Prime cost is called prime for a reason. It is the single most important number a restaurateur must know to run a profitable business and have a solid restaurant business plan. Ignoring these will lead you to be a part of the restaurant failure rate.
If you're unsure how to calculate it and what it means, you're not alone. Along with important restaurant accounting principles like food cost and liquor cost, many restaurant owners have never been shown how to calculate it.
Don't worry, it's not as daunting as it seems. The main abilities it will require are calculating inventory usage and inventory variance. We'll help take the guesswork out of calculating prime cost to help you know how to price a menu and get you back to running a successful restaurant or bar business.
What Is Prime Cost?
Prime cost is the sum of the cost of goods sold and labor cost. Prime cost is the total cost a business incurs to produce an item. This number is vital in determining how to price products and maintain a profitable business. They're also a big part of your restaurant balance sheet.
Here's what the two numbers used to calculate prime cost mean.
Cost of Goods Sold
Cost of goods sold (COGS) is the total cost of all materials used in the production process. For restaurants, this number factors in the cost of all ingredients used to create dishes and drinks.
Total Labor Cost
Total labor cost is the sum of employee wages and benefits. This includes salaries, cleaning crews (for restaurant hood cleaning, for example), insurance, and payroll taxes for all employees that worked during the period being measured. That makes it different, and much broader, than direct labor cost.
What Is Prime Cost in a Restaurant?
Prime cost in a restaurant is the total of cost of goods sold and labor costs. This is the sum of all ingredients used and the overhead expenses associated with the team's labor. Finding this number is accomplished by tracking changes between starting inventory and ending inventory as well as the total amount paid out for labor.
What Is a Good Prime Cost for a Restaurant?
A good prime cost varies by restaurant but should be less than 60% of total restaurant sales. There are many factors that affect the prime cost of a restaurant. Restaurants that use less expensive supplies or have more employees with tip-based pay will see a lower prime cost. However, a prime cost that is too low may indicate that the restaurant sells inferior quality products and may lead to customer unhappiness.
Ideal Prime Cost for Restaurant
The ideal prime cost for a restaurant is 55% of total sales. This number is difficult to reach, but achievable in three ways:
- Lower inventory costs. Purchasing cheaper ingredients or reworking recipes to lower recipe costing and use fewer ingredients cuts inventory costs significantly.
- More effective usage of labor. By adopting hospitality technologies to streamline your operations and automate repetitive tasks you can lower labor costs by eliminating hours wasted on manual tasks such as inventory management.
- Increase prices. Using prime cost to set prices is known as menu engineering and can greatly improve profits. Look at your beer pricing and alcohol pricing to see where you can get the best return.
Prime Cost Formula
The formula for prime cost is:
COGS + Total Labor = Prime Cost
How to Calculate Prime Cost in a Restaurant
Calculating prime cost in a restaurant is best shown through an example. Remember, investing in good accounting software will save you the time and energy of having to calculate prime cost manually.
Say a diner owner is looking to find their prime cost for the past month. First, they calculate their COGS for the month. We’ll say it was $26,000. Next, they look at their team's labor costs. This includes wages and benefits, in this case a total of $7,000.
All we have to do now is plug these numbers into the formula above.
Prime Cost = $26,000 + $7,000
Prime Cost = $33,000
Now we know that the diner's prime cost last month was $33,000. If we know last month's revenue, we can take this a step farther to find the prime cost percentage.
Prime Cost Percentage
Prime cost percentage is a business's prime cost divided by sales. This calculation helps determine profit margin and can establish if the cost of goods or labor in a business is too high.
Prime Cost Percentage Formula
The formula for price cost percentage is:
Prime Cost / Sales = Prime Cost Percentage
How to Calculate Prime Cost Percentage in a Restaurant
Let's continue with our example above to find the diner's prime cost percentage.
We know that the diner's prime cost was $33,000. All we need is the month’s sales. This can easily be pulled from the diner's point of sale system. If they don’t have a bar POS system, they can just multiply the amount of product sold during the month by sales price. We'll say sales were $58,000 for our example.
Armed with these numbers, let's use the new formula from above.
Prime Cost Percentage = $33,000 / $58,000
Prime Cost Percentage = 5.9%
We find that the diner's prime cost percentage was 56.9%. In simple terms, this means they spent just under 57 cents on ingredients and labor for every dollar they earned last month.
Now You're Primed and Ready
You should now have a better grasp of the steps needed to find your restaurant's prime cost. It's not nearly as complicated as it may have seemed. Just make sure to consistently take a thorough inventory and you'll be able to find your prime cost.
It's important to learn how to manage cost for restaurant business to succeed. Now you can make smart decisions about bar promotions like happy hour and where you can cut costs. Just make sure you know what is happy hour and the best happy hour times.
And check out some restaurant marketing plan examples to get your promotional juices and restaurant SEO flowing.
Armed with this new information, you can make informed decisions regarding pricing. This includes determining your price per glass of wine and wine price. Prime cost is the perfect tool for finding your break even cost and trying to hit your goal profit margin.