Chapter 2 – Introduction: Revenue and Expense
Learning Objectives:
- Define key terms and recognize basic financial principles related to managing revenue and expense
- Apply the basic formula used to determine profit and ideal expense
- Describe various revenue sources for foodservice operations
- Describe typical expense categories for foodservice operations.
- Calculate cost percentages (express both expenses and profit as a percentage of revenue
- Compare actual operating revenue and expenses with budgeted operating results
- Calculate performance to budget figures
- Appreciate a realistic expected profit figure (percentage) for the restaurant industry.
Key Terms:
- Revenue
- Upselling
- Loyalty programs
- Expense
- Controllable expenses
- Non-controllable expenses
- Profit
- Profit and Loss Statement
- Budget
- Cost percentage
- Ideal expense
- Performance to budget
Introduction to Revenue and Expense
It is not enough to merely provide outstanding products and services in the foodservice industry. Managers must also create and maintain profitable food service operations. Simply put, driving revenue, while controlling expenses.
In the most basic terms, revenue is money or dollars brought in to the operation, also known as sales. Expenses are the costs associated with doing business and must be paid out to suppliers, the landlord, local government, etc. The basic formula is as follows:
| Revenue – Expense = Profit |
All foodservice operations have expenses, but not all have “sales.” Some non-profit onsite foodservice operations provide their products to guests as part of a larger operation. For example, patients in the hospital don’t pay for each of their meals individually, prisoners don’t pay for their meals, and a few businesses provide an employee cafeteria where the food and beverage are free to the employee. In these situations, the revenue comes from some overall organization budget and participation may be measured instead of revenue. Even in these kinds of operations, managers typically must still work within their revenue budgets.
For example, patients in the hospital don’t pay for each of their meals individually, prisoners don’t pay for their meals, and a few businesses provide an employee cafeteria where the food and beverage are free to the employee. In these situations, the revenue comes from some overall organization budget and participation may be measured instead of revenue. Even in these kinds of operations, managers typically must still work within their revenue budgets.
Revenue Streams
Sales of food and alcohol
The selling of food and beverage is obviously the main source of revenue. Proper marketing of the foodservice operation is also vital. Simply put, there are four different ways to make more money in the food service industry. 1) Bring in more customers. 2) Get them to come back, or purchase more often. 3) Get them to bring others with them. 4) Get them to spend more while they are there (increase the average check).
Upselling
Employees should be trained in proper techniques as they relate to upselling. Upselling is when we get customers to order “extra items”. An example of unsellable items would be: appetizers, desserts, coffee, both alcoholic, and non-alcoholic beverages, or menu add-ons, like mushrooms for their steak, extra or higher priced sides for their meal, such as fries instead of chips, etc. Can you think of a time when a server practiced upselling on you?
Meeting Room Rental Space, or “Buy-outs”
One way that a foodservice operation can bring in more revenue is by collecting money for private dining rooms. Buy-outs are another way that a restaurant can make more money. A buy-out is where the food service operation sells the entire property for the evening. It is important to understand what you would charge on a particular day, to ensure that this would make financial sense.
Off-Premise Catering
Off-premise catering is another area where the operator can bring in additional revenue. Off-premise catering is where the restaurant brings the food, beverage, and service to another location. Another benefit is that the event does not utilize seats in the restaurant. Off-premise catering is also a great way to build the reputation of your business.
Delivery, drive-up
Delivery is a popular service to offer to your customers. Another benefit of delivery is that it does not take up any space in your dining room. Many restaurants offer delivery, and third party delivery is a growth area in the foodservice industry. Many restaurants also take advantage of drive-up as well. This is where the customer can order their food by phone, or online and drive to the property and be met by an employee when they pull up. The employee then brings the food to the car, and can process the payment via a wireless system.
Service Charge
For tax purposes, tips and service charges are two completely different things. A service charge can be added to the guest check, and typical amounts can vary from 15-20%. Often times a portion of the service charge goes to the employee and a portion stays with the “house”. The portion that stays with the house can be considered revenue, and can be utilized in any manner the owner or manager wishes. This money is often used to off-set sales and marketing costs, and can also be added to the employees compensation in the form of “gratuity.” Tips, on the other hand, are money left for the server, should not technically be pooled, nor should a portion be held back from the server. Tips would not be considered a revenue source for the foodservice operation.
Merchandise
Many restaurants bring in additional revenues through the selling of merchandise. This can be as simple as selling hats and t-shirts at the cashier’s station, to operating elaborate stores and online purchases in places like Hard Rock Café, and Cracker Barrel.
Gift Cards
Gift cards are another great way to bring in additional revenue. Many restaurants offer gift cards, and this can be particularly popular during the holiday season, and can also be an “up-sell” item. Another benefit could be that many of the gift cards sold will never be redeemed, and would then be nearly 100% profit.
Revenue/Yield Management
In the past, the prices of menu items were the same whether it was on a Friday or a Monday. Now, restaurants are applying a similar dynamic pricing strategy that is utilized by the airline industry, and hotels. In this model foodservice operations can charge different amounts based on supply and demand. They can even separate the cost of the seating from the food and beverage. For instance, you might pay a premium price for a certain table based on the day of the week, and/or time of the day.
Some foodservice operations even sell “tickets” for a particular time slot. The ticket price would vary based on supply and demand. Foodservice operations can use a company such as Tock Tickets link to Tock Tickets, to handle the ticket purchase/distribution. Typically, this model only works if your restaurant is in high demand such as Per Se, or Eleven Madison Park in NYC.
Some other examples would be non-peak, and seasonal promotions. The classic “early-Bird-special” is one example where a lower price point is offered to entice customers to come in during slower time periods. An operation that is catering to a seasonal crowd like a ski resort, or beach setting, may lower or raise prices depending on the season.
Guest Loyalty Programs
Loyalty programs are structured marketing strategies designed by merchants to encourage customers to continue to shop at or use the services of businesses associated with each program. [1] These programs exist for most types of commerce, each one having varying features and rewards schemes.
In marketing, generally, and in retailing more specifically, a loyalty card, rewards card, points card, advantage card, or club card is a plastic or paper card, visually similar to a credit card, debit card, or digital card that identifies the cardholder as a participant in a loyalty program. [2] Loyalty cards (both physical and digital) relate to the loyalty business-model.
Source: loyalty program page on Wikipedia
Definition of Expense
An expense is an outflow of money to pay for a product or service. The following section describes the most pertinent expenses as they relate to the foodservice industry. Labor and food costs are typically the most significant of all expenses. A manager should possess the knowledge and skill to both understand and control their expenses. Below we will look at the various expenses associated with the food service industry
Types of expenses
Food Cost – The cost associated with preparing food for sale. Not only do we need to account for entrees, and side dishes, but we also need to account for make-up costs as well. Make-up costs are all those little extras that come with a dish, or can be requested by the customer. These can range from the ketchup, mustard, and pickle spear that may come with a sandwich, to the roll and butter that might accompany an entrée. We need to look at the full picture of our costs before we can price an item on our menu appropriately.
Beverage Cost – The cost associated with preparing a beverage for sale, and in many cases we are referring to alcoholic beverages. We need to account for make-up costs here as well. An example may be the olives garnishing a martini, the soda in a mixed drink, or the celery in a bloody Mary.
Labor Cost– Labor is one of the two highest expenses of any foodservice operation. Examples of labor costs would be salaries, wages, benefits, unemployment taxes, and any applicable bonuses. If our labor costs are too high then profits will suffer. If our labor costs are too low then customer service will suffer. A skilled manager will be able to determine the amount of labor needed on a daily basis and adjust as needed.
One easy way to see if you need to cut labor is by monitoring the first and last hour of the business day. If employees are standing around, then you could consider staggering in your employees at the start of each day, “punching in” instead of bringing them all in at once. The use of time and attendance software and hardware can also help by setting limits on how early an employee can “punch in” before each shift. You could also have them “punch out” on a staggered basis.
Controlling overtime will also be vital to control labor costs. Managers should only allow employees to go into overtime if it is truly warranted. In many cases, overtime may be warranted, and therefore budgeted accordingly.
Labor costs are on the rise, and attracting, and maintaining a steady workforce is more challenging than ever before. Many operations are investing in equipment that can automate as many tasks as possible. Robotics, which were one time only considered a thing of the future, are now finding their way into operations in many forms.
Other Cost – Other expenses are any expenses except food, beverage, and labor. Together these costs can represent nearly 15% or more of your operation’s revenues. Some examples of other expenses: equipment (both small and large), furniture, tableware, occupancy expenses, repairs and maintenance (deferred and preventative maintenance), administrative costs, and associated marketing costs. Most of the costs will either fall into one of the two categories: “Controllable” or “non-controllable” expenses.
Controllable expenses (aka non-fixed, or variable) – Are expenses that vary depending on how busy or slow the operation is. Food and beverage costs, for instance, should go up when you are busy and serving more customers, and down when you are slower and serving fewer guests. Hourly wages would be another example. An operation would typically have more labor when they are busy than when slow. Utilities, for the most part, should also vary depending on how busy or slow the operation is.
As a manager, you will be responsible for controlling and in many instances reducing the cost of controllable expenses. If for example, your food cost percentage is higher than it should be, you will need to determine why, and fix the issue. Some things to look at would be:
- are you charging enough for the items?
- are you purchasing correctly?
- do you have excessive waste?
- are you utilizing leftovers effectively?
- are you over-portioning?
- do you have any theft?
Non-controllable (aka fixed, or non-variable) expenses are expenses that remain the same despite the volume of business the operation experiences. Salaried managers, for example, are paid the same despite the volume of business. Rent in most cases would be another example of fixed costs. Landscaping and a monthly pest control service would also be examples of fixed costs.
Profit
Profit (aka the bottom line) is the benefit that is gained when revenue exceeds expenses. Revenue minus expense equals profit. The owner, or owners, will decide whether, or how much will be invested back into the operation. Typically the general manager will earn a bonus tied to profits. This creates an incentive to drive revenues while controlling costs. In non-profit onsite foodservice operations revenue exceeding expenses is typically not called profit, but something like net excess/deficit.
Two Basic Financial Documents
Profit and Loss Statement (P&L) or Statement of Activities
A foodservice operation’s profit and loss statement show the revenue (sales) and expenses (costs) for a specific time. This statement can be used weekly, monthly, quarterly, or yearly. The foodservice operation’s profit and loss statement typically have three sections.
- A detailed breakdown of revenues. This will help to determine where there are variances from the budget. For instance, if revenues are down, where are they down? Catering? Food? Beverage? Or perhaps a particular day part, such as breakfast, lunch or dinner?
- A list of your cost of goods sold, as well as your salaried, and hourly wages.
- A final section, which includes your operating expenses: insurance, and occupancy costs. This section will vary in non-profit foodservice operations.
The Budget
The budget is simply an estimate of expected revenue, expenses, and profit. This is your “plan” or “roadmap” for the week, month, quarter, or year. This will determine how much revenue you expect to bring in, and how much you expect to spend. Typically foodservice managers are expected to bring in more revenue each year. There are of course exceptions. Will the operation be closing down for a renovation, are new competitors entering the same market, or maybe a major event will not be returning to the area, think Olympics, or a Super Bowl. In these situations, you may actually be budgeting to make less money than you did the prior year. In the onsite foodservice segment, school enrollments could be increasing or decreasing, a business dining operation might be experiencing company growth or a health care facility might be expanding. A formula similar to the one explained earlier also applies to budgeted revenue and expense.
| Budgeted Revenue – Budgeted Expense = Budgeted Profit |
A manager needs to be constantly monitoring the budget and adjusting accordingly. If for example, revenues are down from what was budgeted, then spending would need to be reduced as well.
Some Basic Financial Analysis Ratios & Calculations
Calculating Cost Percentages (Ratios)
One of the most important ratios used in foodservice operations is the cost percentage of revenue. This ratio compares expenses to revenue to identify what percentage of revenue is going to the different categories of expenses. To calculate any cost percentage the dollar cost (expense) is divided by the revenue dollars for the same period. An example of a common cost percentage that is calculated on a regular basis is food cost percentage. If the food cost for a given month is $20,000 and the revenue for the same month is $64,000, the food cost percentage would be 31.25%.
| $ Cost divided by $ Revenue = Cost Percentage |
Profit can also be expressed as a percentage of revenue. The calculation is basically the same as above. Many people are surprised to learn that the profit percentage for commercial foodservice operations is in the range of 2% to 7% (3). Sometimes those in the industry say the average profit is a “nickel on the dollar.”
| Profit Dollars divided by Revenue Dollars = Profit Percentage |
(3) Biery, M.E. , Forbes, Jan 26, 2018 retrieved from Forbes article
Calculating Ideal Expense
Sometimes it is valuable to be able to figure out how much you can spend on a particular category of expenses or on a menu item given financial goals of the operation. If a foodservice manager has a profit goal and revenue forecast, or a price and a desired cost percentage, then a figure termed ideal expense can be calculated. This is the amount that can be spent on all costs to produce the full menu or just an item.
Example: If the desired profit for the chicken entrée is $2.00 and the selling price is $12.00, then the ideal total expense for the chicken entree is $10.00.
| Revenue minus Profit = Ideal Expense |
Example: If the selling price of the chicken entrée is $12.00 and the desired food cost percentage is 30%, then the ideal food expense for the chicken entrée would be $3.60
| Selling price multiplied by desired cost percentage |
| = Ideal Expense |
Calculating Performance to Budget (Ratios)
Since the budget is a plan for an operation’s financial performance, it is useful to monitor the budget from time to time, often on a monthly basis, though it might be done more frequently. One analysis typically performed is a performance to budget calculation. This compares actual revenue and actual expenses to the same categories in the budget for a given time period. The actual amount is divided by the budgeted amount to calculate the performance to budget ratio. An example would be to look at the actual amount spent on labor for a given month, and then compare that to the budget figure for labor in the same month. If a higher amount was spent on labor than was budgeted, then the performance to budget figure would be above 100%. If less money was spent on labor than was budgeted, the performance to the budget would be under 100%.
| Actual expense (or revenue) divided by Budgeted expense (or revenue) |
| equals Performance to Budget ratio |
This calculation might also be used to analyze actual revenue and expenditure performance for a portion of a yearly budget. Example: If 50% of the year has passed, has 50% (or more or less) of the budget been spent or has at least 50% of the revenue been received? This type of analysis allows the foodservice manager to make adjustments in the operation during the fiscal year rather than finding out at the end of the year that not enough revenue was generated or too much was spent and there is no profit or net excess for the business.
Summary
This chapter provides a basic overview of the types of revenue, expenses and financial documents that a typical foodservice operation would generate and use as well as some simple calculations that might be performed. All of these topics will be explored in more depth in later sections of this book.
Review Questions:
- What are some of the key revenue sources for restaurants and other foodservice operations?
- What are some ways to increase revenue in a foodservice operation?
- What are the key categories of expenses of foodservice operations, and which are considered controllable, and which are considered non-controllable?
- Dollars spent are important, but why is it also important to calculate and monitor cost percentages in a foodservice operation?
- If the performance to budget food expense is over 100% for a particular month, what other data would you want to take a look at when completing your monthly budget analysis?
Review Exercises
P&L Statement for the Downtown Bakery
| Description | Dollars | Percentages |
|---|---|---|
| Revenues | $500,000 | - |
| Food & Beverage Costs | $185,000 | - |
| Labor Costs | $200,000 | - |
| Other Costs | $95,000 | - |
| Total Expense | - | - |
| Profit | - | - |