First things first. You do not need to be a math expert to do any of the things I will discuss here. But you should learn how to do basic functions in a spreadsheet (there are plenty of YouTube tutorials), or at the very least know how to use your calculator and a pen! The process of determining your breakeven sales volume should be done long before you sign any leases or contracts. But it should also be done any time there is a reasonably significant change in your business. For example, if minimum wage goes up by more than a few cents or if the city decides to rip up the watermain in the street in front of your restaurant and you are expecting low sales for the whole summer. This process can give you a general idea around the possibility of profit and it can also go very deep to help you set up the financial strategy of your restaurant. It is called a CVP analysis, which stands for Cost Volume Profit analysis, and it is a simple way of determining how much you need to sell to breakeven. And we can modify it a little to figure out what we need to sell to reach specific profit targets. But, to keep our own bias out of the equation, it is important to assess what you think your sales will be before you assess what your new or increasing expenses are going to be. There is some sort of inherent desire in us that makes us want to have everything work out sunshine and rainbows. And that’s awesome, except when we are trying to be objective.
Never skip leg day…or do the legwork first!
To get started on the CVP, or breakeven analysis, you will need to have done some leg work already. You should know, in general terms, what type of restaurant you are going to have. In broad strokes, what will your menu be, and what do you think you’ll be charging for items based on a competitive analysis of your geographical region. And if you are already operating than this step is even easier. You’re more likely using the CVP tool to decide if you need to raise prices, and by how much.
We need to figure out what your average cheque is going to be. Or the average spend per customer. If you’re already operating then you can pull this info from your POS, but if you haven’t opened yet then you’ll need to do some thinking. There is no magic answer for this step so try to be reasonable and err on the side of being too conservative. It is not a problem if your actual average cheque comes in higher than your guess, but it could be a problem if it comes in lower. Let’s say your restaurant is only open for lunch and dinner. You can ask yourself a few key questions to get this going:
- What is the average price of your lunch items?
- What items do you expect to sell the most of and what do you expect to sell the least of?
- Do you expect people to buy a coffee with their lunch or a glass of wine?
- What are your possible upsells for the lunch period and who will buy them?
- What percentage of customers for your type of establishment buy appetizers and/or desserts?
- Are you planning to run discounted daily features?
- And then do the same thing for dinner.
And bear in mind that you do not need to have written a fully costed menu yet. You could have, and that would be great, but that step comes later if you’re opening a new restaurant; and you’ll likely be revising your menu later if you are adjusting your current operations to some significant financial change too. And it doesn’t matter if you’re opening a small 10 course only tasting menu restaurant or a breakfast restaurant with 150 seats selling $6 bacon and eggs. The point of this exercise is to figure out how much you should reasonably expect the average customer to spend.
Now that you have your average guest cheque, I like to break it down by each period and each day. How many customers will you have for lunch on Monday? For dinner on Friday? This is where a small proficiency with spreadsheets comes in very handy. Just set up a chart that references your average spend per period, plug in your expected customer counts and then pop out your average weekly sales. It could look like this:
And now you have your expected sales for an average week which you can extrapolate into an average year!
At this point I like to set all this aside for a few days, or even weeks, and let it leave my mind. If you have partners or a manager or anyone else who is involved it is also a good exercise to get them to do so you can compare and discuss. Two heads are often better than one for this step. Then, once you have had some time to forget about it, do it again before you look at your first run through. See how your two charts compare. And remember, the whole point of doing this is to figure out at a high level if your idea can be profitable, or what you’ll need to do to remain profitable in the face of change. It is much, much better to do this heavy lifting now than to be filing for bankruptcy at the end of your first year!
And now for your fixed costs:
The next stage is pretty straightforward. You’re going to list all your fixed costs and then add them up. That’s it, that’s all. Here’s a list of some common fixed costs to get the wheels turning:
- Accounting fees
- Advertising budget
- Bank charges
- Memberships and subscriptions
- Internet, telephone and television
- Credit card processing fees
- Vehicle expenses
- Rent or mortgage payment
- Décor budget
- Equipment rentals
- Pest control
- Security system
- Waste removal
- Health benefits for employees
- Management salaries
You may have more fixed costs than this and you may have less. It doesn’t matter. All that matters is that you think of every little fixed cost you are going to have and then add them all up. I like to add them up over a year, but you could use a monthly amount too. The problem with thinking monthly is that some expenses only happen once a year. Like your corporate tax filing, your legal minute book update and your depreciation.
It also bears mentioning at this point that this is not a cash flow analysis. You’ll notice that I included depreciation as a fixed cost but did not include any capital equipment purchases. Cash flow is related to your cost volume profit analysis, but still a separate issue.
For now, let’s use a total fixed cost amount of $400,000 for our example.
A few more estimates:
To get to the final step we need to know what our target (and please make sure this is an achievable target!) cost of goods percentage is and our target hourly labour percentage is. I’m not going to go into big detail here because presumably you’ve already done your homework and know generally what to target based on the style of restaurant you are opening or currently operating. For my example I’m going to say that target cost of goods is 30% and target hourly labour is 20%. Nice round numbers. In reality your numbers probably won’t end up so round.
And we’re finally at the heart of it!
It is time to introduce one more term here: contribution margin. This is the amount of cash left over after the variable costs have been deducted from your sales price. For restaurants that generally means taking your cost of goods and hourly labour out of your sales as a percentage. Using our numbers from above, our sample restaurant contribution margin is 50% (100% selling price minus 30% cost of goods minus 20% hourly labour). So, for every dollar we sell, we have 50 cents left to cover fixed costs and profit.
Let’s put that into a formula that everyone understands: Profit = Revenue – Expenses
In a breakeven analysis your profit will be 0. And we are trying to figure out how much we need to sell to breakeven so we will know if our projected sales are higher or lower than that. For a breakeven calculation we divide our fixed costs by our contribution margin %
Breakeven = Fixed costs / contribution margin %
Looking at our example the numbers will be: Breakeven = 400,000 / 50%
Breakeven = $800,000
Based on our best estimation we now know that this location will have to sell $800,000 a year with a cost of goods of 30%, hourly labour of 20% and fixes costs of $400,000 in order for us to have a profit of $0. If any of our variables change then so will our breakeven point.
So how did our imaginary restaurant fair?
We projected weekly sales of $16,492.50 or annual sales of $857,610. We are on the side of profit! If our breakeven sales point is 800,000 and our contribution margin is 50% then at our projected sales volume, we are looking at 857,610 – 800,000 = 57,160 x 50% = $28,580 in profit for the year.
This is generally the point at which people like to start tinkering with the numbers. What would happen if our guest counts were a bit lower or higher? What if we could increase our average cheque? What if we need to hire another salaried manager? What if we can reduce our cost of goods? And on and on and on…
OK, that was fun, but what was the point?
After doing all this work you now either have a financial model for your restaurant that looks promising or one that makes you think you should run away. If you do this high-level analysis and the numbers don’t come in looking promising then you know that you shouldn’t sign the lease; or at the very least that you need to rethink your strategy. Otherwise, you now have a jumping off point to do further work and tweak your Prime Cost percentage, take another look at your fixed costs and think about what you can do to increase top line sales or revenue. And if you’re really ambitious, or you have someone like me around who enjoys this sort of work, then you can use the CVP model to help you establish more refined cost targets and profit projections. Happy math-ing everyone!