Restaurant Profitability: Achieving Greater Margins
March 5, 2021
I frequently speak with owners who need a profitability reboot. They are bringing in money but not holding on to as much of it as they would like. Inevitably, I always end up explaining the basic benchmarks used for assessing the financial health of any restaurant’s operation.
Let’s get started with terms and concepts.
If Revenue exceeds Expenses, one has Profit. If not, one has a Loss.
The Profit and Loss Statement (“P&L”) is the basic scorecard for every restaurant operating team.
We say basic health for a restaurant business is to show a Net Operating Profit (“NOP”) equal to at least 10% of Revenue.
The National Restaurant Association reports the national average for an independent restaurant’s NOP hovers around 5%. Some years a little lower, some a little higher. Never 10%! In our view, this reflects the reality that the industry attracts many who survive with passion and willingness to work hard despite limited financial management skill.
Can your operations achieve 10% NOP ? Yes, though most do take a little while to get there. Here’s what’s needed:
Leader(s) on the premises, leading by example
A strong committed team
The right menu mix and pricing for the location
Good site visibility/signage and a social media marketing plan
Having enough working capital is key to managing the stress until one becomes profitable.
Ten percent NOP is needed because there are many demands on Profit before an owner or investor takes any of it home:
1) One must pay taxes on it for starters, to the state in many states, as well as to the fed.
2) If there is debt, it must be serviced, and the principal portion is taken from the Profit.
3) It is imperative to build a cash reserve for unforeseen challenges, though many fail to do so.
4) Capital equipment will need to be replaced.
5) Facilities must be refreshed or improved periodically.
6) Opportunities to expand or invest in new sites can be seized only if capital is ready.
7) And smart operators craft an incentive program for their team, funded by sharing Profit exceeding a stated threshold.
10% NOP means that no more than 90% of Revenue should be consumed by Expenses.
Expenses are divided into Prime Costs, 60% of Revenue and Overheads, 30% of Revenue.
Prime Costs are Cost of Goods Sold (“COGS”) and Direct Labor (“DL”). COGS and DL interact, and together they should not exceed 60% of Revenue.
Primes less than 55% are suspect: Are they achieved with an insane workload shouldered by the BOH? If so, this is not sustainable over time. Concepts which legitimately achieve Primes in this range attract investors eager to fund an aggressive plan to scale up!
Overheads well under 30% are often achieved by busy restaurants. Many Overheads are fixed, so as a restaurant picks up steam, one can enjoy good leverage on these.
Here is the key: Don’t squander good Overhead numbers by tolerating high Primes. Primes at 58%-60% and Overheads at 22%-25% make for a great business.
We carefully define the P&L terms introduced above, in accordance with Generally Accepted Accounting Principles (“GAAP”.)
Connect with Henry Patterson for more information at: firstname.lastname@example.org