How to Calculate Your Restaurant’s Prime Cost
When it comes to calculating margins and improving profitability, there’s one metric that rises in importance above the rest: prime cost. As operators struggle with inflation and rising operating costs, as well as labor shortages and supply chain issues, understanding and controlling prime costs are more crucial than ever.
In this article, we’ll explain everything you need to know about how to calculate prime cost, its components (labor costs and cost of goods sold), and your prime cost to sales ratio. We’ll also explain why prime costs are important, the average and optimal prime cost ratio, how often to calculate prime cost, and how to lower these costs to improve your restaurant’s bottom line.
What Are Restaurant Prime Costs?
Prime cost is one of the most important metrics for restaurant operators. Restaurant prime costs represent the total costs of goods sold (COGS) and labor costs. In other words, prime costs represent the total amount of money that a restaurant spends on the two most significant expenses – food and labor.
Prime costs are also known as the controllable costs, since they represent expenses directly controllable by restaurant operators and managers.
What are the cost of goods sold (COGS) and labor costs?
To break it down further, COGS encompasses the costs of food, beverages, and condiments. This includes the cost of ingredients and packaging used to prepare the meals. You can calculate COGS with the following formula:
(Starting inventory) + (Purchases) - (Ending Inventory) = COGS for given period
Meanwhile, labor costs include wages, payroll taxes, insurance, and worker’s compensation expenses paid to staff in various roles. This involves the salaries of chefs and cooks on the kitchen side, and the wait staff and other front-end workers on the service side.
Since prime costs cover such significant expenses, it's crucial for restaurant operators to keep a close eye on these costs and to ensure they are diligent about cost control measures in both COGS and labor.
Why Are Prime Costs Important?
Prime costs are critical because they represent the two most prominent costs that a restaurant operator has and greatly impact the profitability of their business. Tracking prime costs can help restaurant owners understand how much it costs to run their business, what areas they can control, and where they need to cut back to maintain margins. Operating prime costs that are high can lead to lower profit margins and ultimately lower revenue, making it challenging for operators to keep their restaurants afloat.
Additionally, keeping prime costs under control can help restaurant owners make more informed decisions about setting prices, menu designing, profitability, staffing, and other aspects of running a restaurant business. Knowing the prime costs is also crucial in making essential decisions such as whether to hire additional staff or reduce labor during less busy periods.
Prime cost is one of the best indicators of restaurant profitability and how well the business is managed on a day-in, day-out basis. Restaurants whose prime costs are out of control nearly always have issues with product consistency and food quality and for that matter, poor management practices. How a restaurant controls its prime cost is often a very telling indicator of how well the overall business enterprise is being managed.
There are two primary ways to improve profitability: increase sales or lower prime costs.
Most operators focus on increasing sales through loyalty programs and other marketing strategies. And while increasing sales is important, it’s only half of the picture. By closely monitoring and optimizing prime costs, restaurant operators can increase margins and improve profitability.
How to Calculate Prime Cost
Calculating prime cost is simple. The formula is:
Total COGS + Total Labor = Prime Cost
Remember, this includes all food and beverage inventory and packaging, as well as all costs that go into labor, including wages, insurance, benefits, payroll taxes, and workers’ compensation. Another way to think about it is that it’s a prime cost if a) it’s sold to a customer b) it accompanies every item sold to a customer or c) it’s paid to an employee or to keep an employee.
Equipment, office and bathroom supplies, furniture and decor, utilities, signage, maintenance, and repairs are NOT included in prime cost.
Restaurant prime cost ratio
To understand where your prime costs fit in with industry averages, you need to calculate your prime costs as a percentage of sales for a given period. To do this, use the following formula:
Prime Cost / Total Sales x 100 = Prime Cost Percentage
Here are step-by-step instructions on how to calculate the prime cost and ratio for your restaurant:
- Determine your total cost of goods sold (COGS) for a specific period (usually a week or a month): add up the cost of all the food, beverages, and condiments used in your restaurant, including ingredients and packaging used to prepare meals.
2. Calculate your total labor costs for the same period: this includes wages, payroll taxes, and worker’s compensation expenses paid to staff in various roles, including those in the kitchen and on the service side.
3. Add COGS and labor expenses together to get your total prime cost for the period. For example, if your COGS was $50,000 in a given month and labor costs were $30,000, your prime cost for that month would be $80,000.
4. Divide your total prime cost by total revenue for the same period to calculate the prime cost percentage. For example, if your revenues were $150,000 during that same month, your prime cost percentage would be 53%.
What is the average and optimal restaurant prime cost?
The rule of thumb for prime cost percentages in the restaurant industry is that the total prime cost should be between 55-65% of total sales or revenue. This approach suggests that a moderate prime cost percentage is 60-65%, while a lower prime cost percentage should be at 55%.
However, the prime cost percentage can vary depending on the type and location of a restaurant, as well as its operational practices.
- For table service restaurants, it’s accepted that prime cost should be no more than 65% of sales. Larger chain operators can usually keep prime cost to 60% or less, while 60-65% is healthy for table service independents.
- Restaurants that go over 65% typically serve as loss leaders for other parts of a business, such as a hotel. When going over 65%, it will be very difficult for a restaurant to be profitable.
- In states such as California, Oregon, and Washington with high minimum wages that don’t allow a tip credit to the calculation of the wage, achieving a prime cost under 65% can be more difficult. Operators should increase prices to meet that ratio.
- For QSRs, prime cost should be 60% of sales or less. Some high-volume QSR operators can achieve a prime cost of 50% or less.
Breaking it down further, the optimal range for cost of goods sold (COGS) is typically between 25-35% of total revenue, while the optimal range for labor costs is between 20-30% of total revenue. As the cost of rent, insurance, and goods rise, it’s important for operators to keep that percentage within that range.
How often should you calculate prime cost?
While it’s common for owners and managers to calculate prime costs once a month, it’s better to do it once a week. This gives owners and managers the ability to identify and react to volatile costs more quickly. Monitoring more often allows inefficiencies such as food waste or overstaffing to be addressed as they happen, rather than once it’s already too late. It also creates more awareness and accountability for managers, making them more cognizant of their choices when it comes to food waste and labor costs. This alone can lead restaurants to see a drop in prime cost once reporting them on a weekly basis.
How to Lower Your Prime Cost
Lowering prime cost is essential to improving the profitability and financial performance of any restaurant. Here are some ways to reduce prime cost or keep it under control:
- Optimize Inventory Management - Implementing an effective inventory management system can reduce food waste, prevent spoilage, and minimize over-ordering. By tracking food usage and making purchases based on demand, restaurants can save money on food costs and reduce inventory carrying costs.
2. Tighten Labor Scheduling - Implementing an effective labor scheduling system can help minimize overstaffing and control labor costs. By using data to analyze peak hours and customer demand, restaurants can accurately predict staffing needs and avoid overstaffing.
3. Menu Engineering - Optimizing the menu to focus on high-margin items and minimizing waste can help lower COGS. Reviewing menu pricing and food costs and analyzing customer preferences can help establish a profitable menu that can lower prime costs.
4. Implement Cost Control Measures - By reducing overhead expenses, maintaining equipment, and regular maintenance, you can help reduce operating costs. Utilizing energy-efficient appliances, streamlining services, and regularly reviewing invoices can help identify areas of potential cost savings.5. Train Employees - Training employees can help improve operational efficiency, minimize food waste, and improve service. Well-trained and motivated employees can help improve the overall customer experience, generating stronger sales and repeat customers to generate more revenue.
By implementing these strategies, restaurant owners can keep prime costs under control, reduce unnecessary expenses, and optimize their operations. Agilence Analytics for Restaurants provides the tool multi-location operators need to reduce prime costs. With Agilence, you can reduce both food and labor expenses, as well as identify theft, fraud, waste, and other sources of preventable loss that are eating into your margins.
By integrating your data sources such as PoS and inventory data to Agilence Analytics, we can use this data to calculate your prime costs, compare them to set levels, and alert you when operational costs go above certain thresholds. These alerts can also be sent to managers or other staff, so they can respond to variations in your operational costs quickly. You can also:
- Compare food cost trends to item sales so you can identify variances
- Use food cost data to assist with menu engineering and pricing
- Monitor employee meals and comped items for out-of-policy discounting
And you can use Agilence to help you control improve labor productivity by:
- Comparing employee performance metrics to identify high- and underperformers
- Analyzing sales by day, channel, and daypart to optimize scheduling
- Help you revise hiring and training practices to minimize turnover costs
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