to reduce spoilage. Even better is if you have a procurement system that tracks your supplier orders as well so everyone knows exactly what’s been ordered and what’s on the way (selfless plug for Foodrazor here; we do that really well!). Procurement systems typically include approval workflows as well, so you can delegate some ordering authority to the new guy…but review it before it goes out the door to the supplier. They can also help avoid duplicate orders due to a lack of communication. There is nothing worse than getting deliveries of avocados on Tuesday AND Wednesday for Thursday’s special. The chance of all the avocados being ripe when you need them is as good as Elon Musk avoiding putting his foot in his mouth for a week.
You also don’t need to play any games with your orders if you're doing inventory management. You know that order you sent to the supplier on the 28th, asking them to deliver on the 30th, but “could you please just invoice me on the 1st?” Inventory management renders that irrelevant because the costs are only hitting your P&L (and your KPIs) when you sell it giving you the freedom to order what you need without worrying about blowing your P&L for the month.
Menu Management
We all build out nice recipes for our products, just like our G&T recipe above, and we use those priced recipes to set our selling price for the menu item. But how often do we update them to reflect the near-constant price increases we’re all getting from our suppliers? Rarely, too late, or never. A good restaurant inventory management software should also notify you when prices increase. If you’re an Aussie Cafe that makes 80% of your money selling Avocado on Toast, you darn well better know when the price of avocados goes up by 10%! Inventory management will help keep you dialed in on your costs and help you keep your menu priced right so you can make money.
Conclusion
It took a few words, but we’re at the grand finale for this article, and hopefully, you’ve found it helpful. Restaurant inventory management helps disconnect what you’re ordering from what’s hitting your P&L. That annoying stocktake you do is the accounting mechanism that moves it from your balance sheet to your profit and loss. I’m optimistic that we demystified a little of a restaurant’s accounting and taught you a little about the “why” behind the stocktake.
Disclaimer: I’m no accountant, but I’ve owned and run businesses for over a decade, and one of the things that I’ve come to appreciate is that knowing this stuff is a superpower that helps you be more successful, work with bankers and investors, and generally gives you a better shot at success.
Drop me a line, jeff at foodrazor . com, I’m always happy to talk restaurant concepts, inventory management, order management, good wine, great coffee, or cocktails.
