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Thursday, May 27, 2010

Spotting A Problem Early

We had a rather difficult winter here in the Washington, DC metro area. With a mild winter snow removal budget, we got hit with a severe winter snow fall during the key month of February. Just as the New Year's resolutions relaxed for Super Bowl Sunday, the snow took away the weekend. Local super markets were out-of-stock on milk, bread, orange juice, bacon, ground beef, and many other staples. Restaurant parking lots were empty.

This rough weekend repeated itself for Valentine's Day and President's Day weekends. I spoke with one operator who said his February food cost percentage hit 45%. This is a common trend - high cost of goods sold % in a low volume month.

I like to chart a month like this vs. a high volume month. The key to using this type of analysis is dollars vs. percentages. If you have a bad month with $200,000 in sales and $90,000 in cost of sales, you'll be close to the person I spoke with in February. Contrast this poor performance with a busy month's $800,000 sales figure and a cost of sales equal to $240,000 or 30%.

The change in sales volume is $600,000 ($800,000 - $200,000). Cost of goods sold had a change of $150,000 ($240,000 - $90,000). The slope is 25%. This is the variable component of the food cost. The fixed component is $40,000.

We'd expect a food cost of 29% if we hit $1,000,000 in monthly sales. On the other hand, we would expect to see a $65,000 cost of goods sold if we only manage a sales figure of $100,000. That's 65%!

If these numbers seem completely off the wall, they are not at all unusual for out-of-control operations. The bad months are explained away with stories of blizzards, rainy days, traffic jams, competitor discounts, etc.

Your cost of sales should be almost completely variable. Food should not be consumed if there is no sale. Why do you use more food when you're slow?

Employee meals have a bigger impact. The fixed staff eats the same meal whether you are slow or busy. This should be minimal and measurable. Chronic waste due to over-ordering is a bigger cause. Reduce your "safety factor" when ordering during slower periods. Sometimes the weekday counts are too low to absorb food left from the busy weekend. If the weekend is a complete bust, freeze everything you can and value any perishables which can't be saved.

You may have a major theft problem. If you're not finding many dollars in the research above, you may have discovered a persistent loss due to theft. If the 45% month had $10,000 in theft and you eliminated this problem, the result would be 40% in an otherwise terrible month. The bad month would have allowed you a chance to discover a $120,000 annual loss.

Saturday, May 22, 2010

Accounting Impact on Cost Control

There are significant differences between financial accounting and management accounting goals. Financial accounting depends on accurate and consistent inventory valuations. Both methods require perfect purchase cutoffs. I consider the cutoff of purchasing activity to be the highest priority.

I am amused at operators who go to great lengths in valuing inventory items (3 places to the right of the decimal point) and also allow deliveries during the inventory count. My early career inventory work involved an inventory count during an active delivery time of day. The food cost percentage was sky high. An entire shipment of meat was included in purchases and excluded in the inventory counts.

Since the operation had shifted into meal service, the recently received meat was being consumed in meal production. The solution used by management involved adding the meat purchases to the inventory counts on the sheets. OK So why bother with increased accuracy on the average purchase price of a case or pound when you are careless with the actual count you use in your valuation? This is more common than many people realize.

A liquor thief used to begin his counts early in his shift while the dinner meal was in progress. All he had left at the end of the meal was the partial bottles in the main bar area. His Excel sheets were a complete joke. He had a count of 30 bottles on an item. I asked where the cases were and he said he meant to put 3 bottles. Since the company paid no attention to specific bottles, an error like this would allow him to steal 2 full cases undetected by the "inventory control" report.

At some time, usually once a year at year end, the higher ranking accountants enter the inventory fray and beat up the team on average purchase costs and a selection of inventory counts. They recommend 2 people on every month end count and careful price look-ups for average purchase prices.

Most theft occurs in central storage and in the top consumption areas: kitchen and main bar. In operations where the menu items are placed in service area storage for self-service, late shift over production is a often undetected form of theft. Good managers should take a count one hour before closing and a second count 10 minutes before closing time. If your count went up, you have a possible theft problem.

If your operation takes a truly accurate inventory only once a year, you are possibly burning 3 to 5 percent of sales in theft and waste (conservative estimate).

Some people purchase software systems to track perpetual inventory. Accurate beginning inventory counts are required in any perpetual calculation. Purchases must be entered immediately upon receipt if you need shift based reports.

A powerful cost accounting report may be produced weekly. Accurate counts taken during periods when deliveries are prohibited and the kitchen is closed are the key. Valuing these accurate counts should be consistent. If you use the last price paid, look up this cost. Software solutions may automatically use the last cost. Some of the more sophisticated solutions use average cost or FIFO.

If you follow this straight forward approach, your annual financial inventory valuation will be a snap.

Friday, May 14, 2010

Accounting Question

Hi Joe,

I've been reading your FoodCostWhiz blog and have to say I really enjoy and find it very informative, particularly as the bulk of my experience is in QSR. I'm hoping you can settle a disagreement I am having.
A back of house software vendor that I have been dealing with for a long time has decided to rename their "Food Cost" calculations and reports as "Cost of Goods". They tell me that the two names are interchangeable, but I am not sure if I agree.
In my experience, Food Cost is based on working out the cost of a recipe, whereas Cost of Goods is simply the value of purchases. They go hand in hand, but are not the same. Am I off base here?

How would define the terms Food Cost and Cost of Goods?



Thanks for the question Brett. Simply stated, Food Cost is part of Cost of Goods Sold. I consider the Cost of Goods Sold category as all items which go into the production of menu items and beverages. In a QSR operation, the Cost of Goods Sold would logically include paper used to wrap the menu items. All items on the table in a sit down restaurant would be included in Cost of Goods Sold.

To recap Cost of Goods Sold, I would include food, beverages, table supplies and packaging supplies for take out and delivery. I would exclude linen, cleaning supplies, and other supplies which do not vary directly with sales. The proper category for these items would be Direct Operating Expenses.

Food Cost is a part of Cost of Goods Sold but it is NOT the same as Cost of Goods Sold.

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