Understanding 5 Basics of Restaurant Accounting

Did you open a new restaurant in last year or two in New York City?  Think about the following questions:

• Are you aware that 46% of all small businesses fail because of bookkeeping and accounting errors?
• Would you believe that cash flow problems wipe out another 82% of those failures?
• What about the fact that, overall, restaurant industry sales are down 1.3%?

These statistics are no joking matter and should be addressed by your eatery before your establishment becomes one of them.  Let’s quickly review and explain five basic restaurant accounting components that will help you manage and run a more profitable hospitality business.    

Profit & Loss Statement. Financial Statement. Balance Sheet. Ledger. Cash Basis.  What do all these words have in common?  These terms are already confusing and misunderstood, and that is before you even hear their synonyms; not everyone speaks fluent “accounting talk”, especially not busy restaurateurs and managers.  Nonetheless, the subject that all these terms have in common is accounting.  Acquainting yourself with the basics of accounting for restaurants can pay dividends in helping you understand your CPA and bookkeeping team better and help manage your restaurant’s cash flow.  

Proper bookkeeping and restaurant accounting processes are must-haves for keeping your restaurant alive.  And because these aspects are so crucial, we have put together a guide/cheat sheet for you to learn essential restaurant accounting concepts.  Whether you hire an outsourced bookkeeping firm or build an in-house team, there are five restaurant accounting principles that you can use to demystify the basics if you are a non-finance background entrepreneur.     

Let’s quickly go over the 5 basic restaurant accounting components that will help you manage and run a more profitable hospitality business.    

1) Chart of Accounts    

The Chart of Accounts (COA) is a term referring to a financial organizational tool used by accountants and CPAs.  The term describes the buckets used to categorize the money that moves or flows in and out of your business.  The COA will include assets, liabilities, revenue, expenses, and equity.   Subsequently, these high-level categories are traditionally broken down into subcategories… line items like marketing, restaurant inventory, supplies, and sales.  A restaurant COA would certainly include these items.

Why is this important?          

The COA is the source of a company’s financial statements.   Without it, getting real-time insights into financial data related to your restaurant or bar’s revenue or spending would be near impossible.  The COA is also used to determine how your corporate tax returns are filed.  This article from The Balance covers the most common Chart of Accounts items listed on restaurant income statements and balance sheets.

2) Cost of Goods Sold

The Cost of Goods Sold (COGS) relates to the total cost that goes into making the product you are selling.  In other words, you can think of it as the cost of all the ingredients and items on your restaurant’s menu.

You can calculate COGS the hard way… how many you sold of a menu item X how much it cost to make it..       

Alternatively, the easier way is to calculate your COGS when you take your restaurant inventory each week using the following formula:

Beginning Inventory – Ending Inventory = COGS

Please note that your COGS will not include labor costs or utilities…it only includes the cost of the actual ingredients that make up the dishes on your menu.    

Why is this important?    

Your COGS is the cost of your food and beverage inventory, which will have a direct tie to the profit you make per plate being sold each day.   Successful restaurants keep tabs on this number like hawks in order to keep pricing where it needs to be.  Following this rule of thumb will render a healthy profit on each plate of food you sell at your eating establishment.    

3) Restaurant Labor Cost, Occupancy Expenses and Operating Expenses

Restaurant labor cost, occupancy expenses, and operating expenses are all different categories of restaurant expenses; they are different compared to other types of small businesses outside of the hospitality industry.      

Let’s start with restaurant labor cost, which is fairly straightforward.  This is where you account for the employee labor it takes to run your eatery (as we mentioned earlier, not included in COGS).   Labor cost includes your servers, cooks, hosts, busboys and anyone else on your payroll…from the front-of-house to the back-of-house.  Payroll taxes and employee benefits are included in labor costs.     

Occupancy expenses are all of the costs related to renting or owning the building and the space or land it occupies.  It includes property taxes, rent, mortgage, utilities and even property insurance.  Keep in mind that occupancy expenses are fixed costs, meaning you cannot reduce the cost of them in order to increase your profits.

Operating expenses are pretty much everything else it takes to run your restaurant on a day-to-day basis.  Don’t think of operating expenses as the cost of the people on your payroll or the cost of ingredients or rent. Operating expenses are everything else…from napkins and flatware to marketing and advertising.

Why is this important?     

Restaurants, bars, and hospitality establishments are the only type of small businesses that have occupancy expenses as a category on their income statement.  This means, understanding the difference between occupancy expenses and operating expense are ‘Yugely’ important for restaurant owners to know (Trump joke).  Keep in mind that, since labor costs are one of the biggest expenses for a restaurant, it’s vital to understand this area so you can invest money wisely, keep costs down and increase profits.   

4) Prime Cost   

Simply put, prime cost is determined by adding COGS + labor costs.  Prime cost accounts for the majority of a restaurant’s expenses because it includes all of the food and beverage ingredients, payroll costs, salaries and wages, taxes and benefits.   

Why is this important?    

Prime cost is an important accounting term to know as a restaurant owner. It’s where you have the biggest opportunity to avoid accounting mistakes, cut costs and increase profits.   

Other fixed costs (occupancy expenses and operational expenses) are not as easy to cut back on, and they usually make up a smaller portion of your overall expenses anyway.  Prime cost is also a direct reflection as to how management is controlling food, beverage and labor costs on a daily basis during a reporting period. A successful restaurant will keep its prime cost at 65% or lower.

5) Cost-to-Sales Ratio

When analyzing the financial health of your business, something to keep in mind is that no number on its own can tell you everything you need to know.  For example, a large restaurant will have a high prime cost and a small restaurant will probably have a low prime cost in comparison.  But, you can’t compare the two since the large restaurant is probably doing much more in sales than the small restaurant.  Essentially, you would be then comparing apples and oranges.  In order to figure out the financial health of your business, you or your accountant should look at your cost-to-sales ratio. This puts your expense categories as a percentage of sales and is calculated as such:

Food Cost-to-Sales Ratio = (Food Cost / Food Sales) X 100%

What’s a good Food Cost-to-Sales Ratio to aim for?  Well, the restaurant industry average is between 26% and 36%… so anywhere in between those numbers is where you want to be.

Why is this important?    

Calculating a cost-to-sales ratio allows you to compare your business to other businesses without sacrificing accuracy.  It allows you to see how your business is really doing, instead of just seeing scary-high prime costs or deceiving sales numbers on their own.  Understanding your cost-to-sales ratio will enable you to see where you’re doing well and where you need improvement.

Conclusion

Accounting lingo doesn’t have to sound like a foreign language.  And you don’t have to be a bookkeeping expert to master your financials.  You can go from novice to pro by digging into the basics of your restaurant accounting.  If you do this, you’ll be able to better communicate with your accountant… and discover practical ways for running your restaurant more efficiently.  You’ll understand exactly where your money is going so you can make changes immediately and avoid further losses.  And that’s a language everyone can understand.    

Pro Tip: If you are already using an account, here are seven restaurant accounting questions to ask your CPA firm:  

• Do you use restaurant-specific accounting processes?
• Do you use cloud-based software or apps?
• Does your restaurant accounting software integrate with your POS and automatically reconcile sales and bank deposits?
• Do you monitor cash tips?
• Do you allocate payroll between the front of house and the back of house?  
• Do you adjust inventory on a weekly basis?
• Do you work with other restaurant owners?
• Do you understand key restaurant metrics and what they should be for your business?

All of these inquiries will give you a better understanding of your CPA firm’s restaurant accounting knowledge and their integration of modern technology and processes into managing financials.  Good restaurant accountants want to see the success of your business as much as you do.  They can help you bring down costs, increase profits and alert you to theft and fraud. They’ll help you with a strategy to grow your business, while preventing the bookkeeping errors and cash flow problems that could close your doors.

The Right Cloud Accounting Software Can Help You Manage Revenue, Losses and Inventory   

Bookkeeping Chef is the one-stop-shop hub for the entire back office. Historically a business owner needs to choose a software platform, find a bookkeeper and a separate CPA for their taxes. Bookkeeping Chef eliminates this friction and allows restaurant operators to easily manage their finances from a single hub.