Restaurant Accounting: For Profit's Sake - Inventory Your Beverage Cost

by Ron Gorodesky and Ed McCarron

The food and drink is great, the service fabulous and the restaurant is busier than ever - but are you wondering why the bottom-line isn't all it should be?

Alcohol sales (beverage sales) are an easy way to increase profitability because the costs are lower and the gross margin is far greater for beverage than for food. However, beverage costs must be controlled if an operation is to reach maximum potential of gross profit from beverage sales. Every reduction in beverage cost percentage renders a higher gross profit. Beverage costs that are above industry averages can negatively impact your profitability. A profitable restaurant typically generates a 22% to 28% beverage cost. Because of the impact beverage costs can make on an operation, it is important to know where beverage cost falls in relation to total sales on a daily or weekly basis. Beyond the bottom line, beverage costs also reflect an operation's control systems, management skill level, and value provided to the customers.

Despite its importance, we find many restaurant managers do not calculate beverage cost correctly, or if they do, they do not fully understand the process. If calculated correctly, the ratio can be compared to industry averages and previous performance. Alcoholic beverages are included in beverage cost calculations. Soft drinks, juices, coffees, and other non-alcoholic beverage sales are included in food cost calculations. With an accurate beverage cost, steps can be taken to improve the operation and ultimately improve the bottom line. The following is a step-by-step method for calculating beverage cost including an example and a worksheet to calculate your own beverage cost.

CALCULATING BEVERAGE COST

Keeping in mind that eventually you want to compare your beverage cost with industry averages, how you determine the numbers must be consistent with industry practices. The industry standard is based on the Uniform System of Accounts for Restaurants (a handbook available from the National Restaurant Association). This system clearly identifies what items are included in each part of the beverage cost formula and is briefly outlined below.

Beverage Cost = Cost of Beverage Sales / Total Beverage Sales

GENERAL GUIDELINES

Establish a specific time period for analysis.

The beverage sales and costs should be generated during a set accounting time period of at least two weeks or more typically, every 28 days, or monthly. Soft drinks, juices, coffee, and other non-alcoholic beverage sales are included in food cost calculations, not beverage cost calculations.

STEP BY STEP - CALCULATING BEVERAGE COST

1. TIME FRAME

Working with your accountant and managers, set up a regular time frame to analyze beverage cost. It is critical that the elements of the beverage cost calculation (sales, inventories and purchases) are representative of this time period.

2. BEVERAGE SALES

This is the relatively easy part - total the customer checks or reports from point-of-sale registers - making sure to only include sales generated from beverage sources (sources other than beverage should be allocated to a "food" or "other income" account). Remember to use sales generated only within the allotted time frame.

Example: Beverage Sales (Liquor, Beer, Wine) $1,850

3. COST OF BEVERAGE SALES

The costs associated with beverage sales are comprised of purchases and inventory level adjustments. In our experience, this part of the calculation is often computed incorrectly. Determining the amount of purchases for the time period is straightforward:

Total all beverage purchases (include delivery charges)

Example: Beverage Purchases in past 28 days $500

Equally important, and often not included in determining cost of beverage sales, is the inventory adjustment. Many restaurants consider only purchases in determining beverage cost. This does not create an accurate beverage cost percentage - depending

on the day purchases are made and what the cut-off date is for including sales in the beverage cost calculation, your beverage cost could appear higher or lower than it actually is. Additionally, this discrepancy makes it difficult to compare and track beverage costs.

For example, suppose you receive (purchase) all your spirits and wine products on Thursday to prepare for the weekend. The time period for determining beverage cost ends on Friday (the next day). In calculating your beverage cost, it appears much higher than last month. While the increase may be due to theft or another operational issue, most likely it is due to calculating your beverage cost inconsistently and incorrectly. Your purchases reflect a large Thursday delivery, however, you do not log the sales from the weekend to offset these purchases, making your beverage cost appear out of line. Additionally, you have not factored in the inventory adjustment.

Determine Inventory AdjustmentTo properly determine beverage cost, a physical inventory of the main bar, service bar and storeroom areas must be conducted at the end of each period.Once you have your ending period inventory level, look at the change from your beginning (start of time period) inventories (bars and storerooms). The key to accurate cost determination is understanding the role inventory levels play. For example, if the beginning inventory level is valued at $100 and four weeks later the ending inventory for the period is valued at $75, the inventory adjustment is the $25 difference - an increase in cost of beverage sales because you used $25 worth of inventory and did not replace it with new purchases.

Considering this change and its effect on cost of beverage sales, apply the difference to the total purchases for the time period, giving you the total cost of beverage sales.

Cost of Beverage Sales =Purchases+/- Inventory Adjustment

(ADD if Beginning Inventory > Ending Inventory, SUBTRACT if Beginning Inventory < Ending Inventory)

Example: Purchases $500 Beginning Inventory $750Ending Inventory $625Total = $125

Cost of Beverage Sales =$500+$125Cost of Beverage Sales =$625

4. BEVERAGE COST PERCENTAGE

The final step - putting the numbers together!

Beverage Cost = Cost of Beverage Sales / Beverage Sales

Example Beverage Cost = $625 / $1,850 = 33.8%

ANALYZING YOUR BEVERAGE COST

What should your beverage cost percentage be? Successful restaurants generate beverage costs in the mid 20% range. However, different types of operations typically run higher or lower percentages - fine dining may run up to 35% (sales of bottles of wine are usually less profitable other alcoholic beverages) whereas brewpub restaurants may run about 15%. Comparing your cost percentage to restaurants with similar menus and service levels provides a more accurate perspective.

For example, the average beverage cost is 32.1% for American/Regional menu themed restaurants and 30.8% for a restaurant in a multi-unit organization.

How can you use your beverage cost percentage? The next step requires compiling the sales and costs consistently and regularly, as comparisons to previous performance can prove very helpful, identifying problems and trends - remembering that a decrease in beverage cost is as important to investigate as an increase. From here, your operation is positioned to tighten its beverage cost by looking closely at various methods used to control beverage cost - with the ultimate goal of positively impacting your bottom line.

CONTROLLING YOUR BEVERAGE COST

There are many methods used to control liquor costs and every operator needs to determine which methods should be implemented. The following are some basic methods that could be applied. A combination of several different controls is the best way to ensure tight control and therefore see the maximum potential liquor sales offer.

1. Par stocked bar

o The bar should be stocked based on a number of bottles of each brand sold on the busiest day plus a margin for safety.

o Bottles should only be restocked by managers and only on a bottle for bottle basis.

2. Receiving and storing

o Purchasing and receiving functions should be undertaken by separate individuals. The beverage buyer should not be the same person receiving the merchandise. A receiving report is generated by the purchasing manager stating the quantities, sizes, and agreed upon prices for the order. The receiver is responsible for inspecting the order when it comes in and making sure it matches the report.

o All bottles received should be marked in a way that makes the bottle identifiable as a house bottle (to prevent bartenders from bringing in their own bottles and keeping the profits)

o All received merchandise should then be stored in a locked area where access is limited to as few people as possible (ideally just one), as this allows shortages to be traced.

3. Maintenance

o A perpetual inventory should be maintained for each time period with adjustments for purchases and requisitions. This perpetual inventory should be compared against a physical inventory at the close of every period and variances should be noted and investigated.

4. Bartending standards

o All bartenders should be required to complete all transactions for sales immediately, either by opening a tab or accepting payment. Any delay in this makes it easier to "forget" to ring in a sale.

o Some method of recording sales should be employed in a consistent way. Either red lining a dupe once payment is made or filing copied dupes for each shift.

o An accurate pouring method should be utilized. o Drink recipes should be consistent and readily available.

These methods of control and properly calculating your beverage cost will go a long way in assisting you, the restaurateur, to manage beverage costs and increase profitability.

Restaurant Accounting: For Profit's Sake,Inventory Your Food Cost!

by Ron Gorodesky and Kate Lange

The food is great, the service fabulous and the restaurant is busier than ever - but are you wondering why the bottom line isn't all it should be?

Check your FOOD COST. A vital ratio - key to the success of any restaurant as it directly impacts profitability. A profitable restaurant typically generates a 28%-35% food cost. Coupled with labor costs, these expenses consume 50%-75% of total sales. Because of the impact food cost makes on an operation, food cost is one of the first things we examine at a troubled property. Beyond the bottom line, food cost also reflects an operation's food quality, value provided to the customer, and management skill level.

Despite its importance, we find many restaurant managers do not calculate food cost correctly, or if they do, they do not fully understand the process. To be useful, food cost percentages must be determined accurately. Then the ratio can be compared to industry averages and previous performance. With an accurate food cost, steps can be taken to improve the operation and ultimately improve the bottom line. The following is a step-by-step method for calculating food cost including an example and a worksheet to figure your own food cost.

CALCULATING FOOD COSTKeeping in mind you want to eventually compare your food cost with industry averages, how you determine the numbers must be consistent with industry practices. The industry standard is based on the Uniform System of Accounts for Restaurants (a handbook available from the National Restaurant Association). This system clearly identifies what items are included in each part of the food cost formula and IS briefly outlined below.

Food Cost = Cost of Food Sales / Food Sales

GENERAL GUIDELINES

Establish a specific time period for analysis. The food sales and costs should be generated during a set accounting time period of at least two weeks or more typically, every 28 days.

Juices, coffee, soda supplies and other non-alcoholic beverage sales are included in food cost calculations.

STEP BY STEP - CALCULATING FOOD COST

1. TIME FRAMEWorking with your accountant and managers, set up a regular time frame to analyze food cost. It is critical that the elements of the food cost calculation (sales, inventories and purchases) are representative of this time period.

2. FOOD SALESThis is the relatively easy part - total the customer checks or reports from point-of-sale registers making sure to only include sales generated from food sources (sources other than food should be allocated to a "beverage" or "other income" account). Remember to use sales generated only within the allotted time frame.

Example: Food Sales (+ Juice, Soda, etc.) $1,850 3. COST OF FOOD SALES The costs associated with food sales are comprised of

purchases and inventory level adjustments. In our experience, this part of the calculation is often computed incorrectly. Determining the amount of purchases for the time period is straight-forward:

Total all food purchases (include delivery charges and non-alcoholic beverages). Example: Food Purchases in past 28 days $500

Equally important, and often not included in determining cost of food sales, is the inventory adjustment. Many restaurants consider only purchases in determining food cost. This does not create an accurate food cost percentage - depending on the day purchases are made and what the cut-off date is for including sales in the food cost calculation, your food cost could appear 5 to 6 points higher or lower than it is. Additionally, this discrepancy makes it difficult to compare and track food costs.

For example, suppose you receive (purchase) all your dairy and meat products on Thursday to prepare for the weekend. The time period for determining food cost ends on Friday (the next day). In calculating your food cost, it appears much higher than last month. While the increase may be due to theft or another operational issue, most likely it is due to calculating your food cost inconsistently and incorrectly. Your purchases reflect a large Thursday delivery, however, you do not log the sales from the weekend to offset these purchases, making your food cost appear out of line. Additionally, you have not factored in the inventory adjustment.

Determine Inventory AdjustmentRealizing the time and energy that counting inventory on the line (in "production") is prohibitive to including inventory in food cost calculations, we recommend estimating a production inventory level. Conduct the inventory of the dining room,

service and production areas a few times, average the inventory levels and use that constant figure each time period. Add the estimated figure to the physically counted storeroom inventories each period for your ending inventory. It is important to update the production inventory level at least once a year.

Now that you have your ending period inventory level, look at the change from your beginning (start of time period) inventories (kitchen and storerooms). The key to accurate cost determination is understanding the role inventory levels play. For example, if the beginning inventory level is valued at $100 and four weeks later the ending inventory for the period is valued at $75, the inventory adjustment is the $25 difference - an increase in cost of food sales because you used $25 worth of inventory and did not replace it with new purchases.

Considering this change and its effect on cost of food sales, apply the difference to the total purchases for the time period, giving you the total cost of food sales.

Cost of Food Sales = Purchases +/- Inventory Adjustment(ADD if Beginning Inventory > Ending Inventory, SUBTRACT if Beginning Inventory < Ending Inventory)

Example:Purchases $500Beginning Inventory $750Ending Inventory $625= $500 + $125= $625 Cost of Food Sales

4. FOOD COST PERCENTAGE The final step - putting the numbers together!

Food Cost = Cost of Food Sales / Food Sales

Example Food Cost = $625 /$1,850 = 33.8%

Now you have the basic steps to complete your own food cost accurately and consistently with industry practices. Following is a form to assist you in the calculation.

CALCULATING YOUR RESTAURANT'S FOOD COST

TIME FRAME:Start Date_______End Date_______

FOOD SALES (including coffee, juices and non-alcoholic beverages): A._______

COST OF FOOD SALES:Food Purchases (including non-alcoholic beverages):_______Inventory Adjustment:Beginning Inventory_______Ending Inventory_______Difference_______B._______

Food Cost = Cost of Food Sales / Food Sales

FOOD COST =Line B / Line A =_______=_______%

ANALYZING YOUR FOOD COSTWHAT SHOULD BE YOUR FOOD COST PERCENTAGE? Ron Gorodesky, President of RAS, maintains that successful restaurants generate food costs in the low to mid 30's. However, different types of restaurants typically run higher or lower percentages - steak houses may run up to 40% whereas Italian restaurants may run about 28%. Comparing your cost percentage to restaurants with similar menus and service levels provides a more accurate perspective.

For example, the average food cost is 35.7% for American/Regional menu themed restaurants and 32.0% for a restaurant in a multi-unit organization.

HOW CAN YOU USE YOUR FOOD COST PERCENTAGE? The next step requires compiling the sales and costs consistently and regularly, as comparisons to previous performance can prove very helpful, identifying problems and trends - remembering that a decrease in food cost is as important to investigate as an increase. From here, your operation is positioned to tighten their food costs by standardizing recipes, evaluating

purchasing systems and taking other steps to create a target food cost for your particular restaurant - with the ultimate goal of positively impacting your bottom line. So, For Profit's Sake, Inventory Your Food Cost!

Restaurant Accounting: How Four Overlooked Numbers Cost You Money

By David Scott Peters

As an Assistant Manager of a full-service restaurant and bar, I was taught how to complete the standard Cost of Goods Sold calculation, the same calculation every new manager is shown: Beginning inventory plus purchases equals total available. Total available minus ending inventory equals total product used. Total product used divided by sales equals Cost of Goods Sold percentage.

That was easy to master, but I had a challenge. As I climbed the ranks of management into an operations role, my kitchen managers were creating good numbers on paper, but our bank account did not reflect those positive numbers. And I learned quickly that profits on paper do not pay the bills; CASH PAYS THE BILLS.

I learned to look deeper into the Cost of Goods Sold calculations to take back control of the checking account and improve the bottom line.

Looking Deeper

The basic Cost of Goods Sold calculation is where most management stops. I discovered that there was more analysis to be done when we were rewarding managers for achieving numbers, yet we didn't necessarily have the dollars in the bank to reward them with. Let me share with you four additional numbers you must look at that allow you to drill down deeper into the numbers. They are Average Inventory, Inventory Turns, Change in Inventory and Budget Variance.

A. Average Inventory. This is the average dollar value in inventory you carry any day during a given period. This is vital to being able to measure how efficient your managers are with product and your bank account. Why? I will shed some light on that next.

B. Inventory Turns. This is how many times the dry storage and walk-in shelves were stripped clear of product and then re-stocked. In real-world terms, when we

refer to an inventory turn, we are really referring to the number of times the dollar value on the shelves turns. The benefit is that this number measures how efficient a store is with its cash and inventory.

C. Change in Inventory. This is how efficiently your store has been ordering product. This number is important, just as inventory turns are, because it clearly represents how much cash you have either freed up or tied up on your shelves.

D. Budget Variance: These numbers show how close your store came to achieving its goals. Without a target you will be unable to quantify performance. These numbers will allow you to better interpret how your store performed in a given period.

In Figure 1, below, I will show you how all of these numbers can come together to give you a crystal ball to see how you are doing. Then you can eliminate circumstances where you can be taken advantage of and recognize opportunities to put cash back into the bank.

Cost of Goods Sold - Food Cost Example

Beginning Inv.  $              3,580.21 Purchases  $            22,522.33 Sub-Total  $            26,102.54 Ending Inv.  $              6,803.01 Used  $            19,299.53 Sales  $            63,045.48 F.C. %                    30.61%Last F.C %                    29.78%+ / - %                      0.83%

 $      5,191.61  Average Inventory                3.72  Inventory Turns

 $      3,222.80  Change in Inventory

 $    18,913.64  Budgeted 30.00% $    19,299.53  Actual 30.61% $       (385.89)  Budget Variance -0.61%Figure 1

You can see that four additional calculations have been added to bring new facts to light. These facts will demonstrate how at first glance we might think that the Kitchen Manager is doing a great job and may be entitled to a bonus, but looking deeper shows

that the KM has made it difficult to make payroll and should not receive that bonus.

We can see from the standard calculation that the KM has come pretty close to hitting the targeted food cost percentage budgeted for. He has achieved a 30.61% vs. the budgeted 30%. The KM might even say, "I'm only .61% off budget." And at first you might say, "You're right, it's not a big deal." But let's look at the numbers deeper.

While the food cost percentage was close to our target and is very close to last month's food cost percentage, our inventory turns are not hitting the minimum 4 to 6 turns desired. This means we have too much food on our shelves. Our change in inventory shows that we added $3,222.80 in product to our shelves. That might mean the difference in making payroll. Remember, cash pays the bills, profits don't! Then we see that .61% means that we wasted $385.89 worth of product. So due to poor management of our restaurant and this controllable expense, we had a negative impact of $3,608.77 in our bank account. And without looking at the four additional numbers, we might have rewarded our KM - even though he actually mismanaged our money.

The Facts

You should have learned that the standard Cost of Goods Sold calculation alone, while important, can get you into trouble with a false sense of well being. A light bulb should have gone off in your head. You should no longer stop with the standard calculation. From here on out, you know what to look for and will be able to take steps to not only make your numbers, but increase your operating efficiency to create a larger bank account, from which you can pay your bills or maybe even yourself.

Restaurant Operations: Who Can Swim In The Tip Pool?

By Michael Mitchell

Another limitation is that tipped employees cannot be required to share their tips with workers who do not customarily and regularly receive tips. The U.S. Wage and Hour Division has said that wait-staff, bellhops, counter personnel who serve customers, bus employees, and service bartenders are among the kinds of employees who are permissible pool participants. But the Division has also taken the position that dishwashers, cooks, janitors, and laundry-room attendants are not the kinds of employees who can be permitted to participate in tip-pooling arrangements.

Sometimes tipped employees decide on their own to share their tips with coworkers who are not tipped employees and who do not participate in a tip pool. Or, tipped employees might voluntarily decide to share a larger proportion of their tips than their employer could require them to contribute to a tip pool. If they do this freely, not under any formal arrangement, and independently of and without any pressure or coercion from their employer, then this does not invalidate the tip credit or a tip pool. However, you cannot use any of those pooled tips to cover any tip credit.

Restaurant Operations: Eliminate Poor Receiving Habits

By Bill Schwartz

Here's a startling discovery. The two worst people to use for receiving goods are the chef and the manager! Although the chef or manager may be the most knowledgeable about what was ordered, they are also the two individuals with the least amount of time to devote to the process. There are far too many interruptions for them to do an accurate receiving job.

Since the receiving function is largely clerical in nature, it is a misallocation of human resource to have managers perform clerical functions. Even though a manager can do a clerk's job, the reverse is usually not true. I strongly advise you to consider another employee for the receiving job.

In order for this to work, you may need to schedule receiving hours with your purveyors. And, you will also need to inform the receiving clerk job what was ordered, from whom, at what price and specification. This can be easily accomplished with purchase orders and specification training.

The person ordering the goods should be responsible for the completion of the purchase order. It takes little or no additional time for that person to write down what is being ordered if this is done while the order is being phoned in to the purveyor.

The fact is that receiving is vitally important and needs as much attention in the food-service industry and it gets in every other industry. Receiving must be done religiously, consistently and accurately. The end result will be well worth the effort. It is possible to absolutely eliminate the possibility of purveyor theft or invoice errors overnight. The effect of good receiving practices on profitability will be immediately evident.

Restaurant Finance: How Much Is Your Restaurant Worth?

by Ron Gorodesky and Ed McCarron

How much money is your restaurant worth? Is it what the equipment and furniture cost? Is it what your sales are - or is it worthless? Restaurant operators need to value their business for various reasons including negotiating a sale price, for financing purposes or to assess new worth. This article will explain the way to value your restaurant business.

The value of a restaurant business is termed Fair Market Value ("FMV"). FMV is the highest price available where the following objectives are met in an open market:

A willing buyer and a willing seller; Both parties to the transaction acting prudently; Both parties are knowledgeable and informed; There is no duress; and There is a monetary transaction.

A transaction will take place only if it is considered fair by both parties.

We do restaurant business valuations for many reasons. It's important to keep in mind that the valuation is done to reflect actions of buyers and sellers in the market. The valuation procedure described here is based on a restaurant's maintainable cash flow and results of comparable restaurant operations.

After you have restated the financial statements in accordance with USA*, you must adjust the statements for unusual income or expenses. For example, you must include any unreported revenues and exclude any unique or individual contracts that provide revenues. As for expenses, exclude such items as non-performing employees, excessive compensation, personal expenses and corporate overhead.

For example, a $48,500 maintainable earnings figure will be used in the valuation. Maintainable earnings is the net income that a restaurant can expect to earn on a consistent basis before depreciation, income taxes and debt service.

The next thing to do is determine a capitalization rate (or cap rate). The cap rate converts the maintainable earnings into business value. The cap rate is determined either by analyzing purchase prices of comparable restaurants including sales prices and maintainable earnings (not necessarily information that is always available) or by calculating a weighted average cap rate. Cap rates are determined based on factors

such as financing (debt or equity), lease terms and cost of capital. In general, a lower cap rate (20 to 30 percent range) effects a higher restaurant value and a higher cap rate (30 to 50 percent range) effects a lower restaurant value. Also, cap rates are sometimes expressed as earnings multiples. For example, a 25 percent cap rate would be a 4 times earning multiple and a 33.3 percent cap rate would equate to a 3 times earning multiple.

Once the maintainable earnings and capitalization rate are established, to calculate the Fair Market Value simply divide the maintainable earnings by the cap rate or multiply the maintainable earnings by the earnings multiple.

The valuation for our sample restaurant is $194,000 and calculated as follows. We have used a 25 cap rate or 4 times earnings multiple:

Maintainable earnings $48,500

Divide by capitalization rate 25%

Restaurant Value $194,000

Using this methodology is the most accurate method of establishing value for your restaurant. This value is based on earnings of a professionally managed business. Since items such as furniture, equipment and a liquor license are used to generate maintainable earnings, they are all part of the business value. Also be aware that if you own the building in which your restaurant is housed, there is a separate real estate value for that building, in addition to restaurant business value.