I’m sure all restaurant consultants and accountants advise their clients to count inventory regularly. Depending on how many menu items and ingredients in use, and how many times you count inventory, this simple procedure can represent a very significant time commitment. Let’s take a closer look at inventory counts and see whether they’re worth the time and effort.
It Takes Time… a Lot of Time
Most restaurants have hundreds of items in inventory from small food ingredients to bottles of wine. Some are measured by volume, others by weight or units. Purchased units may be different from inventory units, which may be different from recipe units. Each stock item needs to be counted, accurately, and costed using the correct cost per count unit.
Almost all restaurants use a periodic inventory method. Cost of sales is determined by adding the opening inventory to purchases during the period, and deducting the ending inventory. In order for this method to yield an accurate cost of sales figure, the ending inventory must only count items that have been recorded as purchases during the period. That is, the physical receipt of the stock items must be in the same period as the invoice for those items, and the invoice needs to be recorded in the proper period. We call this having proper cutoff.
The shorter the period between inventory counts, the more accurate the count must be. Why? The error as a percentage of a month’s cost of sales will be much greater than that for a whole year’s cost of sales. You can just imagine how accurate you must be, if you are taking daily inventory counts – even a slight error will appear to be quite significant.
Now, rather than do this at the end of each year, do it every four weeks.
Is There a Return on This Time Investment?
Even though you have already done a lot of work, it serves only one purpose. It gives you a reasonably accurate, overall cost of sales figure for the financial statements. While you may get a general idea how costs and margins fluctuated during the various periods of the year, these fluctuations are highly unlikely to be accurate or detailed enough to be useful for making profitable decisions. Many factors affect the overall margins, including the sales mix, discounts, spoilage, waste, portion control and theft. Failing to consider these factors means that you cannot know whether your restaurant’s performance was good or bad or whether it was getting better or worse. So, an awful lot of work for very little benefit!
There’s A Better Way
If you are prepared to do a bit more work, you will finally get much more useful information from your periodic inventory counts. Note that food costs involve a much more complicated process. To get really useful cost information, you have to do a lot of extra work. However, alcohol inventory and costs can be analyzed in detail with a reasonable investment of time. In this post, we’ll look at alcohol inventories and costs. The following describes a better way. Of course, this can be refined further, if necessary.
You probably summarize your inventory by major categories, such as wine, beer and liquor. Go a step further and group similar items within these categories, based on the theoretical mark-ups. Beer may be separated into domestic, premium and draft sub-categories. It is always a good idea to keep draft beer separate in the analysis, because it has a much different spillage factor than does bottled beer. Liquor may be kept as a category, or you can add appropriate sub-categories, such as premium, well and regular brands. Since liquor can be served as shots or mixed in cocktails, more detailed analyses of margins may be required. I will cover this in a subsequent article. Wines can be segregated by pourable wines, regular wines and premium wines. Ideally, the distinction between regular and premium wines should be based on their standard mark-up percentages and turnover rates. Now, count the inventory and summarize by sub-category.
You need to keep track of your purchases by these sub-categories. If you maintain logs for things like, tainted stock, kitchen transfers, tasting use, you should assign costs to these items, by sub-category, and make journal entries to allocate the cost to the various expenses. This will give you the true cost of sales related to each sub-category. If you don’t maintain these logs, you should.
Most POS systems will provide a few useful reports. Here are the ones you need:
- Sales Items Report for the period, providing sales quantities and dollars, by item.
- Discounts Report for the period, providing quantities and dollars, by item
- Menu Prices Report for all items sold during the period
We need recipes to determine the theoretical (also called ideal, expected or standard) cost of each menu item. While most POS systems will allow you to maintain recipes within the POS system, this isn’t necessary for our purposes. Calculate the cost of each menu item, using the quantities in the recipe and the costs from the inventory list.
Sales Price Variance
For each sub-category of menu items, you should calculate the standard sales that would have been generated, had there been no discounts. Add up the quantity of each item sold times the menu price for all items in each sub-category. The difference between the actual sales and the standard sales for the sub-category is your sales price variance. It is your “loss” of profit related to sales discounts (customer comps, discounts and coupons). Only you will know whether the amount of price discounts is reasonable for your establishment. This difference should equal the total from the Discounts Report for each sub-category.
You can calculate the actual cost of sales for each sub-category using this formula:
Actual C.O.S. = Opening Inventory + Purchases – Ending Inventory (all figures in dollars)
Now, we can put it all together and calculate margins for each sub-category, and you will be able to calculate sub-category variances, which will be useful for identifying problems.
Most POS reports can be imported or copied into Excel. Start with the Sales Items Report, listing the menu items sold and the total sales for each item. Sort these into the sub-categories you chose, earlier. Alternatively, prepare a standard list of menu items and enter the quantities of each item sold during the period.
Add the recipe cost for each item. The sum of all of the quantities sold times the recipe costs will give you the Theoretical C.O.S. The difference between the theoretical and the actual COS is the Total Cost Variance (by sub-category).
Now, we need to analyze the Total Cost Variance. We can do this using the logs for Kitchen Use, Spoiled/Tainted Items and Tastings. Each of these should be summarized by sub-category and expressed in dollars. These represent documented causes of the Cost Variance. There is another “normal” reason for a variance – Spillage/over-pouring. Based on the amount you consider reasonable, for each type of pourable product, calculate the amount of variance attributable to normal spillage and over-pouring.
Putting it all together, the Total Cost Variance will be explained by each of the causes (Kitchen use, Tainted, Tastings and Spillage/Over-pouring). The remaining variance must be caused by excessive over-pouring and theft. If any sub-category is showing an unusually large remaining variance, there may be errors in the calculations (which should be checked again) OR you have a significant theft/over-pouring problem that needs to be addressed.
If you find significant theft or over-pouring issues in particular sub-categories, you know where you need to focus your cost control efforts. You may wish to perform more detailed variance analyses in the future, by analyzing individual menu items, rather than sub-categories.
As we have seen, for a little bit more work than you already do, you can gain a lot of useful information to help you properly manage your costs and margins.