The Income Statement: The Single Greatest Key to Success, Part Two

Profitability and success are our goals! Last month and this month, I am focusing on the important role the income statement plays in reaching those goals. Last month, we reviewed how to accurately calculate

• Cost of goods sold (COGS)
• Labor cost
• Operating costs

The restaurant and bar businesses can be very tough, but sometimes we make it harder on ourselves. Putting together an accurate income statement and then using it every month to refine your operation is the difference between profit and loss. If you did not get a chance to see the first part, please bring yourself up to speed.

Overhead Can Tell Us Something About Our Business

Overhead includes rent, administrative costs and utilities. In the restaurant industry, I typically look for utilities to be between 3 and 4 percent, rent between 6 and 10 percent, etc. When these costs fall out of the expected range, I know we have a problem. One of my clients had a water bill that was about 1 percent of their monthly income. One month, though, it came in at 8 percent! This caused us to investigate, and we found that a pipe underneath the building had a leak that was not detected until it popped up in the income statement at the end of the month.

In Order to Analyze, We Must Organize 

To analyze a restaurant income statement, the statement must be organized correctly. Most operators don’t set up the income statement properly, and therefore can’t use it as an effective tool to achieve profitability.

Typically, the income statements I review show only gross income as “food and beverage sales.” To use the income statement as a weapon against unprofitability, the income statement must separate food, beer, liquor, wine, non-alcohol beverages, retail, etc. The COGS must be set up the same way. Once the income statement is set up this way, we can then tell where we are doing well and where we need to address high costs. 

Determining Prime Costs, Gross Profit Margin and Variances

Prime Costs: The prime costs for restaurants are Food, Beverage and Labor. These are also considered controllable costs, meaning the operator can increase profitability by purchasing better, wasting less or getting more productivity out of the staff. 

Gross Profit: In the restaurant industry, we typically calculate gross profit margin, also known as gross income, by taking the total revenue and subtracting COGS and labor. We then utilize the gross income to pay the rest of the expenses. We like to see gross income at 70 percent. For perspective, this means that, for every $100 a guest spends, the gross profit is $70.

Variances: Right now, all restaurants are having several variances showing up on the income statement. If food cost is typically 30 percent, but this month it jumps to 40 percent, should we be worried? I wouldn’t, because we are seeing substantial price increases across the country. This variance would mean that we have to reevaluate our pricing and portions, make appropriate changes and get things back in control. Variances are not necessarily a bad thing, as long as we react to them quickly.  

Create an Accurate and Consistent Income Statement

The more detail that you provide in your income statement, the easier it is to understand why you’re profitable so that you can repeat it month after month. More detail also lets you understand and then correct issues that cause you to lose money. Recognize what each and every cost should be, so that when it is out of kilter, it can quickly be corrected. Most importantly, produce a full income statement each month, review it thoroughly and react to it immediately. 

A Story of Agony That Turned into Success

One of my client owners lost $300,000 in their first 18 months of business. I requested two years of income statements. Without ever seeing the property or meeting the managers, the income statements told me the following: 

1) The general manager was embezzling a great deal of money. 

2) The chef had not costed out any recipes. 

3) The staff was giving away food and beverages (beer, wine, liquor).

I fired the manager, had all the recipes costed, adjusted menu pricing accordingly and put programs in place to stop all the product giveaways by service and bar staff. The operation broke even in 60 days and was profitable on the 90th day. As I always say, they did it and so can you!