I very frequently have conversations with people thinking about opening a restaurant. I enjoy these conversations. I wish I could have had such a conversation in 1976, when I was starting Bel Canto!
At the close of these often rambling conversations I like to ask “What was most useful to you here?” The answer almost always includes my having explained the basic benchmarks we use for assessing the financial health of a restaurant operation. So let’s get these basic orienting points on the table:
If Revenue exceeds Expenses, one has Profit. If not, one has a Loss. The Profit and Loss Statement (“P&L”) is the basic scorecard for the operating team.
We say basic health for a restaurant business is to show a Net Operating Profit (“NOP”) equal to at least 10% of Revenue.
Can a start-up achieve this? Yes!
Experienced operators with a strong team and a menu mix that is right for the location can achieve this out of the gate. Admittedly, most do take a little while to get there. Having some working capital is key to managing the stress until one becomes profitable.
Breaking even is the first order of business. I never plan to operate at a Loss, and seek to address the causes of Loss straight away.
Once past the start-up phase, an exceptional performance would be 13% to 18% NOP. We have numerous clients achieving NOP in this range. Some very busy places with phenomenal operating teams achieve NOP over 20%!
You need at least 10% NOP for multiple reasons. (See NOTES below.) But let’s return to our basic orientation: 10% NOP means that 90% of Revenue is consumed by Costs and Expenses. We divide these into Prime Costs and Overhead Expenses. We strongly advise that no more than 60% of Revenue be devoted to Prime Costs. No more than 30% should be spent on Overheads.
Prime Costs are the cost of ingredients, or Cost of Goods Sold (“COGS”) and the wages, salaries and related benefits and taxes, or Direct Labor Cost (“DL”). In a chef-led scratch kitchen or in a bakery, the COGS could be as low as 20% and the DL as high as 40%. In most situations, though, the COGS and DL are closer to 30% each. The point to understand is that COGS and DL interact, and together they should not exceed 60% of Revenue.
Primes less than 55% are suspect: Are they achieved with an insane workload shouldered by the BOH? This is not sustainable over time. In a peak season, such numbers might be booked for a week or two. It’s always a challenge to do it, but it would be smarter to staff up rather than risk burning people out.
Overheads well under 30% are often achieved by busy restaurants. Many Overheads are more or less fixed, so as a restaurant picks up steam, one can enjoy good leverage on these.
Here is the key: Don’t squander good Overhead numbers by tolerating Primes over 60%. Primes at 60% and Overheads at 22%-25% make for a great business.
We carefully define the P&L terms introduced above, in accordance with Generally Accepted Accounting Principles (“GAAP”.) While GAAP is the US Standard, its embrace is far from universal, even among accountants. The same terms are used loosely in everyday conversation, and you can be misled. A term like “Income” is used many different ways. We avoid its use entirely.
You might be surprised by what is recognized as Revenue and what is not. Likewise for COGS, DL, NOP and etc. See Glossary.
The National Restaurant Association publishes many interesting stats. They report that the national average for an independent full service restaurant’s NOP hovers around 5%. Some years a little lower, some a little higher. Never as high as 10%! In our view, this reflects the poignant reality that the industry attracts many who, if they survive, do so with passion and willingness to work hard despite limited financial management skill.
Ten percent NOP is needed because there are many demands on Profit before a responsible owner takes money home:
- 1) One must pay taxes on it for starters, to the state in many states, as well as to the Fed.
- 2) If there is debt, or committed payments to investors, these must be serviced. The principle portion of loan payments is taken from the Profit. (The interest portion is an expense.)
- 3) It is imperative to build a cash reserve for unforeseen challenges, though many fail to do so.
- 4) Capital equipment will need to be replaced.
- 5) Facilities must be refreshed or improved periodically.
- 6) Opportunities to expand or invest in new sites can be seized only if capital is ready.
- 7) And smart operators craft an incentive program for their team, funded by sharing profits achieved in excess of a stated threshold.