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

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.

Tipped Employees

According to the U.S. Department of Labor, a tipped employee is one who regularly receives at least $30 a month in tips.

Reporting 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.

Allocating 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.

Service Charges

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.

Tip Credits

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.

Inventory Management

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

Example

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

“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

Example

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.

Daily Sales

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

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.

Income Statement

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.

Software Solutions

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.