Fixed and variable costs

Starting a pizzeria or running a pizzeria year after year is a tough job. You run into unexpected costs all along the way. You have problems with staff, customers, your building, your lease, your cash flow…The list goes on and on. We get a lot of questions on the Think Tank about how to break down the costs of business. There are two categories costs of business are going to fall into—fixed costs and variable costs.

With the expertise of Big Dave Ostrander, Jim Laube and Mike Rasmussen, here is a breakdown of these costs and how to break down your business costs into these categories. To start, we need to define the categories. “A fixed cost is a recurring cost each month,” Big Dave says. “These are your predictable costs such as rent, utilities, phone and insurance.” Your variable costs are going to be things like labor and food, he says.

Fixed Capital Costs

Big Dave says you should always overestimate on the costs. “You never know when building out that you may have to secure another permit or some other unexpected cost,” he says. Although these costs are going to vary, you should get a basic idea beforehand of what you are looking at. Therefore, the costs associated with building are going to be fixed.

Big Dave sent me a capital budget of a pizzeria he helped open and in it he listed all of the estimated costs that Pizzeria X would incur in construction and pre-opening costs. He broke it down into categories down to the cost per square foot. Included in this analysis, he listed the obvious costs such as equipment, professional services, employee pay, marketing, etc. He outlined what falls into equipment, and said that this would probably be your highest expense. In this example, he secured new and used equipment for the kitchen for around $84,000. When you consider equipment, you also have to factor in other pieces besides ovens, sinks and prep tables. In this analysis, equipment breaks down into kitchen equipment; dining room furniture; dishes and utensils; kitchen smallwares; security system; opening food, paper and supplies inventories; music and sound system; office supplies; interior décor and exterior signs and décor. These are all considered Fixed Capital Costs because you can predict about how much you are going to need or use.

“Fixed capital costs are depreciated over the assets useful life,” Mike says. “For example, machinery and equipment costs would be depreciated over a seven-year useful life. Certain elections can be made to write off the entire cost in the first year.”

Fixed Operating Costs

“You may think that utilities are a variable cost because they may vary from month to month, but you can predict which months you are going to use the air conditioner more,” Big Dave says. Other fixed operating costs include office supplies, advertising, repairs and maintenance, telephone, bank charges, insurance, interest, licenses, professional, royalties and rent. “These costs are not tied to sales volume on a monthly basis and can be budged within reason monthly,” Mike says.

Breaking Down Variable Costs

Your two biggest variable costs are going to be food and labor, Big Dave says. Food is going to be a variable cost, especially cheese and produce because they are market commodities. The best way to control the variance of food is to aim for a percentage of 25 to 30 percent of your total everyday business expense, Big Dave says. He says the best way to do this is use portion control, especially for cheese. “By doing this along with inventory, you will be able to control where your money is going,” he says. “If you notice a spike in cost one week, you'll be able to identify where the waste is going.”

Most operators understate labor, Big Dave says. “It's because they forget to factor in benefits,” he says. “An employee making eight dollars an hour actually costs you about $10 an hour when you factor in employer contribution to social security taxes, unemployment contribution, worker's compensation insurance, meals and benefits.”

The true cost of labor comes after these factors, which basically means you need to add about 5 percent more on top of wages, Big Dave says. “Most people say an ideal labor cost is 22 percent, when in reality, they are running a cost of 25 to 27 percent because they didn't factor in taxes and benefits and other silent costs.”

It All Adds Up to Prime Cost

What is prime cost? It's the combination of food and labor in percent. Big Dave says a prime cost of 50 to 60 percent is the norm. “I never focus on one without the other,” Big Dave says. “I really don't care if food is higher than the norm as long as the combination is in line. Whatever is left after that is gross profit before taxes. After all fixed expenses (Occupancy Costs and Depreciation) are subtracted from Controllable Profit, the money left over (Bottom Line) is called Net Income Before Taxes.”

“Everyone knows that the restaurant business is a ‘people' business, but it's also a ‘numbers business,'” says Jim Laube, a Dallas-based CPA and owner of RestaurantOwner.com. “Success can't just be measured in terms of smiling, satisfied customers but also in the cold, hard realities of facts, figures and finances.”

What Does It All Mean?

Contribution Margin (CM) is the excess of sales (S) over the variable costs (VC) of the products sold. It is the amount of money available to cover fixed operating costs (FC) and to generate a profit, Mike says. The formula is: CM=S-VC. “Typically, for a pizzeria the VC is represented solely by prime costs (food and labor.),” Mike says

He says break-even sales represent the level of sales revenue that equals the total of the variable and fixed costs for a given volume of output for a particular time period, say a month. “Generally, the lower the break-even point, the higher the profit and the less the operating risk, other things being equal,” Mike says. The break-even point in dollars formula is (BEP) = FC/CM Ration. The CM ratio = CM/S.

“Our most asked question is, ‘What sales would I need to generate in my pizzeria to break even?'” Mike says. “Now, you have the formula. The next question is, ‘What would my daily sales need to be to break even?' With this formula and considering your restaurant was open 30 days per month, you would need to generate $1,000 in sales per day ($30,000 (BEP) / 30 operating days in month).”

Pizzeria Owner's Financial Guide

The National Restaurant Association created and has updated the Uniform System of Accounts for Restaurants. The advantages of adapting this system rather than a proprietary one an accountant sets up for you are:

  • It's a common language system based on industry-specific means of understanding their financial position.
  • Allows for easy comparison to any other restaurant.
  • Provides detailed instructions of classifying expenses.
  • Is the only real format that lenders and bankers accept wholeheartedly.

Big Dave and Jim Laube have developed a pizzeria-specific version of the NRA system to fit within the unique accounting needs of pizzerias. They configured a Chart of Accounts for any type of operation, dine-in, carryout, delivery, take-n-bake, self-service, full service, with or without alcohol sales.

It's a good idea to get our your latest profit and loss statement and compare it to the NRA system. Share this article with your accountant and see how painless it will be to get a better understanding of where the money is going and how to boost your bottom line.