Restaurant operating costs: How to calculate operating costs for a restaurant
We know how quickly the costs for running a restaurant add up, so we’ve decided to take a detailed look at all of the different expenses that you’re likely to incur, and share this info with you!
Cost management is quite the skill to master, but we believe that ultimately you don’t need to have professional training to keep your records in order.
Let’s start by examining the different types of restaurant operating costs and paint a clear picture of your restaurant expenses breakdown.
What are the different types of operating costs?
Broadly speaking, you could categorise restaurant operating costs into one of three categories: fixed, variable and semi-variable costs:
Your fixed costs will include insurance, loan payment, rent and license fees. It will be much easier for you to factor these expenses into your budget, as they don’t tend to fluctuate.
Your variable costs include food, hourly wages, and utilities. These costs are harder to predict when opening a restaurant because they vary according to output. After several months, you’ll know what to expect each month.
And finally, semi-variable costs can be defined as those that have both a variable and fixed component. The main one we will be focusing on is labor, given the fact that it can vary greatly because of seasonality and demand, but will retain a constant baseline throughout the year, and might be more or less stable depending on your type of business.
Now let’s take a closer look at each one of these different types of expenses, and see how to calculate operating costs for a restaurant with a breakdown of each type of cost.
Fixed restaurant operating costs
Your restaurant fixed costs are the easiest expenses to factor into your budget given that they will remain relatively stable over time. Your restaurant monthly expenses include:
Rent and loan payments
1. Insurance costs
Insurance is one of the most important and often overlooked investments you can make into your business, especially if you want to be protected from liabilities. The rest environment is one that carries with it a great deal of risks, from the equipment that you operate, as well as unforeseen accidents with your staff or guests. Most restaurants should consider getting:
Business liability insurance, to protect against a wide variety of claims, such as bodily injury and property damage.
Product liability, to protect against claims connected to the malfunctioning of your equipment.
Liquor liability, to cover claims of damage or bodily injury caused by an intoxicated person after consuming alcohol on your premises.
Workers’ compensation policies, to cover claims for your employees as the result of injuries.
Insurance costs can vary depending on the size and type of business that you run, but they tend to average around $4300. You can find insurance plans with low-cost principles, but we advise you to make sure that you’ll be able to afford the cost of your deductibles in the event of an accident if you decide to choose insurance plans with low cost principles and high deductibles.
2. Rent and loan payment
Although there’s a great degree of variability to the costs of rent depending on your location, and the size of your location, paying for rent, repaying mortgage payments or paying loans and building fees will remain a permanent or at least long-term expense.
If you own the property where your restaurant is located, you’ll still have to deal with building administration fees, which can range between 8 and 12% of what would be the total cost of rent.
Before you sign your lease, we always recommend that you have a lawyer or a legal expert go over it to make sure that everything is in order. You might also want to have a look at the costs of rent or loan payments with your accountant.
What can you do to save money on rent?
With the parallel rise of inflation and rent prices that we’ve seen take place throughout the last year of the pandemic, restaurant owners might find it increasingly difficult to cut costs on rent, and assume that it’s essentially become a lost cause at this point.
But there are three key pieces of advice we’d give you to avoid incurring unnecessary expenses in your rent payments. Remember that if the price of your rent remains relatively stable during an inflationary period, you’ll be effectively saving money. That’s why we recommend that you:
Develop a good relationship with your landlord. When you’re out looking for a new place to rent, always strive to find someone with whom you can talk frankly about money. And then aim to cultivate this relationship, so that when it comes time to negotiate, you’re on the best terms possible.
Secure a contract with provisions to protect you from unfair rent hikes. This is one of the main reasons why we recommend getting assistance from legal experts when you’re reviewing your contract. Make sure that everything is in order when you sign the papers, and you’ll be protecting your business in the long run.
If you’re having difficulties reaching a settlement with your landlord, you can bring in a third party consultant to help you review the terms of your contract and settle your dispute.
3. License fees
You’ll have to make an upfront payment for most licenses, but you should take into account the fact that many of them also need to be renewed, incurring further fees. Check out our article on the licenses for restaurants for more information.
Variable restaurant costs
The variable costs for a restaurant are more difficult to project since they fluctuate according to their output. Here are the three main variable costs to account for:
Cost of goods sold
Repairs, maintenance and utilites
Payment processing fees
1. Cost of goods sold
Your COGS or cost of goods sold is one of the main metrics that you’ll need to take into account when you’re striving to increase your restaurant’s profitability. This is because your COGS are the primary metric you’ll be using to calculate your restaurant’s gross profit.
Your COGS will vary greatly depending on the cuisine you specialize in, and the extent to which the cost of your goods will fluctuate with changes in the market, but regardless of whether you sell mac and cheese or top of the line Argentinian steaks, you should still aim to keep your gross profits around 70%.
It’s also worth noting that you should take into account net monthly costs when pricing menu items, to see if you have some wiggle room for the prices on your menu, that will still allow you to earn a net profit.
How to calculate your COGS
In order to calculate your COGS you will need to consider:
The monetary value of your initial inventory for the period you’re analyzing.
The purchases and relevant costs you made during this period.
And the monetary value of your ending inventory for this period.
This can be expressed with the following formula:
(Initial inventory + Purchases) - Ending Inventory = COGS
Let’s imagine that the owner of Wiseau’s Mac and Cheese Joint is trying to figure out how to increase his profit margins, and he decides to take a look at his COGS for the month of November. Their initial inventory, including all of the leftover stock from October, amounted to $2000, on top of which they had to make further purchases during November for a total of $1500.
Thanks to the owner’s excellent management skills, they ended the month of November with only $200 worth of unused inventory.
COGS for Wiseau’s Mac & Cheese Joint: ($2000+$1900) - $200 = $3700
Now the owner of Wiseau’s knows that the total amount of money they had to spend on goods for the month of November was $3700
How to reduce your COGS
And what could the owner of Wiseau’s have done to reduce these expenses? We recommend that you:
Always be on the lookout for new suppliers.
Run inventory checks regularly to keep waste low and make purchases in a timely manner.
Be inventive with your stock. Run promotions on items that have been selling that well to ensure you use all of your inventory, or encourage your staff to upsell said items.
2. Repairs, maintenance and utility costs
In 2010, the National Restaurant Association published a report estimating that up to 1.5% of a restaurant’s budget ended up covering repairs and maintenance. If you don’t keep an eye out for these expenses and include them in your initial budget, you might find yourself in a tight spot when you least expect it.
While it’s advisable to have an insurance policy that covers for unexpected failures in your equipment or external damages to the infrastructure of your building, it’s also worthwhile to have contractors in your contact list whom you know you can trust to do a quick job for a reasonable price.
We also recommend that you check your contract to see if your utilities are covered by the landlord or if you’ll have to pay for them out of your own pocket. On average, restaurant utilities will cost you somewhere between $3.5 and $4 per square foot, depending on your location.
3. Restaurant management software and POS systems.
As we detail below in the semi-variable expense section of the article, a good restaurant management software and POS system can bring your significant savings in the long term by facilitating the work of your best employees. However, automating your business will also help you cut down significantly on your COGS, with less waste and a better understanding of the performance of each item on your menu.
Traditional restaurant POS systems can cost you as much as $2000 just to get a touchscreen terminal, which is why we believe that cloud-based POS systems are the way to go. With Poster, you can get started for as little as $24 per month, without having to spend any more money on antiquated hardware. Get yourself a cash register and a printer, and you’re ready to start selling!
Restaurant mixed expenses
Mixed expenses have both a fixed and variable component. The biggest mixed cost each restaurant has to deal with is labor, but in this section we’ll also be looking at the semi-variable costs you can incur from marketing expenses.
1. Labor costs
Historically, labor costs have always been one of the biggest expenses incurred by restaurant owners, often amounting to as much as 20-30% of total expenses. But with the recent developments in the US labor market, rising wages and shrinking workforces are putting even more pressure on restaurant owners.
This is why we believe that now more than ever, it’s crucial for restaurateurs to develop a solid grasp of their prime costs, and learn to calculate their restaurant labor cost if they want to add more profit to their bottom line, or at least avoid significant reductions to their net profit during tough economic times.
Labor costs vary greatly depending on the type of business you run, as well as the size and nature of your local labor market.
How to calculate your labor cost
Here you’ll be looking at two different metrics. Firstly you’ll want to calculate the total amount your business spends on labor.
These calculations are complicated by the fact that you’re likely to have both salaried and hourly employees, on top of which you’ll also have to take into account bonuses, overtime, taxes, and any type of employee benefit that you offer to your staff, such as health care coverage and paid vacation days.
Once you’ve reached this figure, you’ll be able to calculate the metric which we mentioned above: your labor cost percentage. Your labor cost percentage is calculated as a percentage of your total sales and it will allow you to better understand your labor expenses and figure out how realistic it is to cut down your labor costs.
So to calculate your labor cost percentage, you should follow this formula:
(Total cost of labor/ Total sales)*100 = Labor cost percentage
Let’s return to the example of Wiseau’s Mac and Cheese Joint. In the first week of July, owing to some smart advertising, the team at Wiseau’s managed to bring in a total of $5000 worth of sales, and paid their staff $1200. Which means that their labor cost percentage amounted to a total of:
Labor cost percentage for Wiseau’s Mac & Cheese Joint: ($1200/$5000)*100 = 24%
So how well did Wiseau’s performance compare to the national average operating costs for a restaurant? For this, we need to look at the averages for different types of restaurant!
Labor cost percentage averages for different types of restaurant
While labor cost percentages for quick service and fast food restaurants can run as low as 25%, you’ll find that labor cost percentages for restaurants with table service can run as high as 30%, and you’ll start to see figures north of 30 in the fine dining business, where the labor pool is even more limited and requires specialised training.
Given that Wiseau’s is a quick service restaurant specializing in all-American staples, you could say that they’re performing slightly better than their average competitor, but within a reasonable range for their type of business.
How to reduce your labor costs
Although it might seem near impossible to reduce labor costs in the current climate, we encourage you to plan for the long term. What might seem like a short term hike in your labor costs, can end up becoming a very wise investment in the long term.
Reduce the costs associated with high turnover. Some of the most overlooked sources of high labor cost percentages are the costs that come with the loss of your existing staff. Not only will you have to invest time and money into training and finding new staff, but the reduced efficacy of new employees and the general attrition that comes from constantly losing valuable employees will end up costing you dearly.
Invest in the right people. In order to reduce turnover, pay close attention to who you hire and how you reward their performance. Come up with new and creative ways to encourage your employees, such as sale percentage bonuses, and even if you run a small restaurant, strive to create a warm and competitive environment within your team.
Automate your business. Another great long term investment! Cut down on all of the annoying and repetitive tasks with an efficient restaurant management system to keep both yourself and your staff motivated and productive.
2. Marketing expenses
Marketing costs can be highly variable depending on whether or not you have a consistent strategy, but the more you develop your marketing plan, the more regular these expenses will be, with the notable exception of seasonal promotions. We recommend that you allocate between 3-6% of your budget, and that you take into account these two variables:
Direct costs of marketing: The cost of whatever ads you choose to run on social media or local networks, the cost of printing flyers, posters, etc.
Hidden costs of marketing: Don’t forget to take into account how much money you’ll be losing by running a promotion! However if you keep your stock and underperforming menu items in mind when designing your promotion campaigns, you might find that the lowered profit margin on an item might actually be a loss that you prevented!
To learn more about how to market your restaurant more efficiently, check out this article!
Now you’ve started on a path to develop a better understanding of your restaurant operating costs. Have a look at the expenses we’ve detailed within each section, and when you’ve completed your own restaurant costs breakdown, you’ll be able to understand how you can start increasing your profit margin!
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