Chapter 16 – Developing and Analyzing the Budget
Chapter Outline
- Introduction to budgeting for business
- Operating, cash, and capital budgets
- Budgeting process
- Articulate assumptions
- Quantify assumptions
- Budget versus actual – monitor the variances
Learning Objectives
- define budgeting and financial management terminology
- recognize the importance of planning, including accurate budgeting, in the operational and financial success of a food & beverage operation
- analyze the economic and competitive environment confronting a business (when involved in the budgeting process)
- identify the specific characteristics that provide a competitive advantage (or disadvantage) to a particular operation
- explain how budget figures are developed based on previous years data and projected increases or decreases in activity
- recognize restaurant revenue and cost drivers
- Number of covers
- Average Check
- Contribution Margin
- Prime Cost
- Variable and fixed costs
- explain how revenues and expenses flow through the financial statements analyze budget figures to compare projections to actuals
- describe the difference between
- net income and operating cash flow
- cash versus operating budget
- recognize restaurant revenue and cost drivers
Key Terms and Concepts
- operating budget
- cash budget
- capital budget
- restaurant revenue and cost drivers
- Number of covers
- Average Check
- Contribution Margin
- Prime Cost
- Variable and fixed costs
- net income
- operating cash flow
Introduction to budgeting for business
Budgeting and Cost-Volume-Profit (Breakeven) analysis are two main tools available to food service managers when planning for profit. This chapter will explore developing and analyzing the budget.
In its simplest form, a budget is a projection of anticipated revenues and expenses over a specific period of time. In the case of businesses, this is typically on a monthly, yearly and multi-year basis. The budget functions as a plan materializing what a business expects to achieve during the stated period.
A budget details the operational direction and the anticipated financial results of an operation. It provides a basis for continuously monitoring the operational and financial conditions and trends of an entity. The budget also defines the operational and financial limits of the operation.
The budget serves as a benchmark against which actual results are measured. As such, the budget is a tool supporting managerial decisions regarding resource allocation in order to achieve the goals of the organization.
A budget allows the operator to:
- conduct a critical review and learn from past performance
- involve those responsible for future performance in the forecasting process.
- be aware of how revenues, expenses, and cash flow interact in a restaurant
- plan for future cash events to avoid shortfalls
- evaluate different scenarios and courses of action to achieve desired profit levels
- monitor actual performances and compare them with the standards established in the budget
- take timely corrective actions to correct potential problems
A budget is not a static document and should be periodically modified to take into account the actual data about sales and costs affecting the direction of the overall operation.
Companies generally produce different types of budgets.
- The operating budget forecasts revenues and expenses for the operation. This budget mimics the profit & loss statement and provides anticipated revenues and expenses for each accounting period. An operating budget usually includes twelve monthly statements with a year-to-date and a yearly report. This budget also shows projected net income, the final amount of profit or loss after all expenses have been subtracted from sales (revenue.)
- The cash budget forecasts the cash outflows and inflows for a specific period. It assesses the ability of a business to meet its payment obligations and to ensure that excess cash is managed in a productive way.
In general, an operation’s revenues and cash cycles are not in line. Employee and supplier’s payments may not correspond to the timing of revenues. Revenues may not generate immediate cash when booked as account receivables.
Restaurant operations are affected by seasonality where expenses occur on an on-going basis while revenues may be concentrated over a shorter period (eg. resorts, educational settings, locations experiencing severe climatic events, etc.) requiring operations to plan for the periods of cash shortfalls. This requires food service managers to pay careful attention to operating cash flow, which is the amount of cash generated by regular business operations and indicates whether an operation has the cash it needs to grow.
Cash issues are one of the leading factors for the restaurant’s high rate of failure. A restaurant may appear to be profitable while being unable to meet its payment obligations (revenues exceed expenses but are booked as account receivables).
- The capital budget anticipates future cash requirements for investments in assets and equipment.
Food & beverage operations are particularly vulnerable to rapid shifts in consumption trends as illustrated by the demand for organic food products, sustainable and traceable production sources, healthier cooking methods, and ethnic/fusion cuisine.
Accordingly, the life cycle of a restaurant is limited and requires periodic renovations to maintain an attractive servicescape (impact of the physical environment and service process on guests’ behavior) and functioning equipment. In addition, food & beverage operations are increasingly investing in technology and information systems for such functions as point-of-sales and reservation systems, loyalty programs, purchasing and inventory, accounting, and human resources management.
Businesses may have multiple capital budgets based on the investment horizon under consideration (one to five years). Sound cash management allocates a portion of the operating cash flow to a reserve that will fund any future capital outlays.
Budgeting Process – focused on the operating budget
- Articulate the assumptions
Responsibility for preparing the budget depends on the size of the operation. For smaller restaurants, the owner/operator would be in charge. In larger operations, top-level management defines the objectives and a bottom-up budgeting process involves the persons responsible for future performance. This is crucial, as the managers need a degree of ownership in the assigned goals to believe that they are achievable,Accountants formalize the budget as a projected financial statement and a committee reviews and approve its final version. To be useful, a budget needs to be ambitious but realistic.
The budget relies on assumptions that should be clearly spelled out:
- General economic environment
- Expanding or receding economy
- Consumer confidence indicators
- Overall state of the food and beverage industry
- Food, beverage and labor costs in the marketplace
- Local environment/events affecting the operation such as:
- Business openings or closings
- Changes in local regulations
- Road or construction work affecting the access to the operation
- Labor issues – hiring or retention difficulties
- Competitive environment
- Restaurant openings, closing or renovating
- Competition pricing policies
- SWOT (strengths/weaknesses/opportunities/threat) analysis
- Historical operating ratios and trends
- Changes in customers’ demand and taste
- Revenue
- Cost of goods sold
- Labor (Payroll & benefits)
- Other expenses
- Other factors and constraints relevant to a specific operation
- General economic environment
- Quantify the assumptions
-
- Revenue targets are the first line items in the budget. Previous chapters in this textbook address revenue-forecasting methods in more detail. Forecasted sales determine the production goals and the resources required to achieve the performance levels dictated by the budget (food cost, labor, and other expenses).
A revenue forecast results primarily from the anticipated average check (average dollars spent by guests on food and beverage) and guest count, though some operations have other sources of income, such as merchandise or room rental. - Projecting expenses requires an analysis of the cost drivers and an understanding of the behavior of each line item. Variable costs such as cost of goods sold (food & beverage cost) vary in direct proportion with changes in revenues. Items such as labor costs or energy are semi-variable or mixed as they only partially change as revenues do. (Eg. Only one General Manager, F&B Director or Marketing and Sales Manager is required per operation. Safety lights and power for the refrigeration units are permanently on irrespective of the changes in revenues.) Finally, costs such as equipment leases, insurance, rent, property taxes or mortgage payments are fixed over an extended period.
- Cost of Sales, including food & beverage costs, are estimated based on a percentage of the corresponding revenues.
- Food Revenue ($) X Food Cost % = Food Cost ($)
- Beverage Revenue ($) X Beverage Cost % = Beverage Cost ($)
- Other Sales ($) X Other sales % = Cost of Other Sales ($)
According the Operations Report published by the National Restaurant Association (NRA), the Cost of Sales median value for full-service restaurants approximates 32% of total sales.
- Labor costs:
- The simplest (and less accurate) way to forecast labor costs (payroll + benefits) is to have separate estimates for management and hourly personnel and multiply the total revenue figure by the historical cost percentage derived from prior year financial statements.
- A more accurate approach is to review the forecasted monthly (or weekly) sales figure and guest counts and apply an operating labor productivity standard such as “guests per front or back of the house employee”, to estimate how many persons in each category are required.
According to the NRA study, the median value for payroll cost and benefits is approximately 34% of total sales
- Prime Cost: a review of reasonableness
- Prime cost (Cost of Sales + Labor) is a controllable expense (see the previous chapter on “managing other expenses”) and managers have the power to adjust cost items representing a targeted percentage of total sales within a short period. Accordingly, the prime cost is one of the most closely scrutinized profitability indicators.
- Other Controllable Expenses
- Other controllable expenses include non-food or labor expenses that support daily operations. The main line items are:
- Direct operating expenses
- Music & Entertainment
- Marketing
- General & Administrative
- Repairs & Maintenance
Other controllable expenses are usually calculated by either using historical ratios of total sales or a growth rate percentage determined by the management team.
- Other controllable expenses include non-food or labor expenses that support daily operations. The main line items are:
- Non-controllable expenses
- Occupancy Costs
- Equipment lease
- Depreciation & Amortization
- Interest Expense
- Property and Sales Taxes
Non-controllable expenses are fixed and do not change in the short term, so projecting these expenses is usually based on past history in the operation.
Refer to an earlier chapter in this book on “managing other expenses” for a detailed list of the costs classified as controllable and non-controllable expenses.
- Cost of Sales, including food & beverage costs, are estimated based on a percentage of the corresponding revenues.
- Revenue targets are the first line items in the budget. Previous chapters in this textbook address revenue-forecasting methods in more detail. Forecasted sales determine the production goals and the resources required to achieve the performance levels dictated by the budget (food cost, labor, and other expenses).
-
- Budget vs. Actual: Monitor the variances
A budget variance is the difference between the budgeted expense or revenue and the actual amount. The variance is favorable when actual revenues exceed the budgeted revenues or when the actual expense is below the budgeted expenses.
Variances highlight potential problems that managers have to investigate. The following table illustrates some of the issues that may cause unfavorable revenue or cost variances.
Revenue Problems
Table 16.1 Revenue Problems Potentially Manageable Reasons Potentially Unmanageable Reasons - Revenue theft by employees
- Ineffective marketing/sales tactics
- Guest-relations issues
- New and significant competition for the same guest market
- Operating hours are longer than necessary; incurred labor costs are not offset by sufficient revenue
- Significant layoffs within the community reducing the size of the guest market
- Economic recession
- Significant capital improvement/ remodeling project leading to restaurant downtime
- Street/other community improvement project yielding difficult/no access to property
- Shortage (lack) of key menu ingredients which require popular items to be temporarily removed from the menu
Table 16.1 Revenue Problems
Food Cost Problems
Table 16.2 Food Cost Problems Potentially Manageable Reasons Potentially Unmanageable Reasons - Product theft
- Failure to effectively follow procedures for effective purchasing, storing, issuing, and producing food products
- Improper/inaccurate procedures to calculate actual food cost
- Ineffective selling techniques resulting in sales of higher food cost items
- Portion control issues
- Waste, such as overcooking, reduced yield percentages, cooking errors
- Significant increases in costs paid for food
- Shift of guest preferences to higher-food cost menu selections
- Storage losses (refrigerator/freezer breakdown requiring stored food to be destroyed)
- Shift to more convenience foods in efforts to reduce labor costs
- Formalize the budget (see table below for an example operating budget)Forecast, forecast, forecast, then “crunch” the numbers to make the best projections and plan possible given past history, the current economic situation, and future goals.
Beth’s Homestyle Restaurant
Budgeted Fiscal Year Ending December 31, 2020
Revenue
| Statement Item | January | February | March | April | May | June | July | August | September | October | November | December | 2020 |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Covers Per Day | 110 | 105 | 130 | 135 | 130 | 120 | 120 | 115 | 135 | 135 | 130 | 105 | 1,470 |
| Number of Covers | 3,410 | 3,255 | 4,030 | 4,185 | 4,030 | 3,720 | 3,720 | 3,565 | 4,185 | 4,185 | 4,030 | 3,255 | 45,570 |
| Average Check | $28.00 | $28.00 | $28.00 | $28.00 | $28.00 | $28.00 | $28.00 | $28.00 | $28.00 | $28.00 | $28.00 | $28.00 | $28.00 |
| Food Revenue | $87,686 (90.0%) |
$83,700 (90.0%) |
$103,629 (90.0%) |
$107,614 (90.0%) |
$103,629 (90.0%) |
$95,657 (90.0%) |
$95,657 (90.0%) |
$91,671 (90.0%) |
$107,614 (90.0%) |
$107,614 (90.0%) |
$103,629 (90.0%) |
$83,700 (90.0%) |
$1,171,800 (90.0%) |
| Beverage Revenue | $7,794 (8.0%) |
$7,440 (8.0%) |
$9,211 (8.0%) |
$9,566 (8.0%) |
$9,211 (8.0%) |
$8,503 (8.0%) |
$8,503 (8.0%) |
$8,149 (8.0%) |
$9,566 (8.0%) |
$9,566 (8.0%) |
$9,211 (8.0%) |
$7,440 (8.0%) |
$104,160 (8.0%) |
| Food & Beverage Revenue Total | $95,480 (98.0%) |
$91,140 (98.0%) |
$112,840 (98.0%) |
$117,180 (98.0%) |
$112,840 (98.0%) |
$104,160 (98.0%) |
$104,160 (98.0%) |
$99,820 (98.0%) |
$117,180 (98.0%) |
$117,180 (98.0%) |
$112,840 (98.0%) |
$91,140 (98.0%) |
$1,275,960 (98.0%) |
| Other Sales Revenue | $1,949 (2.0%) |
$1,860 (2.0%) |
$2,303 (2.0%) |
$2,391 (2.0%) |
$2,303 (2.0%) |
$2,126 (2.0%) |
$2,126 (2.0%) |
$2,037 (2.0%) |
$2,391 (2.0%) |
$2,391 (2.0%) |
$2,303 (2.0%) |
$1,860 (2.0%) |
$26,040 (2.0%) |
| Total Revenue | $97,429 (100.0%) |
$93,000 (100.0%) |
$115,143 (100.0%) |
$119,571 (100.0%) |
$115,143 (100.0%) |
$106,286 (100.0%) |
$106,286 (100.0%) |
$101,857 (100.0%) |
$119,571 (100.0%) |
$119,571 (100.0%) |
$115,143 (100.0%) |
$93,000 (100.0%) |
$1,302,000 (100.0%) |
Beth's Homestyle Restaurant (Cost of Sales)
| Statement Item | January | February | March | April | May | June | July | August | September | October | November | December | 2020 |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Cost of Food Sold | $24,114 (27.5%) |
$23,018 (27.5%) |
$28,498 (27.5%) |
$29,592 (27.5%) |
$28,498 (27.5%) |
$26,306 (27.5%) |
$26,306 (27.5%) |
$25,210 (27.5%) |
$29,594 (27.5%) |
$29,594 (27.5%) |
$29,498 (27.5%) |
$23,018 (27.5%) |
$322,245 (27.5%) |
| Cost of Beverages Sold | $1,208 (15.5%) |
$1,153 (15.5%) |
$1,428 (15.5%) |
$1,483 (15.5%) |
$1,428 (15.5%) |
$1,318 (15.5%) |
$1,318 (15.5%) |
$1,263 (15.5%) |
$1,483 (15.5%) |
$1,483 (15.5%) |
$1,428 (15.5%) |
$1,153 (15.5%) |
$16,145 (15.5%) |
| Total Food & Beverage Cost of Sales | $25,322 (26.0%) |
$24,171 (26.0%) |
$29,926 (26.0%) |
$31,077 (26.0%) |
$29,296 (26.0%) |
$27,624 (26.0%) |
$27,624 (26.0%) |
$26,473 (26.0%) |
$31,077 (26.0%) |
$31,077 (26.0%) |
$29,926 (26.0%) |
$24,171 (26.0%) |
$338,390 (26.0%) |
| Cost of Sales (Other) | $877 (45.0%) |
$837 (45.0%) |
$1,036 (45.0%) |
$1,076 (45.0%) |
$1,036 (45.0%) |
$957 (45.0%) |
$957 (45.0%) |
$917 (45.0%) |
$1,076 (45.0%) |
$1,076 (45.0%) |
$1,036 (45.0%) |
$837 (45.0%) |
$11,718 (45.0%) |
| Total Cost of Sales | $26,199 (26.9%) |
$25,008 (26.9%) |
$30,962 (26.9%) |
$32,153 (26.9%) |
$30,962 (26.9%) |
$28,580 (26.9%) |
$28,580 (26.9%) |
$27,389 (26.9%) |
$32,153 (26.9%) |
$32,153 (26.9%) |
$30,962 (26.9%) |
$25,008 (26.9%) |
$350,108 (26.9%) |
Beth's Homestyle Restaurant (Payroll and Employee Benefit Costs)
| Statement Item | January | February | March | April | May | June | July | August | September | October | November | December | 2020 |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Salaries and Wages (Management) |
$8,769 (9.0%) |
$8,769 (9.4%) |
$8,769 (7.6%) |
$8,769 (7.3%) |
$8,769 (7.6%) |
$8,769 (8.3%) |
$8,769 (8.3%) |
$8,769 (8.6%) |
$8,769 (7.3%) |
$8,769 (7.3%) |
$8,769 (7.6%) |
$8,769 (9.4%) |
$105,223 (8.1%) |
| Salaries and Wages (Hourly Personnel) |
$20,460 (22.0%) |
$20,460 (21.0%) |
$20,460 (17.8%) |
$20,460 (17.1%) |
$20,460 (17.8%) |
$20,460 (19.3%) |
$20,460 (19.3%) |
$20,460 (20.1%) |
$20,460 (17.1%) |
$20,460 (17.1%) |
$20,460 (17.8%) |
$20,460 (22.0%) |
$245,520 (18.9%) |
| Salaries and Wages Total Cost | $29,229 (30.0%) |
$29,229 (31.4%) |
$29,229 (25.4%) |
$29,229 (24.4%) |
$29,229 (25.4%) |
$29,229 (27.5%) |
$29,229 (27.5%) |
$29,229 (28.7%) |
$29,229 (24.4%) |
$29,229 (24.4%) |
$29,229 (25.4%) |
$29,229 (31.4%) |
$350,743 (26.9%) |
| Employee Benefits | $2,338 (2.4%) |
$2,338 (2.5%) |
$2,338 (2.0%) |
$2,338 (2.0%) |
$2,338 (2.0%) |
$2,338 (2.2%) |
$2,338 (2.2%) |
$2,338 (2.3%) |
$2,338 (2.0%) |
$2,338 (2.0%) |
$2,338 (2.0%) |
$2,338 (2.5%) |
$28,059 (2.2%) |
| Payroll and Employee Benefits Total Cost | $31,567 (32.4%) |
$31,567 (33.9%) |
$31,567 (27.4%) |
$31,567 (26.4%) |
$31,567 (27.4%) |
$31,567 (29.7%) |
$31,567 (29.7%) |
$31,567 (31.0%) |
$31,567 (26.4%) |
$31,567 (26.4%) |
$31,567 (27.4%) |
$31,567 (33.9%) |
$378,802 (29.1%) |
| Prime Cost | $57,765 (59.3%) |
$56,575 (60.8%) |
$62,529 (54.3%) |
$63,720 (53.3%) |
$62,529 (54.3%) |
$60,147 (56.6%) |
$60,147 (56.6$) |
$58,956 (57.9%) |
$63,720 (53.3%) |
$63,720 (53.3%) |
$62,529 (54.3%) |
$56,575 (60.8%) |
$728,910 (56.0%) |
| Gross Margin | $39,663 (40.7%) |
$36,425 (39.2%) |
$52,614 (45.7%) |
$55,852 (46.7%) |
$52,614 (45.7%) |
$46,139 (43.3%) |
$46,139 (43.4%) |
$42,901 (42.1%) |
$55,852 (46.7%) |
$55,852 (46.7%) |
$52,614 (45.7%) |
$36,425 (39.3%) |
$573,090 (44.0%) |
Beth's Homestyle Restaurant (Other Controllable Expenses Statements)
| Statement Item | January | February | March | April | May | June | July | August | September | October | November | December | 2020 |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Music Entertainment Cost | $779 (0.8%) |
$779 (0.8%) |
$779 (0.7%) |
$779 (0.7%) |
$779 (0.7%) |
$779 (0.7%) |
$779 (0.7%) |
$779 (0.7%) |
$779 (0.7%) |
$779 (0.7%) |
$779 (0.7%) |
$779 (0.8%) |
$9,353 (0.7%) |
| Marketing Cost | $3,410 (3.5%) |
$3,255 (3.5%) |
$4030 (3.5%) |
$4,185 (3.5%) |
$4,030 (3.5%) |
$3,720 (3.5%) |
$3,720 (3.5%) |
$3,562 (3.5%) |
$4,185 (3.5%) |
$4,185 (3.5%) |
$4,030 (3.5%) |
$3,255 (3.5%) |
$45,570 (3.5%) |
| Utilities Cost | $2,436 (2.5%) |
$2,325 (2.5%) |
$2,879 (2.5%) |
$2,989 (2.5%) |
$2,879 (2.5%) |
$2,657 (2.5%) |
$2,657 (2.5%) |
$2,546 (2.5%) |
$2,989 (2.5%) |
$2,989 (2.5%) |
$2,879 (2.5%) |
$2,325 (2.5%) |
$32,550 (2.5%) |
| General and Admission Cost | $4,384 (4.5%) |
$4,185 (4.5%) |
$5,181 (4.5%) |
$5,381 (4.5%) |
$5,181 (4.5%) |
$4,783 (4.5%) |
$4,783 (4.5%) |
$4,584 (4.5%) |
$5,381 (4.5%) |
$5,381 (4.5%) |
$5,181 (4.5%) |
$4,185 (4.5%) |
$58,590 (4.5%) |
| Repairs and Maintenance Cost | $1,267 (1.3%) |
$1,209 (1.3%) |
$1,497 (1.3%) |
$1,554 (1.3%) |
$1,497 (1.3%) |
$1,382 (1.3%) |
$1,382 (1.3%) |
$1,324 (1.3%) |
$1,554 (1.3%) |
$1,551 (1.3%) |
$1,497 (1.3%) |
$1,209 (1.3%) |
$16,926 (1.3%) |
| Other Expenses Total Cost | $12,276 (12.6%) |
$11,753 (12.6%) |
$14,366 (12.5%) |
$14,889 (12.5%) |
$14,366 (12.5%) |
$13,321 (12.5%) |
$13,321 (12.5%) |
$12,799 (12.6%) |
$14,899 (12.5%) |
$14,899 (12.5%) |
$14,366 (12.5%) |
$11,753 (12.6%) |
$162,989 (12.5%) |
| Controllable Profit | $27,387 (28.1%) |
$24,672 (26.5%) |
$38,248 (33.2%) |
$40,963 (34.3%) |
$38,248 (33.2%) |
$32,817 (30.9%) |
$32,817 (30.9%) |
$30,102 (29.6%) |
$40,963 (34.3%) |
$40,963 (34.3%) |
$38,248 (33.2%) |
$24,672 (26.5%) |
$410,101 (31.5%) |
Summary: Budgets and the Budgeting Process
Though this chapter on budgeting is toward the end of this book, it could also be one of the first. Developing the budget is critical for planning for a profitable food service operation. An effective food service manager also recognizes that a budget is a plan or roadmap, but not “set in stone.” The budget requires analysis on a regular basis to be sure that either things are going as planned or that adjustments are made as necessary throughout the budget period to achieve the profit goals of the operation.
Review Questions
Short Answer
- What are some of the purposes of a budget for a food service operation?
- What is the difference between an operating budget, a cash budget, and a capital budget?
- What are some types of assumptions that a food service budget planner has to consider and articulate?
- What are some of the different expense categories in a food service operation budget?
- If there are unfavorable variances in a food service operation budget, what are some examples of manageable problems that could be better controlled to create a more favorable outcome?