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How to Create a Realistic Budget for Your Restaurant

How to Create a Realistic Budget for Your Restaurant

How to Create a Realistic Budget for Your Restaurant

12/01/2018

"If you don't know where you are going, any road will get you there." For restaurant owners there are three "financial" roads, each leading to a different destination. The most preferred route is to take the road to profitability and success. Another, less desirable road is that which leads to break-even, or merely hanging on. But the most treacherous road leads to failure, and in some cases, financial ruin.

Unfortunately, more than 60 percent of all restaurants end up on the most hazardous of these routes by their third year of existence. The vast majority of restaurant failures can be attributed, at least in part, to the absence of a plan or practical budget upon which decisions, accountability and actions are based.

An Organization Plan Expressed In Money

A budget is a fundamental tool by which business owners and managers can predict, with reasonable accuracy, whether their restaurant will profit, break even or lose money. A budget is an organizational plan expressed in monetary terms. It forces management to consider changing conditions and adapt their operations to maintain profitability and consistency of product and service.

The budget is your hypothetical profit-and-loss statement (P&L); therefore, it should be formatted the same as a monthly P&L. (We strongly suggest you adopt the P&L format as recommended by the National Restaurant Association in the Uniform System of Accounts for Restaurants (USAR) publication, a comprehensive guide to standardized restaurant accounting written and published through a collaborative effort between Restaurant Startup & Growth and RestaurantOwner.com.)

The restaurant P&L and budget formats differ from that of other businesses in that they make it easier to identify the four major checkpoints restaurants need to monitor -- sales, prime cost, controllable profit and net income.

Too few restaurants employ effective budgeting, which is a critical path to effective management and profitability. Integrate the steps described in this article to help turn around inconsistent or lackluster financial performance.

Sales. While this is pretty obvious, the top line is the single biggest profit-determining factor on the P&L. Strong sales volume can make up for quite a few management mistakes and cost control glitches -- at least for a while anyway. It's good to compare current sales with the same period of the prior year and to a budget or forecast. It's also helpful to look at check average and customer counts when comparing sales from one period with another.

Prime cost. Prime cost is the total cost of sales plus all payroll-related costs, including wages, benefits, payroll taxes, workers' compensation and other similar expenses. Keeping close tabs on your prime cost is critical for a number of reasons; it represents your two biggest and most volatile cost areas, and is really one of the few costs over which you have control.

In table-service restaurants, the generally accepted rule says that prime cost should run no more than 65 percent of total sales. Many of the larger, casual-theme chain operators can keep their prime cost 60 percent or less but for most table-service independents achieving a prime cost of 60 percent to 65 percent of sales still provides the opportunity to achieve a healthy net income provided a restaurant has a fairly normal cost-and-expense structure in the other areas of their P&L.

Controllable Income. Sometimes referred to as "operating income," controllable income reflects only those expenses over which the operations personnel have any real control or influence. This makes it a good benchmark for evaluating management's overall effectiveness at "running the restaurant."

Net income. Finally, what's left after all the expenses are paid, and hopefully with no brackets around it that indicate a loss. The importance of this number is quite apparent; however, it may be helpful to compare "Net Income" with one or more prior periods to see if you're gaining or losing ground. Another important measure of profitability is to compare annual Net Income with the total investment you have in the restaurant. This is your ROI or "return on investment."

In the "Blue Fish Grill Profit & Loss vs. Budget" example shown here, it's easy to see how each of these four areas is reflected on the financial statement. This particular format includes key ratios and allows the owner to see how to compare results with the annual budget in both dollars and percentages; the importance of percentages is addressed later. In other words, it shows how successful or unsuccessful management was in executing the budget. It provides a definitive measure of what's working and what's not.

Annual Budget vs. Weekly Operating Budget

Typically, an annual budget is created for the following year just before the end of the current year, often sometime during October to December. Extenuating circumstances aside, it does not typically change once established. The purpose of the annual budget is more strategic as opposed to tactical. In other words, the annual budget, while based upon reasonable expectations for sales, cost and expenses, is a goal-oriented objective based upon history and anticipated changes in the upcoming year.

For instance, let's say we have a restaurant that has steadily increased sales by 5 percent each year for the past five years. If that restaurant is on track to do $1 million in sales this current year, then you could justifiably set your budget based upon the usual 5 percent-per-year increase. However, let's say you anticipate remodeling or a big change to your menu or branding. If these changes bring expectations of more sales, then your budget should reflect them accordingly.

The annual budget helps to anticipate hiring levels and salaried positions, decide on financing needs, establish incentive programs and other strategic plans to take your restaurant from where it is now to where you would like to go. It should be broken down by accounting period, whether that is 12-month calendar, 13 four-week periods or "4/4/5" 12-period accounting cycles. Setting a budget for each accounting period or month is particularly important for restaurants whose sales fluctuate broadly due to seasonal trends.

Whereas the annual budget is strategic in purpose, the weekly operating budget is intended for more tactical objectives. Likewise, the weekly operating budget is more fluid in that it allows management to adjust to current conditions or realities. The annual budget is long-term and the weekly budget is short-term.

The annual budget provides direction whereas the weekly budget provides the opportunity for immediate action. The annual budget reflects the big picture while the weekly budget addresses the details of running the business from one day to the next. The annual budget is prepared once a year, whereas weekly budgets are reviewed 52 times a year. The annual budget should include a detailed line item listing of all revenues and expenses you are tracking within your financial statement, including noncontrollable expenses such as amortization, depreciation and interest on notes. For the weekly budget, however, it's pointless to include noncontrollable expenses.

The entire purpose of the weekly budget is to anticipate, monitor and make adjustments as to the things that management can control. The effectiveness of the weekly budget is exceptionally reliant upon daily action. For instance, let's say your weekly budget anticipates sales of $25,000 and you have created a schedule for hourly staff to account for 20 percent labor cost, or $5,000. The $25,000 budget target should be based upon sales expectations for each day of the week.

Likewise, your schedule should reflect daily staffing needs based upon respective sales, not only for each day, but each shift as well. Knowing sales expectations and labor requirements with respect to sales enables an observant manager to quickly make adjustments, such as cutting staff early or keeping some on based on the customer traffic patterns for that particular shift. Shift-by-shift monitoring of daily labor ensures budgeted labor numbers are not exceeded -- at least not unless actual sales forecasts are exceeded as well.

Annual Sales Forecasting

So far we've covered the purpose and benefits of having a budget. Now let's look at how to create them. First, all budgets begin with the forecasting of sales. When forecasting annual sales there are several factors to be considered, including prior-year sales totals, differences in check average from one year to the next, customer counts, seasonal trends, events or other one-time factors and whether sales volume is trending one way or another.

It's important to note when estimating sales that you should categorize sales in accordance with the USAR standards mentioned earlier. The recommended sales reporting categories needed to efficiently track cost of sales is as follows:

  • Food Sales
  • Soft Beverage Sales
  • Liquor Sales
  • Draft Beer Sales
  • Bottle Beer Sales
  • Wine Sales
  • Merchandise Sales
  • Comps and Discounts

As noted earlier, sales forecasting should be done on a monthly -- or by accounting period -- basis. So to begin the process the first thing you should look at is current-year sales for January, or Accounting Period 1, if you use that system.

Using this as a starting point, you now want to identify all factors that could cause sales for the following January to be either higher or lower than the previous January period. Were there events in the previous year that had a positive or negative effect on sales, such as road construction, a large sporting event like the Super Bowl, a catastrophic weather event or anything else for which you might expect to affect sales? What about the upcoming January; what events might be happening that you should take into consideration? Are you planning any type of remodeling or branding changes that could affect your business?

Another factor to consider is changes to your menu and differences in check average from one year to another. If you made menu modifications or began various promotional campaigns perhaps there has been a significant change to the check average or per-person spending in your restaurant. Are you serving more or fewer customers than the previous year? Are your customers spending more or less? Has the ratio of food-to-beverage sales changed significantly?

Yet another consideration that affects your forecast is current trending. Have recent sales trends been higher or lower over previous periods? For instance, when the recession began at the end of 2008, many restaurants experienced a decline in sales over previous years. Likewise, when recessionary factors began to ease sales picked up for many. Or perhaps your restaurant is in a market that is experiencing a recent surge in population or new businesses and you've seen an uptick in customer counts as of late. You have to determine if this trend is sustainable and for how long.

Regardless of why, you need to consider recent increases or decreases in sales trends when estimating. This process is repeated for each month until you have a realistic sales forecast for each month of the year.

Cost of Sales Forecasting

When referring to food-and-beverage costs, most operators express these costs in percentages because cost of sales is a variable expense, and dependent and theoretically only incurred with sales of product. However, one of the most common mistakes made when calculating food-and-beverage cost ratios is to express food or beverage cost as a percentage of total sales. Unless you have restaurant-specific accounting software, your accounting software calculates percentage against total sales as well.

To accurately track cost of sales according to the USAR standards, you need to calculate cost against its respective sales category. Notice in the "Blue Fish Grill Profit & Loss vs. Budget," the percentages reported for each cost-of-sales category. Food cost is expressed as a percentage of food sales, liquor cost as a percentage of liquor sales, draft beer cost as a percentage of draft beer sales and so on.

So to estimate cost of sales we need to establish a realistic cost-of-sales target, expressed as a percentage of respective sales. If you routinely have a 30 percent food cost, are happy with that figure and do not anticipate any changes in that trend, then it's reasonable to project that your food cost expenditures will be 30 percent of your projected food sales for each period. The same goes for the other sales and cost categories as well.

However, if you've never managed a budget and are hoping that doing so can help you lower costs, then you are most likely not happy with your current cost-of-sales numbers. In that case you need to have a strategy to lower your cost through better cost control or price increases or both. This strategy should then be reflected in your budget. But a word of caution: Don't just pull numbers out of the air or use industry statistics to set your cost targets.

There is an ideal cost of sales your restaurant should expect based upon your menu prices and the actual cost to produce it. Your cost-of-sales expectation must be mathematically accurate.

Labor Forecasting

When estimating payroll expense you'll enter a combination of fixed dollar amounts and amounts based upon percentages. This worksheetillustrates the various expenses recorded as part of labor cost for our sample month. It then calculates the percentages or dollar amounts to complete the totals. 

The first thing to record is management salaries (A). Simply divide the total annual salaries for management by the number of periods in the year. The cost for hourly personnel is typically estimated using a percentage of total sales (B) based upon historical results for hourly labor cost. In this example we are budgeting for 18.2 percent labor cost on $91,667 in sales for the month.

Payroll taxes and workers' comp insurance are typically based on a percentage of overall labor cost as shown in item (C). For other expenses incurred in the Employee Benefit section, simply record the estimated dollar amounts (D).

Weekly Operating Budget

As mentioned earlier, once you've finished your annual budget you most likely will not need to revisit it for another year. Print it or add it to your accounting software for use in preparing and comparing with your monthly P&L statements. Next, give a copy of it to your management team -- those who will be accountable for producing results.

Your general manager should be responsible for creating weekly budgets and, ultimately, along with your kitchen manager or chef, bar manager and floor managers, accountable for staying within the weekly budget. Keep in mind that the weekly operating budget, though similar to and loosely based upon the annual budget forecast, is typically not as comprehensive as the annual budget. Rather, the weekly budget is designed to keep management focused on maintaining sales volumes while monitoring cost areas that are controllable. In other words, expenses for which they directly influence each and every shift.

Unlike the annual budget, weekly adjustments need to be made to the sales forecast, cost-of-sales target and labor forecast to reflect the reality of the current sales volume. This is very important when it comes to cost control. Lower-than-anticipated sales volume means you'll need less product and less labor. If sales are on the rise, then more product is needed and possibly more staff to ensure a positive guest experience. If your management team does not adapt to fluctuating sales volume each week your costs will rise and you will be unable to stay within budget. This "Weekly Budget" chart is an example of a weekly budget summary based upon the annual budget. Using this as a starting point, your management can make adjustments as needed.

Results should be reviewed during weekly manager meetings. Ideas can be exchanged to improve cost overruns, slumping sales or buying practices. In fact, if your management team does not compare actual results with budget weekly then the weekly operating budget is of little value. The whole point is to keep focused on setting and meeting goals and expectations.

Which Road Will You Take?

Properly used, annual and weekly budgets can help keep you and your management team on the road to profitability. However, if you're like Alice, and don't really care which way the road takes you so long as you get somewhere, then, as the Cat said to Alice, "Then it doesn't matter which way you go -- you're sure to do that if you only walk long enough."

Source: Joe Erickson for Restaurant Owner