Opening and operating a restaurant is an exciting adventure that requires a lot of time, effort, and willpower. You have to create a menu that your customers want to order from, manage your employees effectively to produce meals that are up to your standards, and control your costs to keep a healthy bottom line.
Understanding and controlling costs is one of the most important parts about managing a restaurant. Restaurant costs and expenses, however, are often confusing or misunderstood. We’ve put together this guide to break down restaurant costs, expenses, and common terms to help you understand where your restaurant is spending money and how you can track it.
What are restaurant costs?
Restaurant costs are expenditures related to opening and operating your business. They most often refer to startup costs, but also include operating costs that are vital to running a business. These are your inputs, the things you need to open your restaurant doors every work day. Costs are your assets, so rather than showing up on your profit/loss statement, they show up as assets.
In other words, a cost is the, “amount spent by the business for the purpose of acquiring an asset or for creation of the assets.” It’s what you spend to open your restaurant and prepare your meals. Understanding restaurant costs is crucial to doing a break-even analysis of your restaurant.
Restaurant costs vs. expenses
Costs are similar to expenses in that they refer to money your business pays to operate. In accounting however, they constitute distinct things. Typically, expenses refer to money spent to generate revenue, while costs refer to money spent to operate and maintain your business. Don’t worry if this feels confusing; the distinctions can be hard to spot.
Example 1: Utilities vs. Rent
Utilities are an ongoing cost to your business because it’s the price your restaurant has to pay to keep the lights on, run your dishwashers, and cook your food. Rent, on the other hand, is an expense because it is a price you pay monthly to operate (and generate revenue) within a specific location.
Example 2: Wages vs. payroll
A wage is a cost because it’s the price you pay for labor. Payroll expenses are the sum total of all your wages and salaries, which are the price you pay for menu items to be created.
Types of restaurant costs
The majority of your restaurant costs will be one-time or non-recurring payments. However (and this is where costs are often confused for expenses), some costs do recur as they relate to business operations. As such, costs are broken down into three categories: fixed costs, variable costs, and semi-variable costs.
Fixed costs
Fixed costs refer to costs that don’t fluctuate from month to month. Fixed costs are different from one-time expenses, like replacing equipment. Examples include
- Rent/mortgage
- Salaries
- Insurance
Variable costs
Variable costs change from month to month. These costs are harder to budget for and predict. Examples include
- Food
- Utilities
- Marketing
Semi-variable
Semi-variable costs are those that can be predicted and controlled, but can also fluctuate based on need or usage. The most notable example is labor: you can predict the cost for salaried workers, and make plans for wages, but hours worked are still inherently variable.
Startup costs for restaurants
Opening a restaurant entails a different set of costs than continuously operating one. There’s no set number for how expensive opening a restaurant can be because factors like rent, equipment, square footage, and food cost can vary greatly. One survey suggests startup costs can range anywhere from $150,000 to $750,000.
Like any business, startup costs entail a mix of financial and construction costs, as well as first-time purchases of equipment, labor, and inventory. Here are some common startup costs.
Renting or buying commercial space
Renting or buying commercial space often constitutes a large part of your initial investment. Signing a commercial lease usually requires a long-term commitment of at least three years, in addition to a security deposit, which is usually at least three months’ rent.
Buying commercial space is a different beast. Down payments, much like for a home, range between 15% and 40%. And then there are closing and broker’s fees. Those costs will depend entirely on your location and the price per square foot.
Construction and/or renovation
After securing a space, there are likely going to be some construction and renovation costs. Those include carpentry, plumbing, electric work, and interior design. Those costs will vary based on your restaurant’s style, setup, and decor. If you’re renting commercial space that hasn’t been used for food preparation before, you may require additional construction to build out a kitchen with proper connections for appliances.
Initial supplies and equipment
Supplies and equipment are the meat and potatoes of your restaurant. You’ll need to factor in what kind of appliances, equipment, and workstations your prep and plating will need. Since these are startup costs, it’s important to think short and long term.
With items that require regular replacement, start out with what you need for the first month (unless buying in bulk makes sense.) For equipment such as appliances and basics such as utensils, knives, and pans, buy what you’ll need for a conceivable length of time — unless you plan on replacing them often, too.
Labor
Initial labor costs include hiring costs for salaried and hourly workers, as well as the first month of wages. Labor costs vary over time, so startup costs are mostly based on hiring what you need to open the doors.
Marketing
This part is crucial. It’s how you’ll land your first customers, who will help make or break your success.
Initial marketing costs include flyers, physical and digital ad placements, social posts, and signage. You may even work with influencers or create an event around your grand opening.
Software and technology
Restaurant software is incredibly important for managing your operation. You can find more efficiency, scale faster, and save money by investing in technology up front. Accounting, inventory management, labor management, staff management, and marketing communications can and should be automated or managed through software.
First month’s inventory
Before you open your doors, you need a supply of inventory on hand. That’s why it’s commonly recommended to add the first month’s inventory into your startup costs. That will give you a good baseline before your inventory deliveries begin.
Hidden restaurant costs
When opening a restaurant, there will always be hidden costs. Maybe something breaks during installation, or some inventory spoils before you open, or maybe there are some construction mishaps. Whatever it may be, be prepared for some unexpected turbulence in your budget.
No need to grab the oxygen mask, however. Murphy’s Law, you shouldn’t spend too much time budgeting for what could go wrong.
Typical monthly costs
Depending on the type and size of your restaurant, you may have different costs related to operating your business. For example, an Asian fusion food truck will have different operating costs from a high-end sushi restaurant. In general, however, there are (roughly) six categories of restaurant costs:
- Financial: loans, security deposits, rent
- Labor: wages, salaries, and benefits
- Food: inventory and inputs
- Utilities: electricity, heat, water
- Equipment: supplies, appliances
- Software: POS, labor management, accounting
Labor, food, rent, and utilities are the most significant cost categories for restaurants.
Controlling restaurant labor costs
Labor costs cover everything you pay to employ an individual. That includes wages, salaries, insurance, benefits, and training. Controlling labor costs requires a combination of retention strategies, task automation, and creativity. It actually costs more to replace an employee than it does to hire them, and a labor shortage can seriously reduce efficiency.
Automating tasks through software like your POS system can help save on headcount and improve the efficiency of your front- and back-of-house staff.
Keeping tabs on food costs
After labor, food costs are the most significant costs in your restaurant. Food costs are essentially how much it costs your restaurant to produce a dish without labor. It essentially determines how much each ingredient — or input — costs when making a meal.
There are three ways to understand your food costs: by recipe, by month, and by restaurant (if you have multiple locations). Understanding your food costs can help you optimize your menu prices and figure out how much inventory you should carry at a given time. Food cost can also give you insight into your suppliers, so you can figure out whether you’re getting the best prices or if you need to find a different vendor for a particular ingredient.
Understanding utility costs
Utility costs are the price you pay to keep the lights on. Typically, they entail your electricity, heat, and water. Staying on top of your utility costs is critical, as a surprise gas bill might eat deeper into your bottom line than you’d expect.
Energy-efficient appliances, insulation, and airflow can help cut down on utility costs, as well Similarly, implementing waste-reducing procedures such as turning off lights when you leave the room, keeping the fridge closed, and reducing water consumption can also make a huge difference each month.
The restaurant prime cost
There are so many different ways to slice and dice your balance sheet to identify and understand costs. The best place to start, however, is your prime cost. It’s a simple formula that combines the two most significant costs in your restaurant: goods and labor.
Total Cost of Goods Sold + Total Labor Costs = Prime Cost
You can compare your prime cost to your total sales to get a rough estimate of how you’re doing over a given period of time. Dividing your total sales by your prime cost will give you the prime cost percentage.
Prevailing wisdom says you should keep your prime cost around or below 60%. Depending on the type of operation you’re running, your costs may trail higher if you’re a full-service restaurant with higher labor costs, or slightly lower if you’re a takeout joint. If your prime cost percentage is higher than 65%, you can use your prime cost ratio, the ratio between COGS and labor, to identify at a glance what needs reducing.
Common costs in restaurants and how to reduce them
In the restaurant business, reducing costs is the name of the game. But it’s crucial to reduce costs without reducing quality. Many restaurants experience similar costs, even if the factors driving them may differ.
Food waste and spoilage
Food waste and inventory spoilage can drive up your food costs. Studies suggest that between 4% and 10% of restaurant food is wasted before it reaches the consumer.
Identifying where waste occurs is the first step, the next step is to think practically about why it’s being wasted .Are your prep chefs using the right techniques? Are your portion sizes too large? Are you buying too much of an item, which then spoils before turning over? Diving into your inventory analytics can help answer those questions.
Prices too high or low
When prices are too high or low, you can lose money on producing a plate, or lose sales because people won’t pay for that plate. Price misalignment can wreak havoc on your bottom line, and can lead to you reducing your menu size or raising other prices to compensate.
High costs to hire/retain
On the other end of your prime cost is labor, and the most common source of labor costs is the cost to hire and retain an employee. A wage may be the price of labor for an hour or a pay period, but labor costs also include training, efficiency, and production capacity. When you have high turnover, you actually lose more money rehiring people.
Next steps: maximizing cost efficiency in your restaurant
Controlling costs in your restaurant is critical to your success. It’s not enough to just lower costs. You want to do it efficiently, and in a way that won’t hamstring your growth or hurt the quality of your experience. Cheaping out on ingredients or running a skeleton crew isn’t always the best way to reduce costs.