Prime Cost Explained: The Most Misunderstood Number In Restaurants

Transcript
Hey there, restaurant pros. It’s David Scott Peters and welcome to the Restaurant Prosperity Formula podcast. For over 2 decades, I’ve been guiding restaurant owners to success with the proven principles of something I call the Restaurant Prosperity Formula. I originally created the formula based on the daily practices of the most successful restaurateurs I coached, and it’s now the foundation of what I teach restaurant owners like you so you can achieve success. What do I mean by success? Success is a restaurant owner who dictates the terms of their life and their bank account instead of their restaurants dictating those things for them. Success is a restaurant owner who has freedom from the restaurant and the financial freedom they never thought possible. How you define success is up to you, but I do know the way to achieving it is using the restaurant prosperity formula. In this episode, number 147, we’re tackling prime cost, one of the most misunderstood numbers in the restaurant industry. And we’re doing it a little differently. Instead of me walking you through it solo, my AI assistant, Alex, is going to interview me using the exact questions I hear every day from restaurant pros just like you. Let’s get started.

All right, restaurant pros, today’s episode is going to be a little different. Instead of me walking you through this topic solo, my AI assistant, Alex, is going to interview me. Alex represents the questions restaurants pros ask me every day in coaching calls, seminars, and live events. So today, Alex is going to dig into one of the most misunderstood numbers in the restaurant industry, prime cost. Alex, let’s jump in.

All right, DSP, first up, what’s the biggest misconception restaurant pros have when it comes to prime cost?

I think the biggest misconception is owners think prime cost equals food cost. They forget about bottled beer, draft beer, wine, liquor, merchandise for that matter. But more importantly, they forget about the labor side. They again think prime cost is just food cost. While food cost may be one of your biggest expenses, especially if, say, you’re a restaurant that does 80, 90% of your sales or food alone, the reality is it includes all the other costs of goods sold. It’s total cost of goods sold plus total labor costs, which includes taxes, benefits, and insurance. And I’ll go through that in greater detail in just a second. But I also would be wrong not to mention the second piece that often puts restaurant owners in a bind, is they measure their prime costs off their profit and loss statement, and that’s too late. Why? Well, I need information today.

When I get my profit and loss statement, if you’ve got a great CPA, a great bookkeeper, accountant, whatever you’re using to get your numbers, You’re going to get a P&L 10 days after the end of the period, maybe 15. That’s reasonable. Most restaurants see them 30, 60, 90 days later. And I have members that have come to me that have not seen their P&L for six months and even a year. It is way too late, past 15 days, to make change in your business because those things have already happened. So the reality is we need to make prime cost a weekly operational number. That’s the way we’re going to control our business. That’s the way we’re going to change our habits and really make a profitable business. Now, what is prime cost? For those of you who have not been following me for any length of time, prime cost is total cost good sold, which includes food, any bev, bottled beer, draft beer, wine, liquor, merchandise. plus total labor cost, which includes your manager’s hourly and salary, it includes all of your hourly employees, and it might include you depending on if you’re running shifts. Plus, plus taxes, benefits, and insurance. Whatever it takes to run those four walls.

Now, if you’ve got a bookkeeper on full-time, if you’ve got a marketing person on full-time, they’re not a part of prime cost. They’re an additional expense. So it’s really only that labor and product in the four walls. So total cost of goods sold plus total labor costs, including taxes, benefits, insurance, and we take that total The use divided by sales being gross sales. Gross sales are the ring of the register before discounts, not including sales tax. So many of you, your POS systems show you net sales. That’s after discounts have been removed. We want to make sure we measure properly, which means we need the gross sale to give our kitchen as if we sold the $20 sandwich for $20. Not that we discounted $10 and the food cost just doubled because the recipe doesn’t cut itself in half. Let me be very clear. It doesn’t change your bottom line. Your profit, your loss will be the same. But we’ll measure our kitchen. We’ll measure our bar. We’ll measure our management team fairly because that’s the money we should have collected. It doesn’t matter whether it made it to the bank or not. They’re doing their job following forecast. Now, be very clear.

I say again, prime cost is the one number you must know to have any chance to make money. This is that number that determines your profitability. Because to old-timers like me, we used to call this something called controllable expenses. In control of management, how we hire, fire, train, utilize our people, purchase product, utilize that product. See, prime cost, to old-timers, we call it controllable expenses because it’s in control of management day-to-day, shift by shift. As a manager, I can’t control whether you drive a beautiful car out of the business, nor is it any of my business. I can’t control that you overpaid for this building and your occupancy cost is astronomical. But what I can control is the people and the product that we work with on a daily basis. So it becomes an extremely important number. Alex, what’s our next question?

Great breakdown, DSP. Next question. How do you recommend they start tracking prying cost accurately from the get-go?

Well, I will tell you it’s not going to make a lot of people happy. It starts with weekly inventory. Why? Because all too often, most people, when they tell me what their prime cost, what they think their prime cost is, they’re generally taking their food purchases, their bottled beer, draft, wine, liquor, their purchases divided by sales. The reality is that’s not your cost of goods sold. See, there’s, it’s the equation is beginning inventory plus purchases minus ending gives me use, usage, what actually left the shelves, whether it was sold, whether it was wasted, spoiled, stolen, or you took it out the back door because you own the joint and you didn’t put it in the POS system. It does not matter. It means it’s disappeared. We start with our beginning inventory. That was our last inventory. All the purchases that came in, whether paid for or not, does not matter. Tells me how much food, in this case, I could sell. We take an ending inventory at the end of the period and we subtract. And that shows you how much product left the shelves. We hope we sold it all, but that’s not the only way we use product. That is truly the usage that belongs in prime cost. So the only way to calculate it properly, to track it properly, is to do weekly inventories. Now I know a lot of you listen to me going, oh my gosh, David, you don’t understand. It takes 3, 4 hours to take inventory in our restaurant. That’s because you have a spreadsheet that you print off, put on a clipboard, and you sit there and go into the walk-in cooler and the first item says milk and you start searching, searching, searching, searching, searching, searching. You find milk and you write down 2 gallons. What we want to do is set up a shelf to sheet inventory system. We want every item to be in the order they appear on the shelves in each one of the inventory locations. We want them to be specifically the inventory unit of measure, I want to measure it by. The case in the freezer, in the reach-in freezer, it’s by the 5 pound bag and on the line it’s in portion bags, 6 ounce portion bags or loose. And that way when my cooks, my kitchen professionals, they’re counting, they count it the way they see it and put it down.

That way we don’t end up with $30,000 in shredded cheese on an inventory because somebody counted ounces and it had a case price. We make it easy. We take away the friction and we train people to literally write it down the way they see it in the order it appears. So we cannot use our food purchases because why? That fluctuation in inventory could be dramatic in one month to the next, even one week to the next. Let’s say, for instance, on the last day of the month, or better yet, last day of the week, I’m calculating this on a weekly basis, I have a food truck show up. last day. And I unload $10,000 in product. And it’s a slower day. It’s a slow Sunday. Well, now does my food cost show it’s extremely high because I took $10,000 in product? You’re not going to take 10 grand, but you get the picture. The reality is it’s still on the shelf. Oh, by the way, the next week I already ordered a ton of food. I don’t need to order much this week. So I order very little. And by doing so, because I’m using food that I already purchased, My orders are low. My food cost looks extremely low, giving me these wild fluctuations up and down, which is not fair to your kitchen pros when you as an owner are yelling at them one week or one month to the next that their food cost is out of control. And then it’s really, really low.

It has to start with taking weekly inventories. Whether you’re using a spreadsheet or I’d like you into software, that’s critical. Now, I do want to be very clear. I want to say tracking is not just product, it’s labor. So one of the things that happens is we wait for our payroll. And our payroll, for many of you, could be semi-monthly, just two times a month. It could be every other week. It could be weekly. But the reality is, even if it’s weekly, if you’re waiting for the payroll data to show up, that’s after the fact. So we’ve got to train our management team and yourselves to start using your POS data. What we’re going to do is we’re going to measure our prime cost and we’re going to remove the taxes, benefits, and insurance from that initial number from our budget so that my managers can manage what they can control. I don’t want them trying to estimate when somebody’s reached their FICA SUI limit. So we, again, reduce the friction, make it simple, but now on a weekly basis, I know exactly what my labor is. I know my salaried managers. That’s it. That’s salaried. I know my hourly people because the POS system, which is up to date with their right position, their right pay rate, and their correct in and out clock times, I have all the data I need to track on a weekly basis. Again, what are we working towards? Weekly prime cost budget variance. Why? Because it allows me to see when there’s a problem and fix it right away. Instead of waiting till the end of the month, 15 days goes by, and I tell my kitchen manager, hey, your food cost is too high. I tell my general manager, your labor cost was too high. It’s too ****** late. We’ve now made the same ******* mistakes for 15 more days. into the next period to try and fix what happened and it’s too late. We’ve now done the same ******* thing for 45 days in a row. When I measure prime costs on a weekly basis, it gives me the ability to change the next week and the next week and the next week to get ourselves back on budget without cutting product quality, without cutting guest satisfaction, reducing service levels to where we can’t provide a great experience. So weekly prime cost budget variance is extremely important. Again, most operators track purchases and run their numbers monthly. And then they wait for a P&L. And it’s too late. We need to create a weekly rhythm that creates control when it comes to your prime cost and your profitability. Alex, what’s next?

All right, DSP, question three. Could you share a real example where a restaurant thought they had prime cost under control, but they discovered something surprising? And then what changed?

Absolutely. That’s the hard part. I’ve been doing this for, I’m in my 23rd year. This July, I’m coming up on starting year 24. I was the OG. I’m the original restaurant coach that’s been out there. I’ve seen thousands upon thousands of budgets and numbers through my my years of coaching. And I’m going to tell you that I worked with, comes to mind, an operator who was convinced when we first met that their food cost was only 30%. I say only because why? Most people think that the national average is where they should be at 34%. And that’s not the reality when we start working on budgets, which I’ll talk about. So 30%, they thought they were the number. Well, when we dug deeper, and we started to look at the profit and loss statement. It started to change their chart of accounts and started to really dig into all their GL entries. We realized as we’re gathering this data to create their budget, there were mistakes. In fact, unfortunately, most of the purchases in the food category were not in the food category. They were being accounted for inaccurately in other areas of the profit and loss statement, showing them a falsely low cost of goods sold. So what did we do? When we went through the budget process, which is take your trailing 12 months information, and then we create the next 12 months. if we operated the same way. Then we decide what systems we’re going to put in place, how quickly you’re going to put them in place to achieve better numbers. Well, we started the process, and one of the first things, like we talked about earlier, is we started weekly inventories, which took time. You had to set up a system in order to count. Well, we discovered when we started doing beginning inventory plus purchases minus ending gives us use, use divided by sales, their food cost was actually 36%. 6% higher than they thought. Imagine running your business thinking you’re doing a great job, but you can’t figure out why there’s no money in the bank account when you’re actually throwing money away day-to-day because you’re operating at a much higher cost and not controlling anything. So what did we figure the problem was? We determined that there was portion creep. There were people who liked Lurch on the line instead of 6 ounces of french fries. Lurch would take his huge hand in there and drop 8 ounces to 9 ounces every single time. That’s money that goes out the door. That’s waste. That’s overuse. That is still use, which is cost of goods sold, the product used, whether you got money for it or not. We saw that they had inconsistent prep yields. There was kitchen people, prep people particularly, who were going through chicken tenders very quickly for a cheesesteak, a chicken cheesesteak. And to prep the product, they bought the tenderloins and the prep people were going straight down and cutting away the ligament, but also 2 ounces of chicken every single time. By paying attention to this, by taking all the waste and putting in a clear Lexan and having a manager review it before it ever got thrown away, they discovered the problem. That they had either not trained their people properly or people that were lazy and it was costing them thousands of dollars instead of taking the knife at an angle and taking just the ligament off. So inconsistent prep yields is often a major factor and it was in this case. But I’ll tell you the big one is no inventory discipline. If you’re not counting your product, You don’t know what product you have. You don’t know that you’re overusing it. You don’t know that there’s problems. When you start paying attention, when you start doing weekly inventories, which we did, you start controlling your product. You’re aware of what you’re doing. Then when you train people to follow recipes your way, like Lurch, instead of using his hand, he had to make sure he weighed the french fries and made it consistent for the guest every single time. Not only do the guests get a better experience, but you have a chance to make money. And along the line, we put more portion controls in place. And that’s all we initially did. And the results were amazing. Food costs dropped in this restaurant by 5 to 6 points for our member within two months. Now, I don’t think that’s atypical. Most restaurants take three to six months to see that kind of change, but they were on it. They were diligent with those systems, but really setting up that count system that they could take inventory and calculate things right away. So the lesson in all this is your numbers reveal all of your operational problems when we do that budget. Your habits are what change your reality when it comes to prime cost, and that’s what we change for this owner. Alex, what’s your next question?

All right, DSP, next question. What’s the biggest mistake restaurant pros make when they try to implement prime cost controls? And how do they avoid that pitfall?

What are some of the biggest mistakes they make? Well, I think some of it may be blaming the opposite of what we talked about when it comes to what systems put in place and any examples. I’m going to give you another example. Often restaurant owners come in blaming food costs. if I could have a dollar for every time a restaurant owner told me, my prime vendor, my distributor, they’re the ones screwing me. It’s their fault that my food costs so high because the costs keep going up. Well, that is true. The costs keep going up. But is it really their fault? When we realize, when we have accurate update recipe cost cards, find your ideal food cost should be 30%, but you’re running 39, you’ll never run 30. A rock star chef will be two points above. You run 32. A good kitchen manager chef run 33, 34%, 3 to 4 points above your ideal cost. But most restaurants don’t pay attention. It’s 9. Well, put that aside. The reality is we do the budget process and we learn that your labor is actually the problem. I can’t tell you how often restaurant owners who are especially undermanaged, they don’t spend the money on management because they don’t think they have the money. They throw money at the problem. Oh, ticket times are high. Let’s add another cook. Oh, service should be better. We add another server. And all of a sudden we just bring everybody in at the same time. We’re worried. We’re fearful of what happens. What if? And we schedule for what if. And we pray. We pray. that we’re going to be on budget. And when sales are low, we cut, but it’s too late. If you have 5 extra people on and your sales are way less than you expected and you cut them two hours into the shift, 3 hours into the shift, you’ve wasted all that money. You’ve burned your labor budget. So our budget tells us where we need to be. And what we’ve got to do is then change our scheduling habits because our schedule needs to be tied to our sales. And that’s where we teach a system called the Restaurant Payroll Guardian. where we tell our managers how many, not only dollars they have to spend by position, but how many hours. And we’ve determined the value of that is not only do we help them put the puzzle together of a schedule, meet the needs of the business, needs of the employees, and make sure we’re giving great service, but we’re going to do it on budget. So instead of bringing everybody at 4 o’clock, we may have to stagger start. We’re just not going to bleed labor. And it’s truly powerful because the other thing it brings to the table is when you’re a manager, sometimes on a Monday, you get the owner walking in and they’re yelling at you, why is your labor costs so high? You’re at 38% when that was actually approved on the budget or that week’s schedule, I should say. But nobody paid attention to that because why? We have our slowest sales day of the week and we have all this prep to do. So we have production. If I don’t do the production, I don’t have anything to sell Monday, Tuesday, and Wednesday. But on Friday, because I’ve got no prep to do, and we’ve got a two-hour wait at the door, and our customers manage our efficiencies, my labor cost is 19%. So what happens is, by using the hours that have been allocated by position, the days that I need those hours based on production, I’ll end the week on budget, and I will have a different labor target by day of the week for my managers to manage to, and now we’re on the same page. That is huge. So by scheduling the sales, using something like the restaurant payroll guardian, you now have labor targets by shift that have been approved. And now we can control the business. We can go into the week proactively on budget versus reactively sending people home. Now that’ll still happen, but this is so much better. Because labor can quietly destroy your prime cost. That’s the reality of it all. Alex, what else do you have for me?

Here’s the final one for you, DSP. If someone listening is just starting today, what’s the first step they should take this week to get prime cost under control?

Well, I’m going to tell you right now, if your prime cost is out of control, that is your priority number one. Assuming you take care of restaurant 101. Hot food, hot, cold food, cold, clean, safe worker environment for your guests and employees. Wow, customer service, incredible product, now to go. Delivery. If you take care of the great guest experience, truly deliver incredible hospitality, now we can work on the numbers. We can work on prime costs. But I’m going to tell you right now, if your restaurant sucks and you’re not delivering what you promised to the guest, don’t worry about what I’m teaching right now. But let’s assume you are. we want to control our prime costs, which means we need to start weekly inventories. I understand what that means. I would recommend you use software, but one of my coaches, David Militell, will tell you start with a spreadsheet. The fact of the matter is start. It does not have to be a perfect system. We will get it to perfect, but you have to start counting. And by counting, you’re going to start to pay attention to things and control your food cost. I need you to start to make sure you’re looking at your labor on a daily basis and make sure that you are on pace to be on budget, that you can react on a daily basis instead of waiting till Friday. I think you also need to start thinking, I need a weekly prime cost report. I need to know what food cost is, bottled beer, draft beer, wine, liquor, NA bev, merchandise. I need to know my labor cost by position. so that I can see where I hit or missed my budget, that I still have, if it’s week one, two, three, 4 weeks to make a change without a knee-jerk reaction, without pulling all the people off on a shift on a Friday or Saturday because my labor cost is too high and give crappy service and long ticket times on the busiest sales day of the week. I need to be able to react. And be able to do so requires you calculating your prime cost on a weekly basis. And I would do that with a budget variance report. I will also say, as a reminder, make sure you’re scheduling based on sales. It’s extremely important, which means you’ve got to track your sales as well. Now, understand, here’s the deal. Prime cost, prime cost is math. But what it really is, habits. The reality is this. If you want to change your prime cost, you have to put yourself in a position to where you change your habits. Because if your prime cost is high, it’s not because you did the math wrong. It’s not because you really don’t know your numbers. It’s because you’ve allowed habits of your management team and your employees to be poor. So if we implement something like a key item tracker, if we put something in place like a waste tracker, which are two clipboard systems, easiest systems in the world to put in place. One, we count 5 to 15 items on the key item tracker to make sure things aren’t stolen. The waste tracker, we write down what was wasted, stolen, spoiled, whatever it is, and we track it and we fix it that day when we review it. That gives you huge power. But if you don’t pay attention to those, if you allow employees to be lazy and not use the system you put in place to control your food cost or prime cost, then you get the results of that. You get results of the habits.

See the numbers, your budget, your profit and loss statement, all your calculations, just reveal what you’ve done or not done. Prime cost changes when you change your habits, when you make sure those systems are being used on a daily basis. So while I may overwhelm you in today’s episode and say, oh my gosh, inventory, and you want me to do this with budgeting on labor, and you want me to do this, and you want me to do this, pick the one action you’re willing to take. See it from start to finish. Make the changes necessary and then make sure you’re doing those things every single week. And I promise you, You’ll see results. Your prime cost will come down. You will put yourself in a position to where you can make money. Now remember this. Prime cost and all the prime cost controls that you put in place equal your restaurant profitability. And better yet, it is the key to restaurant prosperity, which is freedom for your restaurant and the financial freedom you deserve. By putting those systems in place, to control your prime costs, you’re ensuring you trained your managers on what their job is, how to do it, how well it should be done, more importantly by when. And they do it when you’re there, but especially when you’re not, which gives you freedom from the business that you can count on these people to do it your way because it’s your system, your process, your way. That requires you to become the leader your restaurant needs. It requires you to train people, put your SOPs in place, and it requires you to be willing to hold them accountable or in my world, answerable.

Then not only do you get time away from your business, but because now you’re controlling your prime costs, because your managers on the ground on a daily basis pay attention to what’s important and are being held accountable to these numbers in the budget, and you gave them the systems and the way to achieve that budget, you start making the money you deserve. It’s up to you. You just need to start. Ready to take the next step towards achieving restaurant prosperity, freedom for the daily grind, and the financial success you deserve? Book a discovery call with Ryan James to learn about our group coaching program. Ryan will guide you through how our program can transform your restaurant and help you achieve the prosperity and freedom you’ve been striving for. Click the link in the description below or visit DSP.coach forward slash talk dash to dash Ryan to schedule your call now. Hey, that was an awesome episode. I want to thank you for taking the time to take action on building a better, more prosperous restaurant. Before you go, I want to give you these three thoughts.

One, by combining leadership and taking action with systems and training, being checked by accountability, you are on your way to creating prosperity for you and your restaurant. Two, I have something I need from you. Please leave a review on Apple Podcasts, Spotify, or wherever you happen to listen to podcasts. By leaving us a review, other restaurant pros seeking out this information are able to find it. I read the reviews, and hearing how this information has benefited you does wonders for me. And three, if you find any of the discussions helpful, share them. The more restaurant pros who have access to them, the better we become as an industry. For more restaurant resources or to get in contact with me, connect with me at davidscottpeters.com. Be passionate about what you’re doing. Be persistent. But more importantly, become better and help everyone around you become better. And your restaurant is going to kick some ***.