Restaurant Prime Costs: How To Calculate Them?

Let's face it. The last few years haven't been a walk in the park for the restaurant industry.

First, there was the pandemic. Then, supply chain issues, and now a cost-of-living crisis. Now more than ever, it's important for restaurant owners to keep a close eye on their finances, and one of the key numbers you need to know is your restaurant's prime cost.

Not quite sure what prime cost is or how to calculate it? Don't worry. We've got you covered. This guide gives you the lowdown on everything you need to know about prime cost, from what it is to how to calculate it and why it's so important for your restaurant.

So, let's get started!

What is prime cost?

In short, your restaurant prime costs are the total sales from cost of goods (COGS) plus labor costs. In other words, it's the direct costs of making and selling your menu items.

Let's break it down further to get a more accurate picture of your restaurant's prime cost.

COGS refers to the direct costs of ingredients, packaging, and other supplies that go into making your menu items. For example, if you're a pizzeria, your COGS would include the cost of flour, tomatoes, cheese, and other toppings.

On the other hand, labor cost for restaurant refer to all wages paid to employees who directly contribute to the production of your menu items. This includes everything from cooks and dishwashers to servers and bartenders.

COGS: what to consider

To get an accurate picture of your COGS, you need to consider the following:

• The cost of ingredients, including spices, sauces, and other condiments

• The cost of packaging, such as boxes, bags, wrappers, and menu prices

• Other miscellaneous costs, such as disposal fees

COGS can be a little tricky to calculate because ingredient prices can fluctuate. For example, let's say you own an Italian restaurant, and one of your signature dishes is spaghetti with meat sauce. Your COGS for this dish would include the cost of ground beef, tomatoes, garlic, and other spices.

Now let's say the price of ground beef goes up. This will obviously have an impact on your COGS. To account for this, you need to keep track of the prices of all your ingredients and update your COGS accordingly.

Labor costs: what to consider

When calculating the amount you spend on labor, you need to consider the following:

• Wages paid to all employees who contribute to the production of menu items, including cooks, dishwashers, servers, and bartenders

• Payroll taxes, such as Social Security and Medicare

• Employee benefits, such as health insurance and retirement contributions (learn more about cost of restaurant insurance here)

Calculating how much you spend on labor is simpler than calculating your COGS because you usually don't have to worry about fluctuating prices. However, you do need to be mindful of things like overtime and employee turnover.

Overtime refers to hours worked beyond the 40-hour work week. For example, let's say one of your servers works 50 hours in a given week. The overtime rate for this employee would be time-and-a-half, which means their wages for that week would be calculated as follows:

40 hours x regular hourly rate + 10 hours x overtime hourly rate = total wages

Employee turnover is another factor to consider when calculating how much you spend on labor. This refers to the number of employees who leave your restaurant within a given period. For example, let's say you have a high turnover rate and need to hire two new servers monthly. This will impact your overall prime cost.

Now that we've gone over the basics of prime cost let's take a look at how to calculate it.

How to calculate prime cost

There are two ways to calculate prime cost: the basic method and the more detailed method.

The basic prime cost method:

The basic method is simply the sum of your COGS and labor costs. The basic method is simply the sum of your COGS and labor costs. Its prime cost formula looks like this:

COGS + labor cost = prime cost.

Let's see this in action.

Your COGS cost:

Cups of coffee: $1,000

Bags of coffee beans: $500

Milk and cream: $200

Takeaway coffee cups and lids: $100

Total COGS: $1,800

Your labor cost:

The hourly wage for baristas: $15

Payroll taxes: $300

Employee benefits: $150

Total labor costs: $1,550

Simply add your labor and COGS costs together to calculate your prime cost using the basic method. In this case your prime cost would be $1,800 + $1,550 = $3,350.

The more-detailed prime cost method:

The more-detailed prime cost method is a bit more complicated. It includes everything in the basic method, plus other costs like occupancy and marketing expenses. This prime cost formula looks like this:

COGS + labor costs + occupancy costs + marketing expenses = prime cost

Let's take a look at how this works with all variable costs for a restaurant.

Your COGS:

Food costs: $5,000

Beverages: $1,000

Total COGS: $6,000

Your labor costs:

The hourly wage for servers and cooks: is $20

Payroll taxes: $600

Employee benefits: $300

Total labor costs: $3,900

Other costs to consider:

Rent: $2,000

Utilities: $500

Marketing: $1,000

Total other costs: $3,500

When calculating prime cost using the more-detailed method, simply add your COGS, labor costs, and other costs together.

In this case your prime costs would be $6,000 + $3,900 + $3,500 = $13,400.

Now that we've gone over how to calculate the prime cost let's take a look at what your prime cost percentage should be.

What is a prime cost percentage?

Your prime cost percentage is simply your prime cost divided by your revenue.

Let's look at this in action again. Suppose you own a dive bar and your revenue for the month is $30,000.

Your basic COSG and labor cost might look something like this:

COGS: $6,000

Labor cost: $9,000

Total prime cost: $15,000

Simply divide your prime cost by your revenue to calculate your prime cost percentage.

In this case, your prime cost would be $15,000/$30,000 = 0.5, or 50%

What is an ideal prime cost percentage?

While there is no magic number, most experts recommend keeping your restaurant's prime costs between 55%-60%. If a restaurant's prime costs percentage is over 60%, it's a sign that it's in trouble and action needs to be taken to reduce costs.

Of course, depending on the type of restaurant you have, your percentage will vary. For example, QSRs (quick service restaurants) prime cost will typically be lower than a fine dining restaurant's prime cost.

According to ResraurantOwner.com [1], the prime cost percentage for QSRs has achieved a prime cost of 50% or lower. That's because, in contrast with a high-end restaurant that will likely need more skilled labor and will have a higher restaurant food cost, QSRs typically have a lower labor cost and food cost.

It's also worth noting that your restaurant prime cost will fluctuate throughout the year. For example, it will likely be higher in the summer when you have to pay more for ingredients, and labor costs are higher because you're busy.

Now that we've gone over how to calculate prime cost and what your prime cost percentage should be let's take a look at some tips for reducing your prime cost.

Tips for reducing Your restaurant prime cost

Review your inventory on a regular basis

To keep your prime cost down, you need to be aware of what ingredients you have on hand and how much you're using. This means regularly reviewing your inventory and keeping track of what's being used and what needs to be ordered.

Using a restaurant POS system can help with this. A POS system will track your inventory and help you quickly and easily see what needs to be ordered.

Some things to look out for when reviewing your inventory:

• Are you overstocked on certain items? This could be a sign that you're ordering too much of something or that you're not using it as often as you thought. By changing this, you'll see an instant improvement in your restaurant prime cost.

• Do you have expired items? This is wasted money and needs to be addressed immediately, so your prime cost isn't badly affected.

• Are you running out of items frequently? This could be a sign that you're not ordering enough of something or that you need to find a more reliable supplier. Your prime cost could take a hit if you're turning away customers due to a lack of inventory.

Find ways to reduce your labor costs

Labor is typically one of the biggest expenses for a restaurant's prime cost, so finding ways to reduce labor costs can greatly impact your bottom line.

Here are a few tips for reducing your labor costs:

• Review your staffing needs on a regular basis and make adjustments as needed. For example, if you're not as busy in the mornings, you may not need as many staff members during that time. Having too many people working will increase the amount you spend on employee wages, therefore, increasing your prime cost.

• Train your staff members properly, so they are efficient and productive.

• Use a labor management system to help you track your labor costs and identify areas where you can improve your prime cost.

Improve your employee experience

According to the U.S. Bureau of Labor Statistics [1], the annual average employee turnover rate across all industries is between 12-15%, yet some hospitality businesses such as QSRs, routinely experience 150% annual staff turnover. This will massively affect their prime cost.

While it's not possible to eliminate turnover, there are things you can do to improve your employee experience, reduce turnover and, as a result, improve prime cost.

Some things you can do to improve the employee experience in the hospitality industry:

• Offer competitive wages and benefits: make sure your employees have the tools and training they need to do their job well: and create a positive work environment.

• Listen to your employees and take their feedback seriously.

• Don't overwork your employees. Make sure they have a good work/life balance.

Evaluate your food cost regularly

As we mentioned earlier, food cost is one of the biggest expenses for a restaurant. So, it's important to evaluate your food costs weekly to make sure you're not overspending.

Here are a few tips for evaluating your food cost:

• Track your food cost percentage regularly. You can use a spreadsheet or a restaurant POS.

• Comparing prime cost (and your food cost) to industry averages will help you see where you need to improve.

• Evaluate your menu regularly and make changes as needed. For example, if you have items that are costing you more than you're making in profit, you may want to consider removing them from your menu, so your prime cost isn't affected.

Introduce a restaurant POS system

A restaurant POS system can help you manage your prime cost by tracking your inventory, labor costs, and food cost. A POS system will also help you streamline your operations, which can lead to cost savings.

Some features that can help you manage your prime costs:

• Inventory management: helps you track your inventory levels and see what needs to be ordered.

• Labor management: tracks your labor costs and identifies areas where you can improve.

• Food cost tracking: monitors your food cost percentage and compares it to industry benchmarks.

• Franchise cost: if you have more than one restaurant, be sure to monitor your restaurant franchise costs.

• Menu engineering: evaluates your menu, including best-selling items, and make changes as needed.

• Loyalty programs: a POS system can help you create loyalty programs that will encourage customers to come back again and again.

Track your progress and make adjustments as needed

Once you've implemented some of the tips we've mentioned, it's important to track your progress and make adjustments as needed. This will help you see what's working and what's not so you can continue to improve your prime cost percentage.

Firstly, you'll want to track your prime costs weekly. You can use a restaurant POS system to do this or you can track it manually. This will help you see how your prime cost percentage changes over time.

Secondly, you'll want to compare your prime cost percentage to industry benchmarks. This will help you see where you need to improve. So, if your competitors have a lower prime cost percentage than you, then you'll know you need to work on reducing your costs.

Finally, you'll want to make adjustments as needed. For example, suppose you see that your labor costs are too high. In that case, you may need to implement some of the tips we've mentioned earlier such as increasing efficiency or improving your employee experience.

Conclusion

So there you have it. Our complete prime cost guide including what prime cost is, how to calculate prime cost, and how to reduce your prime cost. When determining how much does it cost to open a restaurant, you must always consider prime costs.

One thing is for sure. The restaurant business is not for the faint of heart. There are a lot of moving parts, and things can quickly go wrong for restaurant owners. But if you're able to manage your prime cost, then you'll be in a much better position to succeed.

Remember, your prime cost is made up of your food cost, labor cost, and other operating expenses (be sure to look into other associated costs such as the restaurant licenses and permits cost). So, it's important to keep an eye on all of these costs when it comes to restaurant pricing and make adjustments as needed.

Good luck and happy budgeting!