Do You Know Your True Profit Margin?
Reduce
Whether you’re just looking into the restaurant business, or you already own a successful restaurant. You should always ask yourself: What is my profit margin?
Maybe you’re just starting out, and you’re still talking to leasing offices to confirm your next restaurant tour. Why would you want to calculate your profit margin at such an early stage? Because that determines how much you can afford for rent. It’s too late to find out your profit margin after you sign up for a 10-year lease.
When looking at bizbuysell.com the other day, I saw a modern and fully renovated restaurant listed for less than $80,000. The restaurant is located in an upscale downtown area with tons of foot traffics. It seems like a great deal until I realized that the rent is at $18,000 a month plus NNN. I doubt if that restaurant owner knows his/her profit margin before signing the lease. I doubt if he/she knows how many businesses he needs to do in order to breakeven every month. Restaurant owners have to achieve a balance between finding a suitable place and paying the least possible rent for it.
I often see restaurant owners calculate their profit margin without considering the overhead costs. If they sell a sandwich for $10 and it only costs them $5 to make it, then they would consider this as a 50% profit margin. Yes, this is your gross profit margin but not your true profit.
You will read a lot of articles telling you that a restaurant’s average profit margin is 3%-8%. I recommend you to have a minimum of 20% net profit margin for your menu items. With a 3%-8% profit margin, you won’t be able to afford any miscellaneous cost such as a maintenance fee for your refrigerators, decorating for Christmas days, inspection for pest and termites, and this list goes on and on. You also can’t afford any promotion or discounts for marketing, such as giving 10% off for happy hours or paying Google to put you on the first page.
Net Profit Margin
(Gross sales – Cost of Goods - Expenses) / Gross Sales x 100 = Net Profit Margin
The calculation for the net profit margin is simple, but the key is: Do you know all your expenses?
As a restaurant owner ourselves, we will try to list out a breakdown of all the costs we can think of. You can use our tool to calculate your net profit margin and this should also help you determine your menu price.
Cost of Goods:
This is simply the cost required to make each menu item you sell.
Expenses:
- Labor cost:
The salaries for all employees including worker compensation, benefits, taxes, and insurance. This article by Joe Hadzima, Senior Lecturer of MIT, gave a thorough breakdown to help you calculate your true labor cost. - Rent plus NNN:
On top of the base rent, you should also include any property-related expenses such as common area maintenance and property taxes. If your landlord is taking a percentage of your revenue, you should also include it here. - Utilities:
This includes printing and designing costs for flyers and banners. Photography costs for online marketing. Domain and website maintenance, business email suite, etc. Advertising costs to marketing platforms (e.g. Yelp, Tripadvisor). Decorating cost for holidays. Giveaway promotions for loyal customers. - Insurance:
This includes your general liability insurance, liquor liability insurance, and any other insurance you might have purchased (e.g. business income insurance). Do not include worker compensation in this field, since you already included this as part of the labor cost. - Office Expenses:
Receipt paper and inks for your printer, pens or sharpies you use for your street sign, etc. Stamps and shipping cost for your mails and packages. - Storage and Lease:
The monthly payment for extra storage, and car rental for special occasions. (We leased a storage space to keep extra supplies in case our distributor ran out without notifying us, and we have attended night markets and street events which requires us to lease a u-haul van.) - Payment Processing and POS Terminal Cost:
This is the fee you pay for every card transaction, and this fee varies depending on your merchant company. Square charges a flat rate of 2.6% + 10¢ on every transaction, and this might seem like nothing until I calculate it and realized that I am paying Square more than $13,000 a year. You can try to promote more cash sales, but definitely include this as part of your cost if you’re accepting cards.
Some companies might also have annual or monthly charges, and lease payment for the hardware.
Don't forget to try our tool to calculate the merchant fee for you here. - Misc:
This part is mostly unexpected expenses such as maintenance, inspections, and penalties… If you’re not sure how much you should put here, it’s safe to say $200/month.
Others:
These are other recurring payments that most restaurant owners have, and you can determine if you want to calculate this as part of your expenses.
- Licenses & Permits:
This includes your annual health permit renewal fee, business license fee, etc. - Gas & Fuel Expense:
If you drive a long way to get your supplies, this cost can add up.
Side Note: Do not include sales tax as part of your gross sale. You might see your bank account growing but 7-9% of that is sales tax. Set this money aside to report your quarterly sales tax. You can also switch to a monthly plan if that works better for you.
The Best Way To Lower Your Cost Is Increase Your Sales
Yes. You can lower your cost by turning off the lights at night, by not printing receipt papers every time, by getting a fan so you don’t have to turn the AC on. However, the most effective way of cutting restaurant costs down is to get more sales.
By getting more sales, you can:
- Negotiate a better price with your supplier
- Negotiate a better price with your merchant company
- Never have to worry about food waste
- Increase your profit margin (Because the average expenses on every sale become lower)
- And much more...
The only expense that will increase along with getting more sales is your labor cost. You will need to train and hire more staff in order to handle the increase in sales. This is where Reduce’s self-order comes into play. You should only train staff in the back to focus on cooking and prepping, take advantage of self-order kiosks to be your cashier.
In our next article, we will introduce proven ways that we’ve used to increase our sales. Stay tuned!
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