Marty Bombenger's Rules of Thumb: How Does Your Operation Measure Up to Industry Averages…

The first and most fundamental restaurant rule of thumb is “every  independent restaurant is unique.” However, rules of thumb regarding  the financial and operational aspects of restaurants can provide a  valuable starting point for evaluating and understanding the financial  feasibility and performance of proposed and existing restaurants.
Restaurants generate a lot of numbers so particularly for those new to  the industry, deciding what numbers to focus on first and knowing what  they mean can be more than a little perplexing. Rules of thumb can help  operators determine where to look first and what to expect.
This article discusses several of the restaurant industry’s basic rules  of thumb. While there will always be exceptions, they have proven to be  surprisingly reliable over the years that I have worked with operators  who collectively manage thousands of diverse restaurant operations.  Keep these numbers handy when planning your restaurant and assessing  your performance after you open.
Investment Rules of Thumb
One of the primary indicators chain operators use for evaluating the  feasibility of a new location is the sales-to-investment ratio. This  ratio compares the projected annual sales of a proposed site with its  estimated startup cost. The ratio looks like this:
Sales to Investment = Annual Sales /Startup Cost
Startup cost includes all the costs necessary to open the restaurant  including leasehold improvements (or land and building), furniture and  equipment, deposits, architectural and design, accounting and legal, preopening expenses, contingency and working capital reserve.
Sales to investment – leasehold. When evaluating the feasibility of a  proposed restaurant in a leased space, a rule of thumb says that the  sales-to-investment ratio should be at least 1.5 to 1, or a minimum of  $1.50 in sales should be expected for every $1 of startup costs. This  means that if the cost of opening a restaurant in a leasehold situation  was estimated to be $500,000, the location should be given further  consideration only if the annual sales volume of at least $750,000  could be a realistic expectation.
Sales to investment – own land and building. The rule of thumb for  restaurant projects in which the operator owns the land and building  calls for a sales-to-investment ratio of at least 1 to 1, or $1 in  sales for every dollar of startup costs.
While there are many other considerations in deciding whether to open  in a particular location, this is one ratio that many operators use as  an early indicator of whether to move on to other factors in the go/no  go decision process.
Profitability Rules of Thumb
Sales per square foot. While not all high-volume restaurants make lots  of money, they do have the greatest opportunity to generate a sizable  amount of profit. Sales volume is the most reliable indicator of a  restaurant’s potential for profit and a useful way to look at sales  volume when evaluating profit potential is through the ratio of sales  per square foot.
It’s easy to calculate a restaurant’s sales per square foot. Just take  annual sales and divide by the total interior square footage including  kitchen, dining, storage, restrooms, etc. This is usually equal to the  net rentable square feet in a leased space. The ratio looks like this:
Sales Per Square Foot = Annual Sales /Square Footage
In most cases, full-service restaurants that don’t generate at least  $150 of sales per square foot have very little chance of generating a  profit. For example, a 4,000-square-foot restaurant with annual sales  of anything less than $600,000 would find it very difficult to avoid  losing money. This works out to $50,000 in monthly and $12,000 in  weekly sales.
Limited-service restaurants that generate any less than $200 of sales  per square foot have little chance of averting an operating loss.  Industry averages reveal that limited-service restaurants tend to have  slightly different unit economics than their full-service counterparts.  Higher occupancy costs (on a per-square-foot basis) and lower check  averages are two of the primary reasons for this difference.
At sales levels of $150 to $250 per square foot (full-service) and $200  to $300 (limited-service), restaurants with effective cost controls may  begin to approach break-even, with some well-managed operations able to  achieve a net income of up to 5 percent of sales.
At sales levels of $250 to $325 per square foot (full-service) and $300  to $400 (limited-service), restaurants may see moderate profits, which  are defined as 5 percent to 10 percent net income (before income taxes)  as a percentage of total sales.

start quote. . .Generally, you don’t want management salaries to exceed 10 percent of sales in either a full- or limited-service restaurant. This would consist of all salaried personnel.end quote

High profit can be defined as sales levels more than $350 per square  foot (full-service) and more than $400 (limited-service). Generating  sales at these levels affords the opportunity for some operators to  generate a net income (before income taxes) in excess of 10 percent of  sales.
There are many factors that influence a restaurant’s profitability  besides sales volume. Two of the biggest are prime cost and occupancy  costs. Without competent management and effective systems and controls  over food, beverage, labor and other operating expenses, no amount of  sales will produce much more than mediocre operating results.
Likewise, occupancy costs, which are not controllable by restaurant  management, will have a significant effect on profitability. The sales  volume rules of thumb above assume an “industry average” occupancy cost  from $15 to $22 per square foot. If your occupancy costs are higher  than $22 per square foot, the sales numbers above will be low when  using them to evaluate your restaurant’s profitability.
Percentage of Cost Rules of Thumb
Food cost. Food cost as a percentage of food sales (costs/sales) is  generally in the 28 percent to 32 percent range in many full-service  and limited-service restaurants. Often, more upscale full-service  concepts, particularly those that specialize in steaks and/or fresh  seafood can have food cost of 38 percent, 40 percent and even higher.  Conversely, I’m familiar with some gourmet pizza restaurants in upscale  areas that are able to consistently achieve a food cost of 20 percent  and sometimes even less.
Alcoholic beverage costs. Alcohol costs vary with the types of drinks  served. Among the reasons that bar service is so desirable are both the  relative profitability of alcohol and the ability to control costs, as  long as servers are trained to pour accurately, and theft is not a  significant problem. Below are typical costs in percentages:

  • Liquor – 18 percent to 20 percent.  
  • Bar consumables – 4 percent to 5 percent as a percent of liquor sales (includes mixes, olives, cherries and other food products that are used exclusively at the bar).  
  • Bottled beer – 24 percent to 28 percent (assumes mainstream domestic beer, cost percent of specialty and imported bottled beer will  generally be higher).  
  • Draft beer – 15 percent to 18 percent (assumes mainstream domestic  beer, cost percent of specialty and imported draft beer will generally  be higher).  
  • Wine – 35 percent to 45 percent (the cost percentages of wine can  vary dramatically from restaurant to restaurant depending primarily on  the type of wines served. Generally, the higher the price per bottle,  the higher the cost percentage).

NOTE: All percentages above are the ratio of each item’s cost  divided by its sales, not total sales or total beverage sales. For example,  liquor cost percentages above are based on liquor costs divided by liquor sales.  This applies to the nonalcoholic beverage costs discussed below as well.
Nonalcoholic beverage costs. It is standard industry practice to record  nonalcoholic beverage sales and costs in Food Sales and Food Cost accounts, respectively:

  • Soft drinks (post-mix) – 10 percent to 15 percent (another rule of  thumb for soft drinks is to expect post-mix soda to cost about a penny  an ounce for the syrup and CO2).  
  • Regular coffee – 15 percent to 20 percent (assumes 8-ounce cup, some  cream, sugar and about one free refill).  
  • Specialty coffee – 12 percent to 18 percent (assumes no free refills)  
  • Iced tea – 5 percent to 10 percent iced tea is the low food cost champ of  all time. Cost of the tea can be less than a penny per glass. Biggest  cost component in iced tea is usually the lemon slice.

Paper cost. In limited-service restaurants paper cost should be  classified as a separate line item in “cost of sales.” Historically,  paper cost has run from 3 percent to 4 percent of sales. However, the  recent run-up in the cost of many paper goods has increased the paper  cost percentage to more than 4 percent of sales in many restaurants. In  full-service restaurants, paper cost is usually considered to be a  direct operating expense and normally runs from 1 percent to 2 percent  of total sales.
Payroll and Salaries
Payroll cost as a percentage of sales includes the cost of both salaried and hourly employees plus employee benefits, which includes payroll taxes, group, life and disability insurance premiums, workers’ compensation insurance premiums, education expenses, employee meals, parties, transportation and other such benefits. Total payroll cost should not exceed 30 percent to 35 percent of total sales for full-service operations, and 25 percent to 30 percent of sales for limited-service restaurants.
Generally, you don’t want management salaries to exceed 10 percent of  sales in either a full- or limited-service restaurant. This would  consist of all salaried personnel including general manager, assistant  manager(s), chef or kitchen manager.
One caveat on this would be in a situation in which a working owner  fulfills the role of the general manager and/or chef and takes a salary  in excess of 3 percent to 4 percent of sales. When this occurs,  management salaries can easily exceed 10 percent of sales and total  payroll cost can appear excessive as well.

start quote. . .Some people might be surprised that some of the most profitable restaurants in our industry have a food cost in excess of 40 percent.end quote

 
To compensate for a highly  paid working owner when comparing costs and margins that contain  management salaries, subtract the amount of the owner’s salary that  exceeds 4 percent of sales. This will make comparisons to industry  averages and rules of thumb much more meaningful and useful.
Hourly Employee Gross Payroll · Full-service Restaurant – 18 percent to 20 percent · Limited-service Restaurant – 15 percent to 18 percent
Limited-service restaurants generally have lower hourly payroll cost  percentages than full-service restaurants. In limited-service  restaurants, managers often perform the work of an hourly position in  addition to being a manager. In some cases, however, hourly workers may  also perform management roles on some shifts, which could lead to  higher hourly payroll costs in these restaurants.
Employee Benefits · 5 percent to 6 percent of total sales · 20 percent to 23 percent of gross payroll
Employee benefits can vary somewhat depending primarily on state  unemployment tax rates and state workman’s compensation insurance  rates. California, for example, has had for the past several years very  high workers’ compensation premium rates as compared with rates in  other states. Restaurants that are new or have had a large number of  unemployment claims may have state unemployment tax rates that could  cause their employee benefits to be higher than the rules of thumb  above.
Prime Cost Rules of Thumb
Prime cost is one of the most telling numbers on any restaurant’s  profit-and-loss statement. Prime cost is arrived at by adding cost of sales and  payroll costs as shown in the Prime Cost Calculation chart below:


 
Prime cost reflects those costs that are generally the most volatile  and deserve the most attention from a control standpoint. It’s very  easy to lose money due to lax or nonexistent controls in the areas of  food, beverage and payroll. Many successful restaurants calculate and  evaluate their prime cost at the end of each week. (For more  information, see “How to Make Your Profit & Loss Statement One of Your  Most Important Management Tools.”)
In the chart, if total sales were $60,000, then prime cost would be  running $39,100 or 65 percent of sales.
Prime Cost · Table-service – 65 percent or less (total sales) · Limited-service – 60 percent or less (total sales)
As prime cost exceeds the above levels it becomes increasingly  difficult to achieve and maintain an adequate bottom-line profit in  most restaurants. When looking at a restaurant’s overall cost  structure, prime cost can be very meaningful, particularly in cost of  sales and payroll cost. Some restaurants, such as steak and seafood  restaurants, may carry very high food cost and yet be extremely  profitable. Again, this can be exhibited by looking at prime cost.
Some people might be surprised that some of the most profitable  restaurants in our industry have a food cost in excess of 40 percent.  I’m familiar with a seafood restaurant outside of a major Midwest city  that, according to reliable sources, consistently operates with a food  cost of 45 percent or higher, which is not all that uncommon in  restaurants specializing in high-quality steak and/ or seafood.
You might be thinking, though, how any restaurant could make money let  alone be highly profitable when its food cost gets close to 50 percent  of sales. Well this particular restaurant does more than $20 million in  annual sales in about 20,000 square feet. This means that its sales are  more than $1,000 per square foot, which is among the highest in the  industry.
Even though their food cost is as high as say 45 percent, what do you  think is their labor cost as a percentage of sales when they generate a  sales level this high? I’m fairly certain it’s much lower than the  industry average, which is around 30 percent to 35 percent. In fact,  their payroll, including management, hourly staff and taxes and  benefits is probably around 15 percent to 18 percent of sales, but  let’s say it’s 20 percent to be conservative.
Let’s also assume that their sales mix is 85 percent food and 15 percent  liquor, beer and wine. If their combined beverage cost is, say, 25 percent of  beverage sales, here’s an estimate of their prime cost percentage (see below):


 
If our assumptions about beverage and payroll costs are fairly  accurate, you can see that its prime cost is well below the 65 percent  threshold. This means that even with a very high food cost, this  particular restaurant should be very profitable, assuming its remaining  costs and expenses are in line with restaurant industry averages.
Some restaurants, like many ethnic concepts, have relatively low food  costs, with some well under 30 percent of sales. You might think that  these restaurants would be extremely profitable. They might be, but  often these restaurants have lower check averages and are more labor  intensive, so their payroll costs are much higher as a percentage of  sales than, say, a steak or seafood restaurant.

start quote. . .Determining the reasons for any differences may prove to be an insightful process in learning more about the financial and operating nuances of your restaurant.end quote

Looking at cost of  sales and payroll costs together as prime cost usually provides a much  more meaningful and valid indication of a restaurant’s cost structure  and potential for profit.
 
Rent and Occupancy Cost Rules of Thumb
Rent (6 percent or less). Rent used here is the ongoing payments made  by an operator to the lessor for the use of premises. Rent payments may  be fixed or based on a percentage of sales. Generally, the goal is to  limit rent expense to 6 percent of sales or less, exclusive of related  costs such as common area maintenance (CAM) and other occupancy  expenses.
Occupancy cost (10 percent or less). Occupancy cost includes rent, CAM,  insurance on building and contents, real estate taxes, personal  property taxes and other municipal taxes. Many operators want to keep  occupancy cost at or below 8 percent of sales, however, 10 percent is  generally viewed to be the point at which occupancy cost starts to  become excessive and begins to seriously impair a restaurant’s ability  to generate an adequate profit.
Sales Value of Restaurant Business Rules of Thumb
Accurately determining the potential sales value in any restaurant  requires the services of a professional business appraiser, preferably  with experience appraising independent restaurants.
However, there are two rules of thumb that may be helpful to arrive at  an initial, rough estimate of what your restaurant may be worth,  assuming you operate in leased space:
Sales value of business  (gross sales method) – 38 percent to 42 percent of gross sales. Sales value of business (cash flow method) – annual cash flow (basically net income before depreciation, debt service and owner compensation) times a multiple of three to four.
On this page, we show how to estimate business value, based on the cash flow method.


 
When determining the value of a restaurant in leased space, one of the  most important determinants is the terms, particularly the  transferability and the amount of time, with options, remaining on the  existing lease. Lease factors such as these and other terms can have a  significant effect on the value of any business.
In restaurants where the operator owns the land and building, the  inherent value of the business will be influenced significantly by the  underlying value of the real estate. For this reason it is difficult to  value the business in a meaningful way using rules of thumb.
Final Rule of Thumb: Not Every Rule of Thumb Fits Every Restaurant
Most restaurants will probably deviate from one or more of the rules of  thumb discussed in this article. That’s to be expected. Rules of thumb,  as discussed above, are merely guidelines, not an ironclad collection  of industry mandates from which no successful restaurant can deviate.
Where your numbers do stray from these norms, it may be useful to  determine “why.” Determining the reasons for any differences may prove  to be an insightful process in learning more about the financial and  operating nuances of your restaurant.
Another rule of thumb says that the more you understand how your  restaurant works, the better the manager you will become. Using these  rules of thumb could go a long way in helping to better understand your  restaurant and provide insights for building a more successful  business.
Restaurant Startup & Growth


At a Glance: Rules of Thumb
Sales to Investment (Annual Sales/Startup Cost) · Leasehold – at least 1.5 to 1. · Own land and building – at least 1 to 1.
Sales Per Square Foot ·Losing Money Full-service – $150 or less. Limited-service – $200 or less. ·Break-even Full-service – $150 to $250. Limited-service – $200 to $300. ·Moderate Profit Full-service – $250 to $350. Limited-service – $300 to $400. ·High Profit Full-service – More than $350. Limited-service – More than $400.
Food Cost · Generally –  28% to 32% as a percentage of total food sales.
Alcoholic Beverage Costs ·Liquor –  18% to 20% as a percentage of liquor sales. ·Bar consumables –  4% to 5% as a percentage of liquor sales. ·Bottled beer –  24% to 28% as a percentage of bottled beer sales. ·Draft beer –  15% to 18% as a percentage of draft beer sales. ·Wine –  35% to 45% as a percentage of wine sales.
Nonalcoholic Beverages ·Soft drinks (post-mix) –  10% to 15% as a percentage of soft drink sales. ·Regular coffee – 15% to 20% as a percentage of regular coffee sales. ·Specialty coffee –  12% to 18% as a percentage of specialty coffee sales. ·Iced tea – 5% to 10% as a percentage of iced tea sales.
Paper Cost ·Full-service –  1% to 2% as a percentage of total sales. ·Limited-service – 3% to 4% as a percentage of total sales.
Payroll Cost ·Full-service –  30% to 35% as a percentage of total sales. ·Limited-service –  25% to 30% as a percentage of total  sales.
Management Salaries · 10% or less as a  percentage of total sales.
Hourly Employee Gross Payroll ·Full-service –  18% to 20% as a percentage of total sales. ·Limited-service – 15% to 18% as a percentage of total  sales.
Employee Benefits ·5% to 6% as a percentage of total sales. ·20% to 23% as a percentage of gross payroll.
Prime Cost ·Full-service –  65% or less as a percentage of total sales. ·Limited-service  – 60% or less as a percentage of total sales.
Occupancy and Rent ·Rent – 6% or less as a percentage of total sales. ·Occupancy – 10% or less as a percentage of total sales.

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