Let’s talk about calculating food cost, one of the most important numbers you need to know in your business. In this article, I’m going to walk you through the food cost calculation and then give you even more tools so you can dig deeper into that number to ensure your cash is in the bank and not on your shelves.
To start, I want to be very clear that calculating food cost is not your purchases divided by your sales. Why? You might order a lot of product and then not use it, so it’s left on the shelves. When you pay for all that and then you look at your sales, your food cost will look really high. The next month, because you have so much food on the shelves, you order very little. This makes your food cost look low. But that is not food cost. Food cost is based on inventory. Did you just groan out loud or roll your eyes at the idea of doing inventory? You’re not alone. But the fact is to properly calculate food cost, you must start with your beginning inventory.
The food cost calculation is as follows:
Beginning inventory + Purchases = Total Available – Ending Inventory = Product Used / Sales = Cost of Goods Sold %
Beginning inventory is what you have on your shelves at the end of last period, the last time you took your inventory. Next, you have your purchases based on accrual accounting¬ – earn or use. That means it doesn’t matter whether you paid for it. If you signed for it, it’s an expense today. Your beginning inventory plus your purchases gives you total available of what you could sell at the end of the period. Ending inventory happens at the end of the last day of the period. Your inventory period could be a week, a month, a day, or a year. (Further on in this article, I’ll explain why you should do inventory weekly.)
So, let’s go with a weekly inventory period as an example. If it’s Sunday, the last day of your week at the close of business or before you open the next morning before anyone starts using products, that is the ending period. Beginning inventory plus purchases gives me total available, minus any inventory, gives me my use. Now, what is use? Use is what leaves the shelves. What’s the number-one way you hope to lose product? Sales! You’re in business to sell. There is also spoilage, waste and theft.
- Spoilage: if you bought too many tomatoes and have to throw them away, that’s spoilage, and you paid for those, so you have to account for them. That’s cost of goods sold.
- Waste: picture a server who is supposed to use a two-ounce portion cup of dressing for salads grabs a four-ounce portion cup and leaves it there. For the rest of the night, everyone who pours dressing pours four ounces. That’s waste, right? Or eyeballing handfuls of cheese on the pizza instead of using a portioning tool, there is likely waste happening. As long as it’s more than what the recipe costing card counts, it’s waste.
- Theft: I know what you’re thinking, “I don’t have any thieves in my business, David. We’re a family business.” Look, there is theft in the restaurant business. Period. What I want to do is put systems in place and management on the floor to keep honest people honest and get the dishonest guy.
- Comps (not rung up in the POS) Last but not least are comps that are not in the POS system. This is you taking tax advantage of your business and taking product home for personal use. This is different from comps that are rung up because if I comp that burger, chef gets the full $10 credit for food costs. No problem.
Beginning inventory plus purchases minus ending is use. Use divided by gross sales gives you your food cost (also referred to as cost of goods sold). For instance, if I calculate a 30 percent food cost, that means for every dollar I bring in, I put out 30 cents in product.
Now, we can stop here, and you’ve done more than a lot of independent restaurant owners. But some of you are thinking, “David, I’ve been doing this,” or, “But David, I want to do more.” That’s where the four extra calculations come in. With these four calculations, you put more and more money in your bank account.
Before I explain the four calculations, let me assure you nothing I give you is too tough. There’s no Pythagorean Theorem, no coefficient of friction formula. There’s nothing fancy. It is literally just addition, subtraction, multiplication, division. You just have to understand where the numbers come from and how to use them.
Calculation No. 1: The first equation is your average inventory: beginning inventory plus ending inventory divided by two. How do you use that? That is the second calculation.
Calculation No. 2: Remember that product we use? I’m going to use average inventory to come up with an inventory turn. What is an inventory turn? If you fill your shelves and empty them and then refill them, that’s a turn. But it’s a theoretical turn because you don’t actually empty your shelves 100 percent. It’s a dollar value turn. If you fill your shelves with $3,000 in product, then use and replace $3,000 in product, that’s a turn. This is true even if you have items that move very slowly and are still sitting on the shelves for months at a time.
How many inventory turns do you think a restaurant should have in a calendar month? It’s four to six. For breakfast places, it could be as many as six to eight because there’s just not enough room to store all of the eggs. That means at any given time you should have at the most three to four days’ worth of food on your shelves. You’re not going to run out because you’re receiving orders all the time. You’re not going to deplete down to where you have almost nothing on the shelves. You have three days you could make it at your lowest point. But you’re making better use of your cash, which I’ll explain in a second.
Calculation No. 3: Look at your change in inventory. Ending inventory minus beginning inventory. Did your inventory go up and down? If you have less product on the shelves, it means you have more money in your bank account or pocket. If you have more product on the shelves, it’s more money on the shelves at risk to be wasted, spoiled or stolen.
Calculation No. 4: The fourth calculation is a budget variance and you can’t have a budget variance if you don’t have a budget. The importance of having a budget is too big to be covered here but know that having one helps you dig deeper into your food cost and strengthen your cash position.
These four calculations go the extra mile in protecting your cash. Owners, what pays your bills? Cash or profits? CASH. Last time I checked, you can’t go to the power company with a case of steaks. Cash is king so managing your cash flow is important.
All of calculating and examination should be done at a minimum monthly, but I really recommend you do it weekly. Here is why. Even if you do your inventory and make these calculations monthly, you get your profit and loss statement on the 15th of every month (if your accountant is that timely). It’s likely the numbers don’t line up with what you thought, but it’s 15 days into the next period, halfway through another month. You can’t go back and fix the past six weeks and now you only have two weeks left in the current month. That means you and your managers have made the same dumb mistakes for 45 days in a row. With weekly inventories, you take a snapshot of what your food cost is that week. If there’s a mistake, you’ve got a week to correct it. Better yet, if it’s a big mistake, you’ve got three more weeks to turn the month around. When you calculate your food cost on a weekly basis, your managers should never miss budget and your food cost is on target.