Basics of Restaurant Accounting and How to Avoid Common Mistakes
Most restaurant owners and managers don’t want to be accountants. Fortunately, you don’t need to become one to effectively run your restaurant, but learning the fundamentals of restaurant accounting improves your ability to manage the finances and communicate this information with others.
Key Restaurant Accounting Concepts
You probably aren’t hands-on with all the day-to-day accounting duties, but you need an understanding of the primary concepts.Accounting involves recording and summarizing your business’ financial transactions. Most businesses have similar core accounting needs: recording all expenditures, sending in tax payments, paying all invoices, and tracking revenue. Restaurant accounting adds a few industry-specific processes and functions.
A restaurant’s inventory covers all of the ingredients that you use to create your menu items. A typical food service business allocates one-third of expenses on its inventory. Effective inventory management is crucial for daily operations and long-term profitability. This process prevents shortages, cuts down on waste, identifies theft and controls your costs.Best practices in inventory management include the following:
- Organize your inventory: Go through your stock areas and throw out spoiled and expired food. Put similar ingredients together so employees can easily find what they’re looking for. The first in, first out principle is particularly useful in food service. You put the older goods at the front of the shelves. New inventory goes behind your current goods.
- Count your inventory weekly: Pick a day and a time to check your inventory each week. When you go through this process on a consistent schedule, you end up with better data for direct comparisons. The ideal timing takes place before you open your restaurant or after close. Make inventory counting easier on yourself by planning it before regular deliveries. You have less to count and you can move older goods to the front. If possible, assign inventory counting duties to the same staff members for improved accuracy and efficiency.
- Use the shelf-to-sheet method: Some restaurants use an inventory list to go through their goods. However, this method leads to inaccuracies. Some items may be on the shelves but not on the list. Other ingredients end up in multiple locations. You count every item on the shelf with the shelf-to-sheet approach, eliminating these problem areas.
- Run reports on costs and usage: Identify areas of waste or opportunities for cost-saving by running frequent reports. Look for discrepancies between sales and usage numbers. A difference between your chefs’ number of plates sold and the amount of ingredients used to make those plates might indicate your staff may need additional training on portion sizes or ingredient measurements in recipes.
Payroll and Tipping
Restaurant payroll is more complicated than a typical business’ due to the tax rules and credits surrounding tipped employees. Federal, state, and local regulations apply to these employees’ wages and have implications for reporting and documentation requirements.
Under Internal Revenue Service regulations employers must keep employees’ reports of tip income. Employers must withhold employee income taxes, as well as withhold the employee share and pay the employer share of social security and Medicare taxes for both wages and tip income received.
Under the Federal Labor Standards Act, employers may reduce their liability for paying the minimum hourly wage to tipped employees through use of a “tip credit.” Employers can pay tipped employees a reduced wage as long as tip income and that wage equal at least the minimum hourly wage. The federal guidelines as of April 2019 allow a tip credit maximum of $5.12. State and local guidelines do not necessarily follow the federal guidelines, though. Some states do not allow tip credits, and others have different minimum wage requirements.
If your state allows tip credits and you choose to use them, then you must notify your employees in advance and you must calculate the correct tip credit every payroll.
Review These Reports
With more complete information and accurate data you can make better business decisions. At minimum, you should familiarize yourself with the following financial reports and review them regularly for a better understanding of your restaurant’s financial health.
The income statement, also known as a profit and loss statement or P&L, shows whether your restaurant’s operations achieve a profit or suffer a loss. The basic formula is:
Total Sales – Cost of Goods Sold (COGS) – Expenses = Profit (or Loss)
Cash Flow Statement
The cash flow statement shows you how much cash your restaurant receives, where the cash comes from, and where the cash goes during a period of time. This report is important to review to make sure your restaurant has enough incoming cash to pay for all necessary expenses.
Review These Restaurant Key Performance Indicators
Key performance indicators, or KPIs, are the most important metrics that relate to your business objectives and your measurement of success.Look for KPIs that meet these criteria:
- Relevant to your restaurant category
- Created from your actual data
- Available in a timely manner
- Tied to your vision of restaurant success
- Monitored on a regular basis
A regular review of your KPIs allows you to track profitability as well as to identify performance changes and areas that need improvement. KPIs work well as a basis for comparison. Look at your historical performance and see how that changed through your current data. Compare your reports with benchmark data that’s available for your restaurant’s market.
KPIs are only useful if based on accurate information. If you’re running reports based on poor quality data, you don’t get a true understanding of your restaurant operations. Many food service businesses use restaurant accounting software or point-of-sale systems to collect and organize their data.
Human error is another issue when generating KPIs. Restaurant accountants can enter data accurately and check calculations when the numbers don’t seem right.
You have many KPIs to choose from at your restaurant. Get started with this list of significant KPIs.
Cost of Goods Sold
The cost of goods sold, also called the cost of sales, is the cost of food and beverages at your restaurant. You calculate this number through this basic formula:Beginning Inventory + Purchases – Final Inventory = Cost of Goods SoldYour beginning inventory covers the value of your products in the kitchen and storage areas when the accounting period begins. The purchases include the value of additional purchases during the reported time period. Your final inventory number is the value of your products at the very end of this timeframe.Here’s an example of calculating a restaurant’s COGS on a weekly basis.The restaurant has an inventory valued at $3,000 on Monday. A delivery comes in during this week with a value of $1,500. At the end of business on Sunday, the food and drink inventory totals $2,000.Using the formula above, this is the COGS calculation for that week:$3,000 + $1,500 – $2,000 = $2,500The final number shows how much money it took to create the dishes during that week.COGS gives you visibility into one of your restaurant’s biggest expenses. Controlling these costs is a key factor in improving your company’s profitability. Familiarizing yourself with your restaurant’s COGS will help you:
- Find opportunities to minimize your costs. You can negotiate your rates with your food distributor or choose to go with a less expensive supplier.
- Adjust your menu prices or portion sizes based on the actual ingredient cost.
- Provide accurate information on your restaurant’s financial statements.
- Have precise numbers for your tax filings. COGS reduces your restaurant’s gross income, which brings down your tax liability. You don’t want to pay more taxes than necessary.
Your direct costs for making menu items is called the prime cost. This KPI totals your COGS with your labor costs. When you look at labor costs, you must include staff salaries and wages, taxes, insurance and other benefits that you pay for your employees.The formula for this KPI is straightforward:Cost of Goods Sold (COGS) + Total Labor Costs = Prime CostYour restaurant’s prime costs are the biggest expenses you have. They’re also dynamic, as ingredient and labor costs fluctuate over time. You have to monitor it closely to ensure that these expenses don’t get out of hand. A weekly prime cost check-in is a good frequency.You get more insight into your profitability and a better control over your costs when you know your exact prime costs. For example, this calculation may show that your food inventory expenses changed from $2,500 to $4,000 month-to-month. You can investigate why this is the case. Your restaurant may have sold more dishes or customers may choose more expensive menu options. On the other hand, your ingredients may cost more or staff scheduling could account for the increase.Take action once you know the root cause of this change. If you let prime costs go up without looking into the reason behind it, you could cut into your profitability and make it difficult to keep the restaurant going.The prime cost influences your menu prices, inventory orders, staff hiring and scheduling, and how much you spend on indirect expenses.
The cost-to-sales ratio presents your expenses as a percentage of your restaurant’s overall sales, or sales for that specific category.Use this formula to calculate the food cost-to-sales:
Food Cost / Food Sales = Food Cost-to-Sales Ratio
The typical food cost-to-sales ratio for restaurants falls between 28 and 32 percent of their total food sales. This number does vary based on the type of restaurant that you operate and the ingredient costs for your location.
Your prime costs should range between 60 and 65 percent of your restaurant’s total gross sales. You calculate this number with the following formula:
Prime Costs / Total Sales = Prime Costs-to-Sales Ratio
Your KPIs don’t tell you a lot of information on their own. Your prime cost doesn’t tell you whether your restaurant is making a profit, and you can’t compare this number to other restaurants. The larger a restaurant is, the higher its prime costs tend to be. However, the sales volume probably is bigger at that restaurant.
When you use ratios, you add context to your calculations. The cost-to-sales ratio shows your expenses and how they relate to the financial health of your restaurant. When you have high costs and low sales, then you have to improve your performance. If you have high costs and high sales, then you’re in a much better position.
Watch Out for These Pitfalls
Several pitfalls get in the way of accurately managing your restaurant’s finances.
Doing Restaurant Accounting Monthly
Too much changes in a month for accounting to work on this schedule for a restaurant. Ingredient costs can go up or down on a daily basis, the number of dishes that you sell may change, and your labor costs are impacted by many factors. You need to schedule time to do at least weekly accounting.
Not Paying Attention to Labor Costs
Your labor costs are typically your biggest expenses behind your ingredients. This number is more than how much you directly pay your employees. You also have to account for staff turnover, the changes in employee schedules based on seasonal demand, payroll taxes, insurance, benefits and bonuses offered. If your labor costs become too high, you may need to adjust your hiring practices or determine wages that reduce rapid turnover.
Forgetting to Reconcile Bank and Credit Card Accounts
Small errors in your accounting can lead to many problems over time. Inaccurate numbers can lead to massive wastage or increased costs across the board. You could pay more in taxes or end up falling short and getting in trouble with the Internal Revenue Service. When you reconcile your bank and credit card accounts against the restaurant’s accounting, you can pick up mistakes before they pile up.
Viewing Your Costs Through Total Sales
Total sales only tells one part of your restaurant’s accounting story. You need a granular look at the categories that influence these sales to determine where your restaurant is performing well, and where you need to improve. When you break down your sales and costs, you gain more visibility into this area. These insights lead to better reporting and a deeper understanding of your operations.
Keeping Static Menu Pricing
Ingredients and labor costs change over time. If your menu price stays the same for decades, you can end up pricing yourself out of business. You need a menu pricing strategy that is tied to your actual costs, while not upsetting regular customers. A seasonal menu is one way to approach this, since you’re changing the full menu every few months. New prices are expected by the customers.
Making Accounting Mistakes
Without a comprehensive understanding of restaurant accounting concepts, you can make basic mistakes that spread throughout your business. Learning the calculations above are the first step in this process, but you can run into many situations that make it difficult to accurately account for your operations.
Simplify Processes With Software Solutions
Streamline your restaurant’s business processes through specialized software solutions. They automate repetitive tasks, reduce human error, and reduce the time spent on your workflows. Consider these software categories for your business:
A POS acts as a combined cash register and credit card terminal. It also has employee time clock functionality. You end up with an accurate and complete view of your labor costs and sales through this solution.
Accounts Payable Software
This software category automates many parts of accounts payable processes. You get digitized invoices with the line-item details extracted into your accounting system. This software, such as Sourcery, eliminates manual data entry and categorization for invoice expenses.
Inventory Management Software
You can get rid of your manual inventory lists and inefficient spreadsheets. Inventory management software simplifies this essential restaurant workflow and generates data for analysis and reporting.
How Hiring an Accountant Can Benefit Your Restaurant
An accountant brings their financial and tax knowledge to your business. Due to the specialized accounting requirements for the restaurant industry, hiring a specialist in this area is essential.An accounting firm with extensive experience working with restaurants, such as Founder’s CPA, provides guidance on industry-specific topics. This skill set becomes particularly important when it comes to taxes.Your accountant needs an in-depth understanding of the following tax areas:
- The accounting and reporting requirements for tip credits
- Restaurant-specific depreciation rules
- Smallware tax treatment
- Restaurant-specific startup cost amortization
- Gift card tax treatment
Restaurant accountants help you create benchmarks and compare your performance with other businesses in your category. If you fall behind similar restaurants, the accountant provides insights on why this is the case and what to do to improve.You face a particularly challenging landscape when it comes to accessing capital. Your equipment has a lower resale value, which makes it a poor choice of collateral for some lenders. An accountant finds loan options and walks you through the process, whether you’re dealing with a private lender or the Small Business Administration.
Your Role in Restaurant Accounting
Restaurant accounting is a complex, but critical component of your business’ success. To accelerate your restaurant’s profitability and help ensure its continued operation, you should take weekly inventory, monitor KPIs regularly, review financial reports monthly, calculate COGS at least weekly, and watch labor scheduling and costs. You also need to be aware of tax implications and requirements. Accomplishing all these tasks and more is much easier and more effective if you work with an accounting firm with restaurant-specific knowledge and if you implement the use of software solutions.