The corner cafe, upscale bistro and fine dining restaurant serve different dishes, but all face at least a few common issues when it comes to accounting. Restaurant accounting includes items unique to the food service industry. Whether you outsource your accounting function or not, you would benefit from learning at least the basics.
Payroll probably represents the largest portion of your expenses. Though payroll expenses vary by region, type of restaurant and the restaurant itself, labor costs typically range from 25 to 40 percent of gross revenue.
Labor costs include salaried employees, hourly wages, benefits, taxes and tips. Minimum guidelines for all of these labor expenses are in place on the federal level, but there is much variation at the state and even local levels. In Washington, for example, employers must pay employees a minimum of $12 per hour as of April 2019. But the city of Seattle requires that employees receive a minimum wage of $15 per hour, which is twice the national minimum.
Be mindful of which wage laws and minimum wages apply to your workforce, especially when it comes to the handling of tips. Employers have multiple obligations for documenting and reporting tip income, as well as for paying taxes on that income.
According to the U.S. Department of Labor, a tipped employee is one who regularly receives at least $30 a month in tips.
Under Internal Revenue Service regulations, employees must keep a daily record of the cash and non-cash tips received, either directly or indirectly. If they receive at least $20 in tips during the month, then employees must report the amount of cash tips to their employer by the 10th of the following month. (Employees must report any non-cash tips on their individual tax return. They do not report these to employers.)
Employers must keep their employees’ tip reports. They also must withhold employee income taxes and the employee share of social security and Medicare taxes for both wages and tip income received. You must report this information to the Internal Revenue Service on the quarterly federal tax return filing (Form 941). Employers also must pay the employer share of social security and Medicare taxes for the total wages paid to tipped employees as well as the reported tip income.
Owners of large food and beverage establishments have additional tip reporting requirements. They must file Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips.
If you operate a large food and beverage establishment (which means, according to the Internal Revenue Service, on a typical business day you employ at least 10 staff, among other criteria), then you might need to allocate tips. If the total reported tips total less than eight percent of your gross receipts, then you need to allocate the difference among your tipped employees.
Be sure you do not treat service charges as tips. Tips are voluntary payments from customers to employees. Service charges are non-optional fees charged to the customer by the restaurant. Service charges are part of the restaurant’s gross income.
Under the Federal Labor Standards Act, employers may pay tipped employees a reduced wage as long as that wage plus the tip income total the minimum hourly wage. The employer’s reduced liability is known as a “tip credit.” The federal guidelines as of April 2019 allow for up to $5.12 per hour in tip credit. This means that employers must pay an hourly wage of at least $2.13. Only 17 states match the federal minimum cash wage amount, though. Some states do not allow tip credits at all.
If your state does allow tip credits, then you must calculate the appropriate tip credit every payroll. You must make sure that the employee earns at least the minimum wage through a combination of cash wages paid by you and tipped income earned by the employee.
You probably spend about a third of your expenditures on your food and beverage inventory. Accurately tracking and effectively managing your inventory is critical to daily operations as well as long-term profitability. Without proper inventory management you can not accurately track the cost of goods sold.
Cost of Goods Sold
Knowing the cost of goods sold, or COGS, is one of the key accounting terms restaurant managers should know. It is essentially a calculation of how much it costs to make your menu items. COGS is typically one of a restaurant’s largest expenses. Identifying your COGS allows you to do the following:
- Prevent theft of inventory
- Identify ways to minimize the costs, such as negotiating better rates with your food distributor
- Adjust menu offerings or prices
- Report accurately on financial statements
- Report accurately on tax filings, and be sure you are not paying taxes on income that you should not be, since COGS reduces your gross income and thus reduces your tax liability
Basically, reducing your COGS adds to your restaurant’s profit.
To calculate COGS, you need to record your inventory levels at the beginning of a period of time and at the end of that period of time. You also must record any additional inventory purchases. The equation for COGS is:
Beginning Inventory + Purchased Inventory – Final Inventory = Cost of Goods Sold
For example, at the beginning of the week, your food inventory totaled $4,000. During the week, you bought another $1,500 in food. At the end of the week. you have $3,000 left in inventory. That means your COGS is $2,500 for that week.
Inventory management can be a time-consuming process. Various software solutions are available to help streamline and improve your processes, though. For example, Sourcery scans your restaurant invoices, reads all the data, and tracks costs of individual food items. This line-item invoice tracking and monitoring of data improves the accuracy of your COGS calculation. The automated nature of the scanning saves your staff time and headache.
“Prime cost” is another key restaurant accounting term. Its basic equation is as follows:
Cost of Goods Sold (COGS) + Total Labor Cost = Prime Cost
Again, the prime cost will vary by the type of restaurant and location. This number on its own does not provide much information about the restaurant’s performance. For context, you need to calculate the prime cost in relation to revenues. A high-end restaurant with premium ingredients will have a relatively high prime cost, to reflect the higher wages paid to service staff and the more expensive ingredients. But this high-end restaurant almost certainly has higher menu prices and thus higher revenues, so its prime cost as a percentage of sales will not necessarily be any higher than a more affordable diner down the street.
Generally, a financially healthy restaurant’s prime cost should be about 60 to 65 percent of the gross sales. Ideally, the prime cost as a percentage of sales should be lower than 60 percent. To calculate the percentage of sales, use the following formula:
Prime Cost / Total Sales = Prime Cost as a Percentage of Sales
To illustrate why it is important to calculate the prime cost as a percentage of sales, let’s compare two restaurants. One is a fine dining restaurant (Restaurant A) and the other a small cafe (Restaurant B). Restaurant A has a monthly COGS of $50,000 and labor costs of $10,000.
- $50,000 + $10,000 = Prime Cost
- $60,000 = Prime Cost
Restaurant B has a monthly COGS of $30,000 and labor costs of $5,000.
- $30,000 + $5,000 = Prime Cost
- $35,000 = Prime Cost
Comparing the two restaurants’ prime cost reveals nothing about how the two are performing financially, though.
In the same example, if Restaurant A’s total sales for the month totaled $100,000:
- $60,000 / $100,000 = Prime Cost as a Percentage of Sales
- 60 percent = Prime Cost as a Percentage of Sales
And if Restaurant B’s total sales for the month totaled $50,000:
- $35,000 / $50,000 = Prime Cost as a Percentage of Sales
- 70 percent = Prime Cost as a Percentage of Sales
In this example, then, Restaurant A seems to be performing very well financially and better than Restaurant B. The first restaurant has $0.40 of every dollar in sales left to pay other expenses, like rent, and hopefully profit, while the second restaurant has only $0.30 left to pay all other expenses.
Importance of Tracking Prime Cost
Nationally the cost of food continues to rise. Additionally, labor costs continue to increase, especially in parts of the country that have enacted minimum wage increases. Los Angeles, for example, raised the minimum wage three times since 2016. These costs add up to your prime cost. Uncontrolled prime costs with stagnant revenues lead to lowered profits and sometimes means the closing of a restaurant.
Tracking your prime cost, especially tracking your prime cost as a percentage of your sales, allows you to make timely adjustments. You can increase menu prices or change your menu offerings to include impressive dishes with lower-cost ingredients.
At the end of the day, you will close out your credit card transactions. This initiates a transfer of funds from the credit card holder’s account to yours. This means you will have a daily deposit of funds. Be sure to track these daily deposits in your accounting system for the most accurate picture of your finances. These daily sales also are important to your tipped employees, who likely will have received tips on credit cards. You must pay these tips to the employee by the next payroll after receipt.
Financial statements are accounting reports that provide a snapshot look at how your restaurant is performing financially. These statements help you spot weaknesses in your operations. They help you assess the profitability of your restaurant, both in the short-term and long-term.
The usefulness of the financial statements, of course, depends on the accuracy of the information used to create the statements. This is one reason why accurate and timely entry of accounting information is critical. Managers should regularly review a few key financial statements. This will help you know whether your restaurant has enough revenue to cover its expenses, whether expenses need to be better controlled and more.
The income statement, also known as a profit and loss statement or P&L, shows your restaurant’s performance over a period of time. The basic formula for an income statement is:
Total Sales – Cost of Goods Sold (COGS) – Expenses = Profit (or Loss)
Cash Flow Statement
The cash flow statement shows you how much cash is coming into your restaurant during a period of time. It shows the sources of that cash. The statement also shows where the cash is going to during that same period of time. This is important to monitor to make sure your restaurant has enough cash incoming to cover the necessary expenses.
The cash flow statement includes sections on operating activities, financing activities and investing activities. Most of the cash flow usually will happen in operating activities. A typical cash flow statement might show the income generated by sales, the changes in inventory and the amounts paid out in payroll.
Simplify your restaurant accounting functions through the use of smart software solutions. Use a restaurant accounting software that integrates with the point-of-sale system in use by your front-of-house staff. Implement automated tracking systems to help manage inventory. Use Sourcery to automate invoice scanning and to improve the accuracy of food cost tracking.