Why prime cost is important, but shouldn’t be your primary focus

What is Prime Cost Anyway?

Prime cost is a term you hear about a lot in the restaurant industry.  It is composed of your cost of goods and your labour cost but there are a few differing opinions on what should be included.  Some people include the cost of supplies like parchment paper and garbage bags in with their cost of goods; which makes sense because you need them to run a kitchen.  But it also doesn’t make sense because unless you’re serving something ‘en paupiette’ then neither of these items will ever end up on a customer’s plate.  And even ‘en paupiette’ dishes are more often removed from the parchment for service now, at least from what I’ve seen anyway.  And on the labour side, some people like to exclude management labour because it is a fixed cost, and they want to focus on the controllable hourly costs.  And I think this is a fair point too.  But I include management labour when I’m looking at Prime Costs.  I also include the employer portion of CPP and EI as well as worker’s compensation insurance, vacation and stat pay, benefits expenses, EHT in Ontario and BC or the HE Levy in Manitoba or the HAPSET in Newfoundland and Labrador, and any payroll service fees.  These are all costs associated with having staff in the building and as such I like to pool them all together into the total Prime Cost.

The thing about evaluating Prime Cost is that you are looking at your two largest cost centers in any restaurant.  Or at least they should be.  If you find, for example, that your occupancy costs (rent, utilities, insurance) are higher than either your cost of goods or your cost of labour than you either have something fundamentally wrong with your operation, or you have a real outlier of a successful business.  But back to my point.  Since we are trying to evaluate the two biggest, or primary, cost centers I like to look at it from a wholistic perspective.  How much did it cost for all the ingredients on the plate or in the glass, and how much did you spend on the people who make it and serve it?  That’s really all we are talking about. 

Should we include management labour in our Prime Cost?

For me, prime cost means including management salaries.  We’ve all had lazy managers who don’t seem to do anything, but most managers are very active in operations in restaurants.  They greet and seat guests.  They run food.  They jump on the line to bail out the garde station or crank out a few desserts so a table can be flipped.  They cover breaks, run a load of glasses through the washer, serve a small section during a slow afternoon or at the end of the night, and bus tables when the server is caught at a more demanding table.  And that’s just the front of house management.  Even in the union kitchens I’ve worked in the chef’s find a way to get their knives out to do some prep for a banquet or they dust off their tongs and cover the grill for an hour or two during peak service times.  And I can’t even count how many times I’ve seen a chef write something new into a menu so they can work in the kitchen regularly to train their staff on some new skills.  And all of this is on top of the more traditional management duties like writing schedules and supervising staff.  The notion of separating management from hourly labour comes from a traditional accounting approach.  It looks at larger operations, often manufacturing based, and assumes that the role of the manager is to oversee the production staff who ultimately produce whatever it is you are selling.  But that doesn’t make sense for restaurants.  And we don’t have to look at restaurants like they make lightbulbs or cars.

What should your Prime Cost percentage be though?

You can jump on board with what I like to include, or you can include flytraps in your cost of goods and exclude managers from your labour, in terms of evaluating Prime Cost.  In the end it really won’t matter, you’ll just have to adjust your base percentage.  And what is that percentage anyway?  Well, like all things, it depends.  It primarily depends on where your restaurant is and what you pay in rent or for your mortgage.  Because that is likely your next biggest cost, or at least one of them.  If you’re running a franchised location your combined franchise fees may be higher than rent.  But that’s a topic for another time.  Using my definition of what to include in Prime Cost, if you are in the downtown of a medium to large city then you probably need your Prime Cost around 60 – 65% to be left with any profit.  If you’re in an out of the way neighbourhood, or a small town, or you’ve owned your own building for 20 years you could have a higher percentage, and if you’re on Blue Jays Way in Toronto or at the corner of Davie and Denman in Vancouver you probably need it a bit lower.  The point of this article is not to tell you what the percentage should be; that will vary a little by location.  But if you start by thinking about including everything I mentioned to include, and then target 60% of revenues, then your off to a reasonable start.  From there you’ll want to do a breakeven, or CVP analysis to really start to fine tune.  Again, a topic for another article.

What can throw off my reporting?

So, what does the Prime Cost actually tell us?  Seems pretty straightforward doesn’t it.  It tells us how much we spent on the ingredients and people to make the sales that we made.  But how deep did you go into it?  

  • Did you do an inventory adjustment?  
  • Was there a stat day (or 3 of them around the end of the year) in your period?  
  • Are you running bi-weekly payroll and you had 3 pays in that month?  
  • Did a fridge go down and you lost a lot of product?   
  • Were you running a deeply discounted promo for something?  
  • Do you have an employee who likes to steal steaks?  
  • Do you have a manager who likes to void tables and pocket cash?  
  • Was it an unusually slow week or month?  
  • Were there 5 weekends in the month boosting your sales?  
  • Did a manager go on vacation and you used hourly labour to cover while still paying out the salary?  
  • Or did a manager quit and you stepped in and covered, temporarily reducing your labour?  
  • Or any of a hundred other things that could have happened to skew your numbers.

Lagging, lagging, lagging…

The thing about financial indicators is that they are great when viewed over longer time periods against your forecast and/or prior performance.  But information you pull out of your income statement for a single month or shorter time period is not where you should be focusing your energy.  Financial statements are lagging indicators.  They tell you what happened, after it already happened.  Usually, a while after it already happened.  In some cases, a year after it already happened.  And no matter how good your bookkeeper is, that data will never be the data you should be focusing on.  Absolutely you should have good records and be reviewing your financial statements regularly, whether that means monthly or quarterly will depend on your personal motivations.  Because clean financial statements will tell you if what you are focusing on is the right thing to focus on.

Do you have a financial strategy for your restaurant?

The thing about financial indicators is that they are great when viewed over longer time periods against your forecast and/or prior performance.  But information you pull out of your income statement for a You should have Prime Cost targets.  But setting Prime Cost targets is mostly about mapping out the financial strategy of your business.  Do you use a box cutter in the kitchen, or do you whip your cream by hand over an ice bath to order so it is the softest it can possibly be?  Are you a fast-food burger joint on the side of a 2-lane tourist highway employing mostly high school students for the summer season or are you running white glove French table service?  Whatever style of restaurant or bar you operate you want to map out a financial strategy that lands your Prime Cost around 60% somewhere, modified for your specific situation.  It could be 20% in labour and 40% in cost of goods.  It could be an even 30 – 30.  Mapping out the financial strategy of your restaurant is a key to running profitably and for a long time.  Each operation is unique, even in the franchise world to some extent, and you should work with your team to find the balance that is right for your operation.  But then what?

Leading is as leading does, or something like that.

The thing about financial indicators is that they are great when viewed over longer time periods against your forecast and/or prior performance.  But information you pull out of your income statement for a Since Prime Costs are lagging indicators what you want to review regularly are the leading indicators.  The things that drive your Prime Cost.  Here’s an analogy: losing weight is the lagging indicator while doing regular exercise and sticking to your diet are the leading indicators.  If you are tracking how successful you are at sticking to your exercise and diet plan then after a week or two or four you’ll know whether to expect a drop in weight because of how often you stuck to the plan versus how many times you ate a bag of chips for dinner.  And, if you stuck to your plan, any change in your weight will tell you how good your exercise and diet plan were to begin with.  But who cares about that stuff?  Most of us didn’t get into restaurants to make people healthy.

Get to the restaurant example already!

 The lagging indicator is Prime Cost.  Let’s say that after reviewing your fixed costs and other financial obligations your team has set your Prime Cost at 60% split 25% cost of goods and 35% labour.  You’ve created costed recipes for all your menu items and have written schedules based on sales projections.  And you think your biggest issues are that the kitchen staff don’t make items to spec and the management team doesn’t cut servers soon enough.  I should really emphasize here that the key phrasing is that you think you know what the problems are.  So, then you set up systems to track those two things and make adjustments to them as needed on a daily basis.  After a couple weeks or a month of doing this, you review your financial statements and see what impact the daily tracking and adjusting had on your Prime Cost.  If you stuck to your plan and nothing improved then you know those weren’t the issues and you need to try something else.  If you stuck to your plan and Prime Cost did improve then you know you found at least one of the issues.

If you didn’t stick to your plan, then you really haven’t learned anything new.

And there are lots of variables in restaurants of course, so, again, you have to approach this from your unique situation.  Maybe you need to watch things like portion control, waste, fluctuations in pricing from suppliers, actual vs scheduled hours worked against actual vs projected sales, productivity ratios, sales by hour to review operating hours, or anything else.

The Prime Cost journey is a grounding journey.  

First, you figure out what your financial statements need to look like to make a profit and stay in business based on the type of restaurant and location you are operating in.  Then you determine what you think your key leading indicators are.  The things you can monitor and adjust every day.  And then, over time, you see how effective those leading indicators were in controlling or improving your Prime Cost.  Then you make adjustments to your system, look at different leading indicators, reassess the financial model you’ve built, or just keep on truckin’ if everything is working out well.  

Your Prime Cost is a primer.  Set it and forget it.  At least until you have spent enough time working your leading indicators to know what is impactful and what is not.

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