How to Calculate a Restaurant’s Prime Cost
March 28, 2022 • 11 minutes
Prime cost is a key restaurant performance indicator, KPI, that can be used as a barometer for a restaurant’s profitability. Restaurants run on fine margins and calculating prime costs provides a metric that can be used to improve a restaurant’s financial performance.
Here we’ll look at how to calculate prime cost and give yourself an insight into your restaurant’s largest, and most variable, cost item. This includes answering the questions:
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What is a prime cost?
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What is included in a prime cost formula?
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How to calculate prime cost?
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What is a restaurant’s prime cost ratio?
Once we’ve learned the simple formula for prime cost, and put it into practice, then we’ll look at why prime cost is important for a restaurant, what a good prime cost is for a restaurant, and how to control a restaurant’s prime cost.
What is a Prime Cost in a Restaurant?
In a restaurant, the prime cost consists of the largest and most variable parts of a restaurant’s: labor and COGs. Prime costs are calculated over a chosen period, and it is important that the figures used in the prime cost calculation are accurate. If the numbers inputted into the prime cost equation are not accurate then you will not be able to enact meaningful, profit making changes using the result of the calculation.
Prime costs are the costs, labor and COGs, directly associated with the sale and service of a restaurant’s offerings.
Labor cost consists of more than just the wages and salaries paid out to employees. Elements of labor costs include:
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Hourly wages
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Salaries
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Employment taxes
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Insurance costs
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Paid time off, PTO
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Workers compensation
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Employee benefits e.g. shift meals
Some of these, such as salaries, hourly wages, and employment tax, will be being paid everyday. Others, like PTO and workers compensation, are not paid on a weekly basis. To avoid spikes in your prime costs calculations it is advisable that irregular costs, such as workers compensation and PTO, are averaged out across the year.
The Cost of Goods, COGs, element of a restaurant’s prime costs include:
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Liquor, beer, and wine costs
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Soft drink costs
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Food and drink associated dry goods costs e.g. coffee filters, to go boxes, sauces, etc
All of these costs are variable and essential pieces of the food service puzzle. Notably these COGs don’t include recurring fixed costs such as equipment rentals. It also doesn’t include the cost of purchasing items like flatware.
When the numbers entered into the prime cost calculation are accurate the more accurate and useful the results will be.
Why is it Important to Calculate Prime Costs for a Restaurant?
Restaurant prime costs will often make up more than 50% of its total costs. Prime costs are a restaurant’s largest expense, but they are also variable costs. Importantly, this means that you can control them and influence their impact on your business. Doing this means that you can have a direct influence on your restaurant’s profit margin and can gain an insight into the financial health and profitability of the business.
Prime costs allow you to monitor the financial health of your restaurant whilst improving the profitability of your current sales. Conducting a prime cost analysis is simple and free and can offer great insights into a businesses finances.
Many restaurant owners and managers focus on increasing sales and use this metric to track their location’s profitability improvements. Whilst a good metric, it is arguably more important, and cheaper, to increase the profitability of the venue’s current sales rather than trying to generate new ones. The prime cost ratio provides insights that can be used to do exactly that.
How to Calculate a Restaurant’s Total Prime Costs
A restaurant prime cost analysis is conducted over a particular period of time and therefore requires data specific to this period. Some of this data comes from the POS system, other data comes from invoices, and other data points must be taken from tax data. It takes two steps to find a meaningful number for a restaurant’s prime costs.
Restaurant Prime Cost Formula
The first step is to calculate the restaurant’s prime costs. The total prime cost formula is:
Total COGs + Labor Costs = Prime Costs
To work out labor costs you simply add up all of the labor costs factors mentioned above that are applicable to your restaurant. Work out the total COGs for a specific period using this formula:
(Starting Inventory + Purchase) - Final Inventory = COGS
The prime cost formula tells you how much you’re spending on your prime costs, but this doesn’t give you anything to work with. The next step gives this number purpose, turning it into a metric that can be used to gauge the restaurant’s profitability at a glance.
Restaurant Prime Cost Percentage Formula
Once you have the prime costs for a restaurant you can work out the restaurant’s prime cost percentage, also called the prime cost ratio.
The restaurant prime cost ratio displays the restaurant’s prime costs as a percentage of its overall sales.
The formula to calculate a restaurant’s prime cost ratio is:
Prime Costs ÷ Total Sales = Prime Costs as a Percentage of Total Sales
The total sales figure is simply the total from the sales report for the period you want to calculate the prime cost ratio for.
An Example of How to Find Total Prime Cost
To calculate a restaurant’s prime costs we’ll use a prime cost example. First you must calculate your COGs:
We know that a restaurant’s beginning inventory was $12,000 worth of product and that they spent $6000 on purchases over a specific period. We also know that the final inventory for the period was $8000. If we put these numbers into the COGs formula we get:
(Starting Inventory + Purchase) - Final Inventory = COGS
($12,000 + $6000) - $8000 = $10,000
We now need the restaurant’s labor costs for this period. After adding hourly wages, salaries, employee benefits, and averaged PTO and other metrics that make up a restaurant’s labor costs we find that this restaurant has a labor cost of $12,000 for the period.
So, to calculate this restaurant’s prime costs we use the prime cost formula:
Total COGs + Labor Costs = Prime Costs
$10,000 + $12,000 = $22,000
$22,000 is how much this restaurant spent on its prime costs. Now, for this amount to be useful, we need to know how this relates to the restaurant’s total sales. To do this we need the prime cost percentage formula and the restaurant’s total sales for this period, these were $40,000. So:
Prime Costs ÷ Total Sales = Prime Costs as a Percentage of Total Sales
22,000 ÷ $40,000 = 55%
Here our Prime Costs are 55% of our total sales. This is an example of how to find the total prime cost for a restaurant.
What is a Good Prime Cost Ratio for a Restaurant?
A good prime cost ratio, or prime cost percentage, will differ by the concept of the restaurant. The often quoted ideal prime cost percentage for a restaurant varies between 55-60%. Higher end restaurants will often be at the higher end of this spectrum and quick serve locations will be at the lower end, potentially even lower.
A restaurant’s prime costs will be split roughly 50/50 between COGs and labor costs. Although this can vary depending on the style and needs of a particular restaurant.
If your location’s prime costs fall below 50% of your total revenue then it can be a sign that corners are being cut somewhere and is often a bad sign for a restaurant as these things can hurt a business long term. Such things can include:
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Using sub-par ingredients
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Charging too much for menu items
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Serving portion sizes that are too small
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Not having enough staff on shift
If a location’s prime costs equal 70% or more of its total sales then that restaurant is probably struggling to turn a profit, and will run into a cash flow problem sooner or later.
Maintaining and Lowering Prime Costs
There are tactics that can be employed to bring down a restaurant’s prime cost ratio, helping to increase the profitability of the restaurant.
1. Track Prime Costs - Tracking your prime costs from one period to another can prevent surprises at the end of the year and helps to set you up for success. It also means that you can compare figures across periods.
2. Have a Target Prime Cost - Having a target prime cost gives you something to work toward. This target can be long term and doesn’t have to be for the period immediately following the current one.
3. Manage Staffing to Suit Business Levels - Use previous data to accurately predict how many staff you will need on a certain shift. Cut people early and try to streamline sidework tasks to increase employee efficiency and reduce hours.
4. Evaluate Menu Item Prices and Ingredient Costs - Periodically track ingredient costs and take these into account with price increases. Seek out new suppliers who can give you common items at a better price and look out for bulk deals from all your suppliers.
How Often Should Prime Costs be Calculated?
Prime costs require inventory results to be calculated. Therefore, practically, the calculations can only be completed for each inventory cycle.
It is recommended that a restaurant calculates its prime costs every week.
Weekly is a best practice, because the sooner you know that your prime cost percentage is straying from the norm the sooner you can correct it. Prime cost reports can be compared across periods and can show the effects of certain changes, be those changes in restaurant menu prices, staffing adjustments, or improved COGs management.
The Final Course
Regularly calculating a restaurant’s prime costs and prime cost percentage can improve your financial understanding of your restaurant’s profitability and help you to increase it.
Prime costs are dynamic and their value will fluctuate with business, however the ratio should remain constant. Now you know how to calculate and how to impact your prime costs you can better work on your restaurant’s profitability.
