So You Want to Start a Restaurant, huh? Let's Get into the Numbers.

Posted by David Siminoff on 12/27/18 9:00 AM
David Siminoff

When planning your menu for the restaurant you're launching, you can’t just tell suppliers “send the right amount of sea bass.” You have to give an actual number. Figuring out budgets and resource allocation for a restaurant (especially with your moody clientele) is hard.

So, companies usually derive what is called The Actual Budget. The Actual Budget represents what the company actually spent. It contrasts with what’s called the Standard Budget, the estimated expenses ahead of time.

Think of the The Actual Budget as things seen in a rear view mirror. The Standard Budget, meanwhile, represents a predictive model, which starts with the number of pounds of sea bass that should be ordered for a Tuesday night in the middle of January.

The Standard Budget becomes the Holy Grail for profit optimization for the restaurant, because if they mess up the standard budgeting, or volume of food ordered, they take the $10 per pound sea bass at their cost and, in about 48 hours, turn it into $1 a pound gourmet cat food. Not a good formula. 

restaurant budgeting copy

Standard, Flex, and Actual Budgets

The sea bass ordering juggling act is a study in perpetual motion. Every day is different.

You typically serve about 200 people a night, but the number of sea bass orders varies greatly. Sometimes 50 people might order the sea bass. Sometimes only 10. It makes a significant difference, because you have to order the fish in advance and it goes rotten pretty quickly.

You order 25 servings at $8 a serving (the good stuff, not the stuff from crazy Uncle Dooley’s buddies who somehow has access to a bunch of sea bass). If 20 people order it that night, you end up throwing away 5 unused servings. But that’s alright, because your profit from the 20 servings makes up the difference. But what about if only 7 people order the sea bass? That’s a disaster. You end up throwing out 18 servings and all your profits (plus some additional money you’ll have to make up somewhere else).

That’s why the waiter/actors need to push the sea bass so hard. It’s important to sell out of that inventory. It makes a huge difference on the profit/loss for the restaurant. If a you get too many orders (say 30 people try to order the sea bass when you only have 25 servings available), that’s not as big a deal. You’ll get them to order the steak instead. At least you don’t have to throw anything out.

seabass

Here’s a term for you: highly volatile variable cost.That’s sea bass, or any food products that go bad in a short period of time.

Variable costs, like that for the raw ingredients to make the food, are only one kind of cost though. There are also the set of expenses known as fixed costs. 

For a restaurant, this would include things like rent, actor/waiter salaries, insurance, electricity, gas, protection money to crazy Uncle Dooley’s “friend” Jimmy the Snake, and a bunch of other things. These get billed as the same amount all the time, whether business is good, bad, or ugly. 

To remain in business, i.e. not go bankrupt, the restaurant’s contributions to profit from revenues have to at least cover these basic fixed recurring costs, or the show is over.

There’s a third budget to keep in mind here. It’s called the Flex Budget and it represents a theoretical test case used to try to guess what will happen under some given hypothetical situations. It’s like a story problem that helps you plan for contingencies. 

Here’s the basic formula for business survival:

Total Cost  = Fixed costs + (Variable X Rate Changes)

Companies plan for a profit structure with:

  • Wishful thinking (Standard Budget)
  • A comparison to what actually happened (Actual Budget)
  • And then a comparison to the theoretical test case (Flex Budget)

Back to the restaurant. Your fixed cost of rent and labor and insurance and so on totals about $400,000 a year.

  • $50,000 - Rent
  • $3,000 - Insurance
  • $4,000 - Utilities
  • $343,000 - Labor

Looking closer at the labor costs, the fully loaded cost per actor/waiter comes in at $40,000 a year. No, not “fully-loaded” like they spend too much time with Uncle Dooley at the bar. “Fully loaded” as in “all-in cost,” including things like taxes and workers comp.  (The tips they pick up - both for their serving and thespian efforts - don’t get counted, because it doesn’t come out of the restaurant’s budget...customers pay that directly).

So, in a given year, when the restaurant has revenues of $1 million, the fully-loaded cost of that waiter is 4% of sales. If in the following year, sales double under the hot new high-margin absinthe lemonade product, the cost of the waiter does not change. (Presumably the waiter makes more in tips, but, again, those cash flows exist outside of the restaurant’s tracking system.)

If absinthe lemonade takes sales to $2 million a year, that waiter/actor represents only 2% of revenues. Structurally, this notion is called operating leverage, meaning that once the basic fixed recurring costs of the restaurant are met, the profit margins contributed by marginal, incremental dollars is very high. Once you get above the fixed costs, a lot of those extra dollars fall to the bottom line.

dooley's lemonade

Simply put: the cost of an annual actor/waiter, then, is amortized over a much broader base of revenues when times are good than when times are bad. (Amortized, by the way, is a fancy way of saying something like “spread out over.”) And you can imagine this same structure applied to many industries…from the production of cat food to the production of clickable server results on Google.

The cost of sea bass is different, though. That’s not a fixed cost. That’s a direct variable expense. The cost of the sea bass increase as volumes get higher. To sell more sea bass, you have to buy more sea bass. (And risk more precious capital doing so.)  The relative cost of your rent (as a percentage of revenue) declines as you sell more.

You open up a side business selling sea bass sandwiches on the beach to take advantage of the word of mouth about the restaurant’s top entré. You send one of your waiters to run the sea bass stand. His salary is $40,000 no matter how many sea bass sandwiches you sell. Similarly, the cost of rent remains the same (you’re paying $1,000 a month, or $12,000 a year, for a small fish-shaped wood shack built just by the beach...it doesn’t look like much, but location, location, location). You have to pay this regardless of the level of revenue.

However, higher revenue, means that the cost of the sea bass goes up. You have to buy more bass for more sandwiches. The cost for the sea bass varies with the number sold. But the percentage in terms of revenue stays the same. The cost is rising in line with revenue.

Cost

Amount for $250,000 in revenue

Amount for $500,000 in revenue

% of $250,000 in revenue

% of $500,000 in revenue

Rent on Sea Bass Stand

$12,500

$12,500

5%

2.5%

Waiter Salary

$40,000

$40,000

16%

8%

Sea Bass

$115,000

$230,000

46%

46%

Total Expense

$167,500

$282,500

   

Total Profit

$82,500

$217,500

   

Profit Margin

33%

43.5%

   

Plug that into the Cost Equation we talked about before. Fixed expense includes the rent and the waiter’s salary. So that’s $52,500 no matter what else happens - $12,500 for the rent plus $40,000 for the waiter. Meanwhile, the sea bass costs go up depending on how many are sold. That represents the variable expense.

For $250,000

Total Cost = $52,500 + $115,000 = $167,500

For 500,000

Total Cost = $52,500 + $230,000 = $282,500

There are other expenses related to the stand, but we’ll ignore those for now. For the $250,000 stand, the profit from these basic inputs would $82,500. For the $500,000 stand, the profit totals $217,500. (Both are figured by subtracting total costs from the revenue generated.)

The profit margins are higher at the $500,000 stand because the fixed expenses become less expensive (in percentage terms) as revenue increases.

Meanwhile, the variable expenses rise as revenue rises—the cost of sea bass climbs as sales of sea bass climbs.

Back at the main restaurant, you run a special on sea bass, selling it for $25 a serving rather than the usual $35. Sales for that night go up from 25 servings to 40 servings. So revenue from sea bass for the night rises from $750 from a normal night to $1,000 on the night you run the special. But while you end up selling more sea bass, you have to buy more raw fish. If ingredients cost $10 per order, your cost for ingredients rises from $250 on a normal night to $400 on the night of the special. It changes along with the number of sales.

On the other hand, the cost of your staff remains the same, whether you sell more sea bass or not. You pay $160 a shift on a normal night, you still pay $160 on the night of special.

Unlike direct variable expenses that increase alongside higher volumes, most SG&A (Sales, General & Administrative costs) are fixed indirect expenses comprising:

  • Rent on the restaurant
  • Maintenance costs (buying new chairs after they get broken in a bar fight)
  • Insurance (especially for tableside “flaming skewer” night)
  • The electricity for lighting or sound systems or laser light shows
  • Salaried employees

Salaries are fixed costs, so employees may as well be put to work.  If an actor/waiter has no tables to attend to…why not just put him to work acting out scenes table-side from Othello to entertain and delight the restaurant patrons? After all, he did put in four years of undergrad perfecting his “Iago.” Would be a shame to let that go to waste. Although...he should probably avoid the “old black ram” line.

Topics: Finance

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