Understanding a Profit and Loss Statement

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Added to the growing list of business skills that a DSR must be familiar with, the review and consultation of P&L’s just might be the most productive and mutually beneficial work performed as business partners on a regular basis. Granted, rarely will you find an owner immediately willing to share this sensitive information, but consistently demonstrating the desire to work on behalf of the customer’s business interests should elevate the level of integrity and trust to the point where little or no information is hidden. Sharing these critical numbers becomes part of a routine business review and planning session.

Consider this effort part of the value proposition you present your customer. A value proposition is simply offering and executing a variety of services that will contribute to the success of your customer’s business. To accomplish this, the DSR must know the operation intimately. Being familiar with your customer’s financials allows you to suggest business solutions that offer the operator a better chance to weather the economic storm we currently face.

Operation of a profitable foodservice establishment rests on two basic fundamentals: raising revenues (sales) or margins, and cost reduction. Restaurants go out of business because they fail to make a profit.

This creates the need to have solid benchmarks, or a scorecard, to measure and compare progress. The P&L is the tool that allows you to understand how the business is performing throughout a specified period, while indicating the needs to meet a business strategy of growing sales and growing profitability.

Excellent operators always have a firm handle on their financials. This is as commonplace to some as “great food, great service, in a meticulously clean environment.”
What about those who have not had the opportunity to learn from one of these masters, or for those that have not come from a corporately structured background where financial reporting was a fundamental requirement? Whether your customers are seasoned financial veterans, or novices, the DSR has a vested interest in protecting the viability of the business both as a trusted partner of the business and for the long-term interests of his company.

A basic profit and loss statement reports sales, expenses and profits (or losses) for a designated period of time, usually one month, or a 28-day cycle. Here are the basic components of the P&L:

Sales:  This is the total of all revenue generated by sales of food, beverages (or bar sales), and retail products if applicable. The sales line is the number that directs the flow of all other numbers. In other words, maximizing top line sales, while optimizing expenses, gives you the best opportunity to derive a reasonable bottom line profit.

Cost of Goods Sold (COGS):  Represents the direct cost associated with the sale of food and beverage. To determine the true cost of goods, a physical inventory or count must be made to calculate the dollar value of all food and beverage product on hand. The total food and beverage are entered into the COGS formula:
COGS = (beginning inventory) + (purchases) – (ending inventory)
It is important to note that the COGS numbers will pertain to the sales of the corresponding category. For example, food cost dollars are divided into food sales, beverage cost dollars are divided into beverage sales.

Gross Profit:  The gross profit number denotes the direct profit associated with the sale of food and beverages. Gross profit is calculated by subtracting the total cost of goods sold from total sales.

Payroll:  Along with food cost, payroll expenses will represent the 1st or 2nd highest expense an owner will incur. In a simplified P&L version, manager and employee wages are grouped together. Other labor related expenses include payroll taxes, workman’s compensation and group insurance benefits. The payroll category offers another significant cost containment opportunity for DSR’s. Consulting with an operator to attain optimal staffing levels (the operation is not under/over staffed), and ensuring all employees are being utilized productively, can add $1000’s of dollars to the bottom line over the course of a year. This exercise begins with writing well thought out, efficient schedules.

Prime Cost:  Prime cost is the sum of the restaurant’s food, beverage, and labor costs. Many owners consider this number to be their profitability barometer; or at least a major benchmark number on their P&L. Because prime cost bundles an operation’s two highest cost categories, it represents the key indicator as to whether the business will be profitable for the reporting period. Prime Cost is a direct reflection as to how well food, beverage and labor costs have been controlled on a daily basis throughout the reporting period. Prime costs should run no higher than 65% in a full service restaurant, and 60% in a quick service operation (these percentages represent generally accepted figures).

Controllable expenses:  Controllable expenses are costs incurred in operating a restaurant. Although these costs are a necessity to operating the business, they can be somewhat controlled by management and personnel, or by means of following a budget. For example, linens and chemicals may be rationed. Or, preventative maintenance might occur on a routine basis to avoid a large very costly break-down or repair.

Operating Profit:  Operating profit is another key indicator of profitability, mainly because it measures how well the management and staff are able to control costs and expenses (food, beverage, labor and controllable combined). This line might also be referred to as controllable profits or net restaurant contribution. In a full-service establishment, an operating profit that represents 18-21% of total sales might indicate a reasonable net income depending on the rent structure. A quick service restaurant might look for a higher percentage, perhaps 23-25%.

Non-Controllable Expenses:  These expenses are normally related to the occupancy of the building. These expenses include rent, property taxes, insurance, interest and depreciation (I have included interest and depreciation here as a matter of simplicity. They might appear on a separate line or category on a different P&L format). Owners may
re-negotiate their rent structure (and I encourage this in this economic climate!), or shop liability insurance, but for the most part there is little control over these line items.

Net Profit Before Taxes:  The “bottom line” number represents the amount of income earned (or lost) by the business before paying taxes. Net profit or net income is computed by subtracting non-controllable expenses from operating profits.

Below is a simplified version of the profit and loss statement as described above.
 

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