Information on industry standards or average spend for food, labour, marketing, and operational costs as a percentage of sales is readily available from many sources especially Restaurant Canada’s “Foodservice Facts.” However, what are the strategies around spending on various assets and using those assets to achieve profitability? What can the numbers tell you and do you know how to read those financial statements that tell the story? What should your food cost and labour costs be? What about operating, advertising, repair and maintenance costs?

The answer is: It depends. It depends on the concept you are running — upscale, casual, quick service, limited service, location, theme, etc. There are no hard and fast rules as to costs. It boils down to your vision of the business. How do you want your customer to perceive your operation, what value proposition do you offer and what is it going to cost to operationalize the concept? The more important question is how do you maximize profit based on your vision or business concept?

Common failure warning signs

An early warning sign of possible failure is when food and beverage purchases plus labour expenses (wages plus employer paid taxes and benefits) exceed 70 cents of every dollar in sales. The combined total of these two cost categories is referred to as “prime cost” and it is these two costs where the battle for profit is either won or lost. Unlike utility and insurance expenses that are relatively fixed, food and labour cost can be directly controlled. Owners can become more effective purchasers, product handers or adjust menu pricing. Similarly, hiring practices and scheduling can impact labour costs. The bottom line is, when prime cost percentage exceeds 70 per cent, it is a red flag. Unless the restaurant can compensate for these higher costs by having, for example, very low rent (e.g. less than four per cent of sales), the likelihood of being profitable is perhaps impossible.

It should also be noted here that occupancy expenses most often make up the single biggest expense after prime costs, and averages around six to seven per cent of sales. As a fixed expense the only way that you can reduce this ratio is to increase sales. Here again it is all about the numbers and knowing the potential solutions to control prime cost. Simulations, which are further explained later in this article, are an effective way to test potential solutions in a risk-free environment.

Mastering cash flow management

The old adage cash is “king” is true. Do you know how much cash you have and what you spend it on?  It is vital that you keep a close eye on cash flow. You must make sure you have enough cash to cover big expenses, like food orders and payroll, every week, along with all the other bills that come with a restaurant. If your chequing account starts running into the red, it is time to look for ways to save money at your restaurant. Many operators do not know where to find this information other than their bank statements and then it is too late. Many operators do not understand cash flow statements or how to project cash flow. A cash flow statement lets you know how much you have to spend for the next period of time.

It is all about the numbers. Bottom Line or Profit versus Top Line or Revenue. The ultimate assessment is based on:

• Return – Investment financial return. What did it cost to build the restaurant and was there a financial return on the money you/owner(s) invested;
• Efficiency – Management’s operating performance. Did you spend your money efficiently on assets to be used to make a profit, and;
• Risk – The investment survival outlook. Could you have made more money on your investment elsewhere?

A successful restaurant has a well-defined concept that not only includes good food and service but an operating philosophy that encompasses all business operations — a balanced approach to spending in those areas that support the vision and concept of the restaurant.

Key factors for success

Restaurant viability is often linked with the amount of capital investment yet many successful restaurants have started with little capital. This suggests that ongoing financial management may be a better predictor of restaurant viability. In fact, the internal environment of the restaurant (strategy, product, management, marketing, operating, entertainment, repairs and maintenance and capital improvements) is the most critical factor of restaurant viability. Therefore, it is imperative to understand and control the numbers that result from strategic actions in each of these internal environment areas. It is the success of these actions in terms of the efficiency of management’s operating performance that will lead to achieving the targeted revenue and profit.

Management efficiency must occur at all levels. Every manager must be able to understand and control the numbers. First they must know where to find the information they need — Income Statement, Balance Sheet, Cash Flow Statement or Operating Reports. They must be able to identify what they spent and the results of that expenditure. In most cases management have difficulty understanding these financial statements as many have had no formal business education and if they have some experience they have difficulty interpreting the information before them. 

Helps teach strategy

Simr – The Restaurant Simulation, which we developed at the Ted Rogers School of Hospitality and Tourism Management at Toronto’s Ryerson University, has proven to be effective in helping restaurant managers quickly understand the importance of a well-defined strategy that drives the actions and goals required for success. In real time it allows participants to see the financial results of their strategic actions.

Simr is a “total enterprise simulation” which deals with the entire organization, provides a balanced number of decision variables in marketing, production (operations) and finance, and thus requires the strategic integration of several subunits for organizational performance. It is designed to replicate the operation of a restaurant over a six-year time period. By networking up to ten teams in one of five scenario cities it focuses on the competitive nature of the restaurant business, emphasizing profitability. The “virtual” restaurant provides the illusion of running a “real” restaurant with full menu and operating control, as well as complete integrated results and financial statement output. The “unique” restaurant data dashboard rates and ranks each restaurant on an annual basis and leads the participants to a high level of learning and an understanding of operating and controlling a restaurant.

Putting concept into practice

Simr emphasizes applying concepts in an action-oriented approach. Participants have to make decisions over a number of iterations composed of simulated weeks, months and years. They analyze situations, identify problems and opportunities, make decisions and implement them. The rapid feedback on the value of these decisions, together with the motivating nature of the competitive situation, provides the context and the means for an effective learning experience.

The objective of the simulation is to develop skills to effectively apply concepts through making decisions and taking appropriate courses of action focused on operating control and profit maximization.  In the simulation, by building and implementing a restaurant business plan, participants, unlike in the real world where experimentation is high-risk, can safely explore and test different tactics to assume control and to increase profitability.

In these days of fast-paced change and instant feedback it is an even more complex process to successfully operate a restaurant and react to the constantly changing environment. Simr allows operators to put their skills to the test and learn how to make better use of financial statements, reports, and market research, and to understand operating control skills so important to achieving profitability.

See also:

About the authors:

David Martin and Bernie McEvoy are Professors at the Ted Rogers School of Hospitality and Tourism Management, Ryerson University. You can find out more about “Simr – The Restaurant Simulation” at www.simrsimulation.com.