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Archives for January 2013

How a Restaurant Should Price its Menu

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Restaurants have fairly tight profit margins.  How they price their menu items can have a large impact on its profits.  This post will describe three ways to price your menu items profitably.

The Prime Cost Method

A restaurant’s prime costs are its food, beverage, and labor costs.  These costs are referred to as prime costs because, in the short term, they are the only costs a restaurant owner can manage.  The Prime Cost method is based on the menu item’s cost and the desired food cost percentage of the restaurant.   On average, restaurants have a 38% to 42% food cost margin—for example, a restaurant with $10 in sales will have a $3.80 to $4.20 food cost.

Under the Prime Cost method, the food cost of the item is divided by the desired food cost percentage.

Example:

Pomo D’oro Bros wants to price an entrée consisting of 4oz of chicken, a baked potato, green beans, and a salad.  The total food cost of the items is $6.  If Pomo D’oro Bros is aiming for a 40% food cost, it would divide the food cost of $6 by 0.4 and come up with a $15.00 menu price for the entrée.

The Peanut Butter Method

This method takes a restaurant’s projected labor, non-food expenses, and desired profit and divides the amount by the number of meals the restaurant estimates it will serve during a year.  It then adds this amount to the cost of each food item.

This method only works if a restaurant has menu items that are similar in cost, otherwise each menu item will have the same markup.

Example:

Projected Labor Costs                                    $60,000

General Expenses                                          $40,000

Desired Profit                                                $10,000

Total                                                         $110,000 (1)

Meals to be Served during the year                    30,000 (2)

Required Markup Per Meal                                   $3.67   [divide (1) by (2)]

The restaurant owner adds $3.67 to the cost of each menu item to determine the menu price. 

Again, this method works best when all menu items have a similar cost.  Under this method, a hamburger with a cost of $2 with have a $5.67 price for a 35% food cost (good) and a steak with a cost of $6 will have a $9.67 price for a 62% food cost (not so good).

Multiply Food Costs by 3

This method is the same as the Prime Cost method above if the target food cost is 33%.  If your menu items cost $4 and you multiply this by 3, you would get a $12 menu price.  This is a 33% food cost ($4 cost divided by $12 price).

A few points to consider:

  • If you have menus printed only once a year, you may want to increase the menu prices for inflation over the next year.  For example, if you come up with a $15 menu price, you may want to figure in a 3% (give or take) inflation rate and increase the menu price to $15.45
  • The price you come up with must be compared with what your competitors are charging.  If your competitor’s prices are slightly less than the amount you came up with, you may want to beat her price.  If your competitor has substantial cost advantages like a low-cost lease you may not be able to beat her prices.  In this case, you may want to stick with the higher price and focus on differentiating your restaurant from the competition.

 

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Reducing Theft in Restaurants

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fraud trianble

Internal controls are the procedures a business puts into place to ensure that assets are safeguarded, fraud is minimized, and procedures are actually followed.   Any discussion of internal controls usually begins with the Fraud Triangle.

The Fraud Triangle focuses on three factors that help predict whether a person will steal.  These three factors are:

  • Opportunity to Steal
  • Motivation/Financial Pressure to Steal
  • Personal Integrity/Ability to Rationalize Theft

Motivation/Financial pressure to steal can be caused by:

  • Large debts and/or pending bankruptcy
  • Low income
  • Living beyond one’s means
  • Extensive gambling
  • Addiction to drugs/alcohol
  • Frustration with job
  • Resentment of supervisors

An employee’s personal integrity is very important because many employees may have the motivation and opportunity to steal, but do not do so because of moral character.

Employee thieves:

  • sympathize with thieves
  • are more vulnerable to peer pressure to steal
  • often think about and talk about different ways to steal
  • are able to rationalize theft

An employee’s ability to rationalize theft can be caused by envy of the employer’s success.  It may also be caused by the employee witnessing the employer cutting corners.  Employees who witness their employers cutting corners may rationalize their behavior by thinking, “if it’s OK for him, then it’s OK for me.”

Once an employee is hired, an employer has little control over the employee’s motivation to steal or the employee’s personal integrity.  The employer does have control over the employee’s opportunity to steal by implementing strong internal controls.

An extensive discussion of internal controls covering all aspects of a restaurant’s operations can’t be done in a page and a half blog post, but I’ll include some examples of how an employee can steal cash and the internal controls that can implemented to help prevent these thefts.  It is important to note that internal controls will never absolutely 100% prevent theft or fraud, but internal controls can substantially reduce the likelihood of such events.

 

8 Quick Ways to Steal Cash

1.       Short-ring: charge the customer the actual price, underring the sale on the cash register, and pocket the difference

2.       Voided Sale / Phony Walkout: cashier voids out the entire check (or certain items) and pockets the money for the voided items / cashier collects the money from the customer, but claims the customer walked out without paying

3.       Fictitious Payouts: cashier claims money in the register was used to pay for food deliveries, to buy supplies at a nearby store, or to pay for other miscellaneous expenses

4.       Charge customer full price, but ring sale up at a discounted child or senior citizen price

5.       Cashier steals coupons, collects the full sale price from the customer, includes a stolen coupon with the customer payments, and steals cash equal to the coupon discount

6.       Double Drop: waiter reuses an old guest check for a customer and does not ring up the current sale

7.       Alter the breakout of tip and check amounts on credit card receipts to overstate the amount of tips and understate the check amounts

8.       Cashier records sales on training key which does not feed into the daily counts

Internal Controls That Will Help

  • Each cashier has his drawer counted at the end of each shift
  • Manager conducts surprise counts of employees’ registers at random
  • Manager conducts a daily cash reconciliation to reconcile cash received, sales, cash payouts, credit card sales, and other cash items
  • Cash payouts require a vendor invoice or store receipt
  • Bank reconciliations are done monthly
  • Spotters (people sent in by management to act as customers and report back to management) are used in the restaurant to observe employee behavior
  • Video cameras observe the registers
  • Comparing the Cost of Food margins on the Profit & Loss statements with industry averages

 

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

IRS Requires Annual Tip Report from Certain Restaurants

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A problem restaurant owners run into frequently is trying to get their employees to report their tips.  Employees hesitate to report the full amount of their tips because tips are subject to FICA and income taxes.  Restaurant owners aren’t thrilled with tips either—the employer has to pay FICA and other payroll taxes on tips.

All tipped employees who earn more than $20 per month (in other words, all tipped employees) are required to report their tips to their employers at least monthly.  Practically speaking, restaurant owners cannot force employees to report all tip income.  Some courts have held that the employer is only responsible for distributing IRS Form 4070 to tipped employees and instructing them to fill it out and return it.  However, if the IRS performs a tip audit on the employer and finds unreported tips, the employer is responsible for the 7.65% employer portion of FICA.  The employer will then have to amend federal and state payroll tax returns to report the additional tips.  As a silver lining, the additional assessed FICA tax on tips qualifies for the Tip Tax Credit.

Restaurant’s Responsibility to Submit Annual Tip Income Report

Certain restaurants must report sales and tip information to the IRS annually on Form 8027.  This form is required for restaurants that meet the following criteria:

  • Tipping is customary—this generally includes most restaurants, but usually doesn’t include fast-food restaurants, cafeterias, and restaurants that assess a service charge greater than 10%
  • Food or beverages are sold
  • More than 10 employees are normally employed

The number of employees refers to all employees, not just tipped employees.  More than 50% owners are not counted as employees.  The number of employees is based on the average number of employees in two months—in the slowest month and in the busiest month of the year.

Restaurants that operate in multiple locations must file a separate tip tax return for each location—even if the multiple locations operate within the same corporation or LLC.

Even if there are 10 or fewer employees and the tip tax return is not required, employees must still report their tips.

There are a few things to note about this form:

  • Gross sales are reduced by sales tax
  • The form requests credit card sales, credit card tips, and total tips and total sales—based on this information the IRA can compare the tip percentage on credit sales and compare it to the tip percentage on cash sales.  If credit card sales are tipped at 15% and cash sales are tipped at 3%, there is likely a problem.
  • The form multiplies total sales by 8% and compares this amount to the total reported tips.  If the 8% of sales is larger than reported tips, employers are required to increase reported tips and allocate the increased tips to tipped employees

It is important to keep track of sales that are not tipped such as carryout sales, sales to employees, sales from nonfood items such as T-shirts or posters, sales for which a service charge was added, and customer walkouts.

 

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

 

New Tax Law Benefits New & Expanding Restaurants

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In 2010, Congress passed a law favorable to restaurants that allowed restaurants to more quickly deduct the costs of buildings and improvements to buildings.  This was done in three ways:

  • The costs of qualified restaurant property was allowed to be depreciated (deducted) over 15 years rather than the normal 39 years
  • Additionally, up to $250,000 of the costs of qualified restaurant property was allowed to be deducted in the year of purchase under the increased Section 179 deduction
  • Finally, if qualified restaurant property also qualified as qualified leasehold improvement property it would qualify for 50% bonus depreciation

The law expired on December 31, 2011; however, as part of the Taxpayer Relief Act of 2012 passed at the beginning of 2013, the law has been reinstated for 2012 and is extended through 2013.

What is Qualified Restaurant Property?

Qualified restaurant property includes:

  • a building, or
  • improvements to a building
  • if more than 50% of the building’s square footage is devoted to the preparation of, and seating for on-premises consumption of, prepared meals.

Shorter Depreciation Period

Qualified restaurant property is the only category where Section 179 expense is allowed on the building itself, rather than solely on the improvements.

Example:  Tomato Brothers Restaurant buys a building for $300,000.  Under old law, the building would be deducted over 39 years at $7,692.31 per year.  Since a restaurant building is qualified restaurant property, it can be deducted over 15 years at $20,000 per year.

This favorable provision also allows costs of leasehold improvements to be deducted over 15 years rather than over 39 years.

Increased Year of Purchase $250,000 Section 179 Deduction

Restaurant buildings and leasehold improvements also qualify for the increased $250,000 Section 179 deduction.  A major drawback of the Section 179 deduction is that it is limited to the restaurant’s taxable income for the year.  Any disallowed Section 179 expense is carried forward.  A second drawback of this special provision is that the deduction cannot be carried forward after 2013.  Any unused deduction is treated as placed into service on January 1, 2013 and is deducted over 15 years.

Example:  In 2012, Paradise Coney Island incurs $200,000 in qualified restaurant improvement expenses.  Before taking in account the $200,000 Section 179 expense, Paradise Coney Island has $150,000 of taxable income.  Paradise Coney Island’s allowable Section 179 expense is limited to its taxable income of $150,000.  The remaining $50,000 of Section 179 expense is carried forward to the next year.  If Paradise Coney Island has at least $50,000 of taxable income in 2013 it can deduct the remaining $50,000 in 2013.  If Paradise Coney Island does not have income in 2013, the $50,000 unused loss is treated as placed in service on January 1, 2013 and is deducted over 15 years.

Qualified Restaurant Property May Qualify for 50% Bonus Depreciation

If qualified restaurant property also meets the definition of qualified leasehold improvement property, it will qualify for 50% bonus depreciation.  Since the building itself will not qualify as leasehold improvement property, only the improvements to a restaurant building (and not the building itself) may qualify as qualified leasehold improvement property.

What is Qualified Leasehold Improvement Property?

Qualified leasehold improvement property means any improvement to an interior portion of a nonresidential building if

  • such improvement is made pursuant to a lease by the lessee, sublessee, or lessor of such improved portion
  • such portion is to be occupied exclusively by the lessee or sublessee
  • such improvement is placed in service more than 3 years after the date the building was first placed in service

Qualified leasehold improvement property does NOT include:

  • an enlargement of a building
  • any elevator or escalator
  • any structural component benefiting a common area
  • the internal structural framework of the building

A lease between related persons (e.g., a lease between a taxpayer and his 80% owned business) does not qualify.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Successfully Managing Inventory in Restaurants

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Food costs of a restaurant tend to be around 40% of revenues.  It is one of the largest expenses a restaurant incurs, and it is therefore critically important that a restaurant effectively manages its inventory.

Restaurant owners must balance two competing forces when managing inventory:

  • keeping enough inventory on hand to meet customer demands and
  • keeping inventory levels low enough so less cash is tied up in inventories

Lower inventory levels have the following advantages:

  • they require less effort to monitor since fewer items need to be counted and tracked
  • they can help reduce theft—it is easier to notice one bottle of scotch missing when you had three in inventory rather than twenty in inventory
  • they reduce spoilage
  • they reduce waste—high inventory levels may cause employees to over-portion

Setting a Par Level of Inventory

The par level of inventory is the amount of inventory needed to meet customer demand and provide a cushion in case of an unexpected spike in demand or a delay in delivery.  This cushion is referred to as safety stock.

Setting the par level requires:

  1. forecasting customer demand
  2. estimating delivery schedules
  3. considering perishability
  4. periodically reviewing current par levels to determine their adequacy

Inventories must be divided into high-turnover inventory and low-turnover inventory.  High-turnover inventory such as meat, seafood, and produce, must be ordered frequently to maintain freshness.  Low-turnover inventory includes spices and dry goods.  Low-turnover inventory tends to be less expensive and isn’t as critical as high-turnover inventory.

As a formula:

Par Level = (Weekly Inventory Use + Safety Stock) DIVIDED BY Deliveries per Week

 

Example:  A restaurant uses chicken in five menu items.  It uses 10 cases of chicken per week and wants to maintain a safety stock of 20% (2 extra cases).  The supplier delivers on Monday, Wednesday, and Friday.  Based on these figures, the par level of chicken is 4 cases—

Weekly Inventory Use (10 cases) + Safety Stock (2 cases) DIVIDED BY Deliveries per Week (3)

As a general rule, the higher the turnover, the higher the safety stock requirement.  Generally, the safety stock should be around 20% to 30% of the weekly inventory use.

You must also be guided by your experience—the formula is an estimate of the par level inventory.

 

When Inventory Levels Can Exceed Par

There are a few situations when a restaurant should maintain inventory in excess of the par level.  These situations include:

  • Minimum Order Quantity—when the order to replenish inventory to par level is less than the supplier’s minimum order quantity the restaurant must order inventory in excess of par
  • Special Price Opportunities—if the restaurant owner can get a good discount on a higher quantity order or if prices will rise in the near future it may be beneficial to purchase extra inventory
  • Delivery Interruptions—holiday, weekends, bad weather may cause delivery delays
  • Special Occasions—Mother’s Day, Valentine’s Day, and other special events will require extra inventory

 Counting Inventories

The regular counting of inventory sends a clear message to employees that inventories are being closely monitored.  This can help reduce theft as well as reduce over-portioning.  It will also help the restaurant owner properly rotate inventory so older inventories are used first.

Generally, it is best to count food and supplies monthly and to count liquor weekly.

Counting inventory can be a bit tedious, but the following steps may make it less painful:

  • Organize the storage area
    • A neat and orderly storage area adds greatly to the efficiency of an inventory count.  Items should be maintained in the same location and similar items should be located near each other.  When a carton has been opened, the contents should be removed and stacked.  This makes it easier to count the open items.
  • Use preprinted inventory count sheets
    • Items should be listed on the sheets in the same general order that they are located in the storage room.  Preprinted count sheets may point out inventory that should be in the storage room, but for some reason is out of stock.  It may also point out inventory in the storage room that was never officially ordered.
  • Use two people to perform the count
  • Focus on key items on monthly counts, and count all inventory items annually

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