An introduction to what are restaurant Prime Costs? How do I calculate them? And why should I care?
Understanding Prime Costs in Restaurants
In the dynamic world of the restaurant industry, understanding and managing costs effectively is paramount to ensuring the sustainability and profitability of a business. One of the critical components in the financial management of a restaurant is the concept of Prime Costs. This term, often used by restaurateurs and the accounts team, encompasses the sum of two major expenses: the cost of goods sold (COGS) and labor costs. These are the direct costs involved in the production and delivery of the restaurant's offerings and are pivotal in pricing, budgeting, and determining whether or not you’re successful. It's always good to remember that a restaurant is just a little food factory, turning raw ingredients (food and beverage) into finished products (menu items).
Breaking Down Prime Costs
1. Cost of Goods Sold (COGS): This includes the expenses directly tied to the production of the items on the menu. For a restaurant, COGS primarily comprises the cost of ingredients used in preparing dishes and beverages. This figure is crucial as it reflects the direct material expenses incurred to generate sales. See our article here about restaurant inventory management that discuss COGS in more details.
2. Labor Costs: This includes all expenses related to paying the staff involved in the day-to-day operations of the restaurant. Labor costs includes wages, salaries, benefits, and any other compensation given to both the front-house staff (like servers and hosts) and the back-house staff (including chefs and kitchen assistants). The only place this gets tricky is with your management team, which generally is not included in Prime Costs, but sometimes you have “player-coaches” that aren’t clearly management or staff.
Calculating Prime Costs is straightforward: simply add the total COGS to the total Labor Costs for a specific period. This figure is essential for restaurant owners and managers to understand because it represents the variable costs that fluctuate with sales volume. Unlike fixed costs such as rent and utilities, which remain constant regardless of sales volume, Prime Costs vary directly with the restaurant's level of activity.
Importance of Prime Costs
Tracking your Prime Costs is crucial for several reasons:
Profitability Analysis: The are three key margins that great operators look at: Gross Margin (Revenue - COGS divided by Revenue) a good target is to keep it below 35%, Prime Costs (COGS + Labor divided by Revenue) targeting below 60%, and Net Profit (Profit divided by Revenue) where the industry average is 3-5%.
Pricing Strategy: Knowledge of Prime Costs aids in setting menu prices that cover costs and yield a desirable profit margin. You all know those menu items that are full of low cost ingredients but take a lot of effort, tracking Prime Costs helps you focus on the big picture profitability of your menu items.
Cost Control: Exploring the components of Prime Costs (labor and COGS) helps you focus your attention in the right place. Do you need to negotiate better prices with suppliers or optimize staff schedules to match business volumes, or both.
Example of Prime Costs in Action
Consider a hypothetical restaurant, "Bella's Bistro," known for its Italian cuisine. In one month, Bella's Bistro spends $20,000 on ingredients and $30,000 in labor costs. The Prime Costs for that month would be calculated as follows:
Prime Costs = COGS + Labor Costs = $20,000 (Ingredients) + $30,000 (Labor) = $50,000
With this calculation, the management can assess how these direct costs are impacting the profitability of Bella's Bistro. If the total sales for the month are $100,000, the Prime Cost Margin, an essential metric, would be calculated as:
Prime Cost Percentage = (Prime Costs / Total Sales) 100 = ($50,000 / $100,000) 100 = 50%
A Prime Cost Percentage of 50% is considered “good” in the restaurant industry, though the ideal percentage can vary depending on the type of establishment and its pricing strategy. By keeping a close eye on this percentage, the management of Bella's Bistro can make informed decisions on menu pricing, cost-cutting measures, and overall operational strategies to ensure the restaurant's success and sustainability in the competitive culinary landscape.