With already narrow margins becoming even slimmer during a pandemic, every penny counts; and restaurant Cost Of Goods (or to some, Cost Of Sales) take up a significant amount of a restaurant’s overall expense. Unfortunately, many owners/operators fail to see how, if mismanaged and handled inconsistently, Restaurant COGS can have major a negative impact on profitability and cash flow. Point-blank: It’s critical to the health and survival of all restaurants that you understand your COGS and how to manage them accurately – here’s how:
WHAT ARE COST OF GOODS AND HOW ARE THEY CALCULATED?
The acronym, COGS, stands for Cost Of Goods – or for those of you who call it Cost Of Sales – that works as well, and when you see COGS on your Restaurant P&L. What is the COGS formula?
( Opening Inventory + Purchases – Credits – Ending Inventory ) / Sales
HOW TO CALCULATE COST OF GOODS?
To break down this formula, we start with opening inventory. This is inventory at the start of the period you’re looking at within your financial statements. If it’s weekly, it’s the beginning of the week; If it’s monthly or period, it’s the beginning of the month or the period. It’s represented by a dollar amount of the product that you start with.
Next, you would add in your purchases which are probably the most straightforward. Those are, as you would imagine, the purchases that you make out make throughout the week.
From there, you would subtract any credits, as well as subtracting the ending inventory, which is the dollar amount of inventory you have left on your shelves at the end of the accounting period or at the end of the week.
When you are looking at that cost of goods formula, the sales basis should be the sales for that cost basis. So for instance, food cost will be a percentage of food sales, liquor cost will be a percentage of liquor sales, etc. whatever your master sales departments are, you should have corresponding costs at categories, and this percentage should be based on that specific sales basis.
For those of you who are counting by the week, this formula is the most accurate way of calculating the costs of the product that you’ve gone through during the week. To evaluate that cost as a percentage of your sales, you then divide that dollar amount into your sales to get your cost percentage. This number paints a picture. It starts to tell you how much money you’re actually making on the food that you’re selling, or the beer, wine, or liquor that you’re selling.
Now we know there are restaurants out there who don’t count inventory, so if that’s you, just change the opening and ending inventory to 0 and then this formula still works. That means your cost is just based on your purchases minus your credits, divided into sales, and won’t even factor in the inventory.
WHY DOES COUNTING INVENTORY MATTER?
Remember that your total inventory dollars actually live on your balance sheet. This is recorded as an asset and represents the total dollar amount of product that you have on your shelf.
Another benefit to counting inventory is that you’re touching everything inside the restaurant; all the equipment, the storage areas, walk-in freezers, etc. so while you’re counting you can actually be performing a facility maintenance check. You’re able to catch any maintenance issues before they become a bigger problem.
In the image above, the up and down “EKG chart” of your cost as a percentage of sales, when it’s only based on purchases, is not meaningful data. All the best restaurant operators are really good at troubleshooting ways to mitigate their waste, and determining if customer behavior changed, or if an item may be priced incorrectly. They’re able to do this so well because they can troubleshoot with meaningful data. When you’re counting inventory and have an expected cot percentage baseline, you’re enabling yourself to make, proactive, meaningful business decisions (review the full example in our video below).
Watch our Cost of Goods 101 video:
WHAT ARE COMMON MISCONCEPTIONS ABOUT COSTS OF GOODS?
Purchases is the same as usage: FALSE – Go back to the COGS formula. Just because you had x amount of purchases for the week doesn’t actually mean you sold all that purchased product. Note: If you’re not counting inventory, whether or not that product was actually sold, it should still be reflected as your cost for that week.
My cost is high because I purchased extra for next period: FALSE – Again go back to the COGS formula. It makes no difference how much you purchase of a particular product if you’re taking inventory. Those higher purchases won’t have any bearing on your cost because you’re actually inventorying that product so the usage will still be what you actually use throughout that accounting period.
Buying in bulk saves money: TRUE/FALE – This one is a catch-22. Just because you might save a dollar through bulk discounts, doesn’t mean that you’re actually going to use that product. All you’re actually doing is tying up cash on your shelf. So, if you want to buy in bulk, be smart when you do it based on the history of your product usage, and ask yourself if saving a dollar here and there is truly going to help you out in the long run.
Inventory is a time suck: FALSE – Think of inventory as an investment. You have tens of thousands of product sitting on your shelf, which is an asset and an investment to the business. It should be properly received, manage, stored, and tracked. The more accurate and consistent your inventory is, the easier it is to identify areas of opportunity and concern.
By engaging your management team in the inventory process and having a real baseline that they can make meaningful decisions on, you’re ultimately going to save more money with the impact they can have, than the actual labor dollars it costs for them to perform inventory.
WHAT ARE BEST PRACTICES TO COUNT RESTAURANT INVENTORY?
- Two-person counting system: Always have the same person call out the inventory and the same person recording it
- Consistent counting units: Make sure you’re counting the product the same way each
- Organize and Maintain Shelf-to-Sheet Count Sheets: Try to make count sheet flow in a way that you’re literally going shelf by shelf and reporting product.
- Keep inventory levels low: This will not only help you count product much quicker, it’s also going to help you manage mishandling theft, spoilage etc. and BONUS it’s going to help with cash flow as well.
- If you can’t consume it, don’t count it (unless you’re a QSR then you can and should include packaging): This should be budgeted out and managers should be utilizing a declining spending budget to manage their supplies as well as their paper products and to-go packaging.
WHAT ARE BEST PRACTICES FOR MANAGING AND CONTROLLING WASTE FOR FOOD AND BAR PROGRAM?
- Declining Spending Budget & Ordering PAR Levels: Get the whole team involved in forecasting and then make sure those order writers know those PARS should be as fluid as your sales are fluid. How do you do this? You use a declining spending budget that keeps track of those purchases throughout the week and tells you how much you have left to spend.
- Waste tracking: Go old-school. Use a clipboard or even a waste bucket in the kitchen to help quantify that waste; or, if you insist on ringing it in through the point of sale, void that sale (with the category of waste) instead of comping or discounting it. NOTE: Make sure you check with your state to see what’s required with waste (especially liquor – some jurisdictions require spillage to go through your POS to ensure it’s all accounted for).
- W: Waste – Is it truly waste like spoilage? Is it over-ordering on those PAR levels?
- E: Error – Is it a mistake in the way the servers are ringing in something through the POS? Do they know the difference between a void in a comp?
- P: Portion Size – Restaurants are businesses pennies, and if half an ounce of extra dressing is going on your salads, those pennies add up quickly.
- T: Theft – Is product going out the back door? Is it being given away to customers without being rung in?
- Keep inventory levels low: Lower inventory levels are proven to minimize your waste. The less product available, the less likely your staff is over portion. Again – this is not to say you should keep your inventory levels so low that you’re running out of product, because that reflects poorly on your brand, but find the level that works for your restaurant.
WHAT ARE ADDITIONAL WAYS TO REDUCE COSTS?
If you are not currently involved in any manufacturer rebate programs (or Group Buying Organizations (GBO’s)) then you might be missing some cost savings that could help decrease your overall cost. A group buying organization leverages the purchasing power of all its members to negotiate contracts with suppliers that end up benefiting everybody in that organization. As part of a larger group, you’ve got strength in numbers, which leads to lower product costs that you couldn’t attain on your own.
Building relationships with all of your direct vendors and reps from all of your food and beverage vendors can help you maximize those savings that the national corporate chains are actually getting from negotiating their own rebate programs, just by finding out what you’ve got available in your area. You can check with your main distributors to see what programs they might have available to you. Learn how a manufacture rebate program can benefit your restaurant!
MOST FREQUENTLY ASKED QUESTION ABOUT COGS:
I use limes in the bar and in the kitchen. Where should they be categorized?
Listen to the full podcast episode – How Restaurant Purchasing Behavior Is Changing to hear our answer!