Restaurant Accounting 101: The Basics of Measuring Your Restaurant’s Profit Margin

While passion for great food and amazing service can fuel a restaurant business, it’s the numbers that dictate where you can take it. Can you afford to open a second outlet, or maybe even launch a franchise? Or do you need to cut costs?

Out of the restaurant metrics you need to calculate regularly, it’s your profit margin that can answer these questions. Profit margin refers to the percentage of profit you earn from sales. 

Restaurants used to have an average of 15-20% gross profit margin, but over the past 20 years, it has shrunk to as little as 4-7%. Some restaurants even operate without profit at all, with many just barely breaking even.

While your profit margin can help you set realistic goals, it can also point out the adjustments you need to make to increase your earnings. We’ll help you understand profit margins and give you tips on how to protect them.

Understanding Profit Margin

Businesses deal with two kinds of profit: gross profit and net profit.

Gross profit margin is the percentage of sales that goes into profit minus deductions. You can also determine the gross profit margin of every menu item. In that case, the formula is as follows:

Gross Profit Margin = (Menu Price – Raw Food Cost) / Menu Price * 100

Suppose you sell a plate of biryani for $11. To make this dish, you spend $6. Therefore, your gross profit margin for biryani is:

Gross Profit Margin = ($11 – $6) / $11 * 100

Gross Profit Margin = ($5 / $11) 100

Gross Profit Margin = 45%

A 45% gross profit margin is healthy for one dish. Let’s see the percentage you’d end up with if we calculate your gross profit margin based on your total sales.

In this scenario, the formula you’ll use is:

Gross Profit Margin = (Total Sales – Cost of Goods Sold) / Total Sales * 100

Let’s say your restaurant’s total sales from January 2022 to June 2022 was $1.5 million, and the cost of goods sold (CoGS) was $350,000.

Gross Profit Margin = ($1.5 million – $350,000) / $1.5 million * 100

Gross Profit Margin = ($1.15 million / $1.5 million) 100

Gross Profit Margin = 77%

If your gross profit margin based on total sales is 77%, it means that for every $100 a customer spends at your restaurant, you earn $77, which you’ll then use to pay for operating expenses.

Speaking of operating expenses, the profit margin you get after deducting them is your net profit margin. On the other hand, operating expenses include inventory costs, labor, rent, utilities, equipment leasing costs, and subscription fees.

To calculate your net profit margin, you can use this formula:

Net Profit Margin = (Gross Sales – Operating Expense) / Gross Sales * 100

Take note, gross sales minus operating expenses equals net profit, so you can also write the formula as follows:

Net Profit Margin = Net Profit / Gross Sales * 100

If your restaurant’s gross sales for the period mentioned above was $1.85 million, and the operating expenses were $1.6 million, then:

Net Profit Margin = ($1.85 million – $1.6 million) / $1.85 million * 100

Net Profit Margin = ($250,000 / $1.85 million) 100

Net Profit Margin = 14%

With a 14% net profit margin, you’re earning a lot more than the national average. This makes you more likely to expand your business with your resources at hand. You can also use your excess profit for investments, which can help you grow capital.

But before diving deeper into making the most out of your profits, let’s discuss the other factors that play into your net profit.

Profit and Income

It’s not enough to look at profit alone to determine how much you’re truly earning. Profit merely represents the amount you’re left with after deducting the expenses from revenues. To know the actual amount you’ve earned after a period, you should calculate your income. Income is determined after deducting the rest of your restaurant’s expenses from your net profit. Such expenses include taxes, interest, amortization, and depreciation.

Restaurant profit margin also affects restaurant income, but assets are the ones that significantly boost it. Three factors affect assets, such as:

• Gain

A gain is an increase in an asset or property’s value. It is the opposite of loss, which happens when the current value of something becomes less than its purchase price. 

Another way to explain a gain is that it is the difference between the price of something upon purchase and its current price. There are different ways to classify gains, such as:

• Gross Gains
• Net Gains
• Unrealized Gains
• Realized Gains or Capital Gains

Gross gain is the difference between current price and purchase price, minus transaction costs and other expenses. When you deduct those, you get the net gain value.

Unrealized gain, AKA paper gain, is the increase of an asset’s value since its purchase while you still own it. For example, commercial property. If you own your restaurant space, you get unrealized gains when its current value is more than the value at which you bought it.

If you sell your restaurant space to purchase a new one, you’ll earn realized gains or capital gains, which is the profit you receive after selling an asset. 

Capital gains are taxable. The taxable amount is the difference between the asset’s sale price and purchase price, after considering brokerage commissions, if applicable. 

• Investments

Investments are assets you buy with the intention of increasing their value over time. Stocks, bonds, and real estate are common examples of investments. Return on Investment (ROI) is the general term for investment income, but if they are drawn from securities, they are specifically called interest (from bonds) or dividends (from stocks). Earnings from real estate investments are called property income.

There are also investments unique to restaurants, like Michelin Star chefs, special menu items, and restaurant technology. Hiring a top chef can elevate the value of your cuisine, allowing you to raise your menu prices. Topped off with an excellent restaurant management system, you can increase your sales and boost your profits. 

Franchise agreements, copyright, and trademarks are also examples of a restaurant asset. In accounting terms, they are called intangible assets.

While we’ve mentioned that interest is an income, it can also be an expense. If you have loans, the interests you pay are deducted from your income, triggering a need to stretch your profit margin in order to maximize your earnings.

• Appreciation

Appreciation happens when your asset increases in value over time. It is the opposite of depreciation, which happens when an asset loses its value over time.

However, appreciation is written off as unrealized values. As mentioned, you need to sell an asset that has increased in value to earn realized gains. But there are ways to realize an asset’s appreciation without selling it.

For example, if you record your investments’ appreciated values on your financial statements, your business can realize that increase, which reflects in your income.

Protecting Your Profit Margins

With food, labor, and operating expenses rising, widening your restaurant profit margin becomes necessary, albeit challenging. 

Thankfully, you can explore various solutions to protect—and even increase—your profit margins. Aside from growing your investments, you can also open additional revenue streams.

Besides sales, revenue can be earned from catering services, venue rentals, merchandise sales, and franchise agreements, among others. But more revenue streams also mean more spending, so you need to offset it by minimizing your costs.

Since labor is often the highest or second-highest restaurant expense, automating repetitive and administrative tasks can help you save money. Consider using QR code menus so your customers can place their orders and pay with less intervention from your servers. Depending on your concept, you may also want to try self-ordering kiosks, which streamline the ordering process and cut long lines.

You can automate tasks in the backend as well, like inventory counts. An automated inventory management system can perform stock counts for you, allowing you to send POs to your suppliers before your stocks reach critical levels.

Bookkeeping tasks can also be automated through real-time business analytics. Simply look at your POS, and you’ll see all the reports you need as well as a summary of your restaurant’s performance at any date and time range.

Stretching restaurant profit margins is no easy task, but these solutions can make a huge difference. Remember to be patient, because an increase in profit won’t occur overnight. Monitor your restaurant actively; watch out for market trends and industry updates. In this volatile economy, your attentiveness and quick thinking can help you address issues before they hurt your profit.