I can remember when, as an assistant manager of a brewpub and café that served “The World’s Best Spent Grain Pizza,” I was taught how to complete the standard Cost of Goods Sold calculation; Beginning inventory + purchases = total available. Total available - ending inventory = total product used. Total product used divided by sales = cost of good sold percentage. See figure #1.

As I reached an operations role, my kitchen managers were creating good numbers on paper, but our bank account did not reflect those positive numbers. I learned quickly that profits on paper do not pay the bills, CASH PAYS THE BILLS.

I later learned to look deeper into the Cost of Goods Sold calculations to take back control of the checking account and improve the bottom line.

The Basic Calculation
What does Cost of Goods Sold refer to? In basic terms, Cost of Goods Sold refers to “what the cost of the product used was to generate sales.” On the item sales level, Cost of Goods Sold is the cost of all the ingredients that go into a recipe. The Cost of Goods Sold divided by selling price gives the cost of goods sold percentage. For example, a pepperoni pizza has 10 ounces of dough, three ounces of sauce, six ounces of cheese and six ounces of pepperoni; total cost: $2.44. It sells for $12.99. So, $2.44 divided by the sale price of $12.99 gives a Cost of Goods Sold percentage of 18.8 percent.

The Cost of Goods Sold calculation is used to calculate a Cost of Goods Sold percentage for a given accounting period as shown below in figure #1 and can be different from restaurant to restaurant. In most cases, an accounting period refers to a calendar month. Some restaurants have found a 13 period calendar year to be extremely effective, where the year is broken into even four-week periods. An accounting period may also be a day or a week if a restaurant is trying to correct a problem right away. For the purpose of this article, an accounting period will be a calendar month.

The Cost of Goods Sold calculation is also most valuable when it is broken down by categories, i.e. food, liquor, bottle beer, draft beer and wine. This is more effective when broken into categories because if the pour costs are high, you can determine where the problem is. You can react by examining your draft system for problems due to foaming issues, because your draft numbers are high. Otherwise, if liquor pour costs had all categories lumped in one figure, you would not know where to look for the problem without redoing all of your work.

Standard Cost of Goods Sold Calculation

Figure1
The Details to the Standard Calculation
A. Beginning Inventory refers to the total dollar value of all of the inventoried items, from the end of the last period, on the shelves, i.e. all food items for the food cost calculation.
B. Purchases are any and all invoices for items that came into the building during that period, paid for or not. It’s imperative that you follow an accrual accounting format when logging in purchases. Then you show an accurate accounting of what product actually entered the building during that period. Since you carry inventory, the IRS will require your tax returns to be done in an accrual basis even if you run your books on a cash accounting basis, so there is no benefit to doing your books on a cash basis. A simple way to look at accrual accounting is earn, owe and use.
1) If you earn it (sales) you are required to account for it.
2) If you owe for it (all invoices, by category, whether you paid for it or not).
3) And if you use it (product that leaves the shelves) an inventory adjustment up or down in the expense account for that category is made (i.e. if you used $500 more in food than you purchase for that period, than you would reduce the inventory figure on the balance sheet and increase the expense on the profit and loss statement, which increases your Cost of Goods Sold for that period).
C. Total Available refers to the total amount of product by category that you could have sold in a given period, beginning inventory plus purchases. For example, if there was $5,000 of product on the shelves when you opened on the first day of the period and you took $10,000 in deliveries though the last day of the period, but did not open your doors at all that period, you would have $15,000 of product on your shelves you could have sold.
D. Ending Inventory refers to the total dollar value of all the inventoried items after the close of the last day in that period or before you open for the first day of the next period.
E. Product Used represents the dollar amount of the entire amount of product used in any given period; Total Available minus Ending Inventory. Use literally refers to product used and can be categorized in four ways.
1) Waste or Spoilage – If food gets thrown away, if giving a larger portion than the recipe calls for, or your refrigeration unit goes down and nobody caught it. You had to throw away product so it is still considered use. Most all waste is avoidable and is a direct result of a lack of management and training.
2) Theft – If your staff takes food home, if they give friends free food or drinks, this too is considered use.
3) Comps – This strictly refers to all comps that are not rung up on the POS or cash registers. This might be an owner taking steaks home for a barbeque. This is Use because product has been used even though no sale has been rung up.
4) Sales – The reason you hope your entire inventory of product gets used is because it means the only reason products left your shelves was to bring in money.
F. Sales are, as described earlier, to be shown by category for a given period. Again sales represent the dollars brought in for the entire product that left your shelves for that period.
G. Cost of Goods Sold percent. Cost of Goods Sold percentage, Use divided by Sales; represent a penny of product for every dollar you brought in in sales. For example, a 32 percent food cost means for every dollar in food sales you brought in, 32 cents of product left your shelves.

Four Calculations You Can Take to the Bank
This is where most management stops with the calculation. When we were rewarding managers for achieving numbers, there is more analysis to be done. Let’s look at four additional equations that allow you to drill down deeper. They are: Average Inventory, Inventory Turns, Change in Inventory and Budget Variance.
A. Average Inventory is calculated by adding the beginning inventory to the ending inventory and dividing that number by two [(Beginning Inventory + Ending Inventory) ÷ 2]. This equation will show the average dollar value in inventory you carry any day during a given period. The number this produces is vital to measuring how efficient you managers are with product and your bank account. The equation for inventory turns will shed some light on why.
B. Inventory Turns are calculated by dividing use by average inventory [Use ÷ Average Inventory]. This will show you how many times the dry storage and walk-in shelves were stripped clear of product and then re-stocked. The benefit: this number measures how efficient a store is with its cash and inventory. For example, in most cases the kitchen of a full service restaurant wants to achieve four to eight inventory turns a month. If the inventory is turned four times in a month, in theory that means they will sell all of their product on the shelves and re-stock them four times and they will be placing a food order only once a week. In the real world this does not happen exactly that way. Think about spices. How long has that large bucket of salt been sitting in your dry storage? What about perishables? Don’t you take delivery of milk and cottage cheese twice a week, so they don’t spoil? So you can see, that some items turn more often than other items. So when we refer to an inventory turn, we are really referring to the number of times the dollar value on the shelves turn. What are some of the benefits to turning your inventory so often?
1) You will reduce your risk of theft because you can immediately see when items are missing. Everything has its place.
2) You will operate a cleaner restaurant.
3) With less inventory on the shelves you will have more cash in the bank to pay bills. Why? Ask yourself what exactly is inventory? It represents cash that cannot be used to pay your bills with.
C. Change in Inventory is calculated by subtracting the Ending Inventory by the Beginning Inventory [Ending Inventory – Beginning Inventory]. This calculation shows how efficiently you store has been ordering product. This number is important, just as inventory turns are, because it clearly represents how much cash you have either freed up or tied up on your shelves. For instance, if my food inventory was $4,000 at the beginning of the month and my ending inventory was $5,000, I just took $1,000 out of my bank account and placed it on the shelves where it can be stolen, wasted and not used to pay bills. Note that an increase in inventory may have no negative impact on you overall Cost of Goods Sold calculation, because Use is the key number to determining the Cost of Goods Sold percentage. An increase in inventory, however, can be devastating to an operation that is tight on cash.
D. Budget Variance first makes the assumption that as an operator you have a budgeted Cost of Goods Sold percentage as a target. With this assumption in mind, the calculation is both the Target Use minus the Actual Use and the target Cost of Goods Sold percentage minus the actual Cost of Goods Sold percentage [Target Use – Actual Use and Target Use percent - Actual Use percent]. These numbers show how close your store came to achieving its goals. Without a target you will be unable to quantify performance. These numbers let you better interpret how your store performed in a given period. For instance, if you have a target Food Cost of 30 percent and your Food Cost percentage came in at 34 percent on $100,000 in food sales, you would have used $34,000 in food product vs. the $30,000 that was budgeted. That means you would have wasted $4,000, most likely due to poor management. It is the equivalent of a kitchen manager taking $4,000 and placing it in front of their general manager, and then setting it on fire.
In figure #2, above, I will show you how all of these calculations can come together to see how you are doing. Then you can eliminate circumstances where you can be taken advantage of and recognize opportunities to put cash back into the bank.
The Food Cost calculation is, as discussed earlier, beginning inventory + purchases = total available. Total available - ending inventory = total product used. Total product used divided by sales = cost of good sold percentage. But as you can see the four additional calculations have been added to bring new facts to light. These facts will demonstrate how at first glance we might think that the kitchen manager (KM) is doing a great job and entitled to a bonus, but looking deeper shows that the KM has just made it difficult to make payroll and should not receive that bonus.    
We can see from the standard calculation that the KM has come pretty close hitting the targeted food cost percentage budgeted for. He has achieved a 30.61 percent vs. the budgeted 30 percent. The KM might even say, “I’m only .61 percent off budget.” And at first you might say, “You’re right, it’s not a big deal.” Let’s look at the numbers deeper.       
While the Food Cost percentage was close to our target and is very close to last months food cost percentage, our inventory turns are not hitting the minimum four turns desired. We have too much food on our shelves. Our change in inventory shows we added $3,222.80 in product to our shelves. That might mean the difference in making payroll. Remember when I said that cash pays the bills, profits don’t. Then we look at that .61 percent means that we wasted $385.89 worth of product. So due to poor management of our restaurant and this controllable expense, we had a negative impact of $3,608.77 in our bank account. And without looking at the Cost of Goods Sold calculation with the additional equations, as simple as they may be, we might have rewarded our KM for making his numbers, when he really didn’t at all.

The Light Bulb
You should have learned that the standard Cost of Goods Sold calculation alone, while important, can get you into trouble. A light bulb should have gone off. You should no longer stop with the standard calculation. From here, you know what to look for and will be able to take steps to not only make your numbers, but increase your operating efficiency to create a larger bank account, from which you can pay your bills or maybe even yourself.

If you would like to learn more strategies and easy to implement system on this topic, you can find more information at http://www.smilebutton.com/cogstraining.

<< Back to Table of Contents