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Explaining Actual vs. Theoretical Food Cost Variance

Explaining Actual vs. Theoretical Food Cost Variance

There are restaurants today adding millions of dollars of revenue to their bottom line by measuring and controlling their food costs.  Using a restaurant back office system with a strong actual vs. theoretical food cost solution is their key to success. 

Restaurant inventory management and food cost control are at the heart of profitability for multi-unit restaurant chains. But often, the methods used to track them are based on incomplete information, which can be extremely costly.

Exploring Actual vs. Theoretical Food Cost Variance will allow companies to truly understand what’s at stake in terms of profitability.  Let’s look at two stores in a fast-casual restaurant chain to demonstrate what we mean:

RESTAURANT (A) FOOD COSTS = 32.1% OF SALES
RESTAURANT (B) FOOD COSTS = 32.8% OF SALES

Who’s Winning?

At many companies, the managers of both restaurants might get some coaching from their GM about controlling costs. But in fact we don’t know how well either manager controls their food costs, unless we take into account:

  • The local costs for all ingredients in each restaurant
  • The menu mix for each restaurant

Both of those issues can cause wide swings in food costs as a percentage of sales, but are often overlooked when evaluating food cost performance.

If I’m a restaurant GM and I’m selling lots of the low-margin specials my boss told me to promote (affecting my menu mix), my food costs will be a higher percentage of sales… does that mean I’m doing a bad job? Or maybe the produce in my region is subject to price drops due to over-supply issues, and my costs are down. Does that mean I’m performing at a high level?

What should a restaurant’s food costs be?

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To gauge how well an operator is managing food costs, it’s key to first understand what a restaurant’s food costs should be, based on current inventory costs of all ingredients for the meals sold, and assuming perfect portions, no breakage and no shrinkage. That’s also known as a restaurant’s Theoretical Food Cost (Inventory always valued correctly? No breakage or shrinkage? Perfect portions? You can see why it’s called “theoretical”.)

Once we know a restaurant’s theoretical food cost, we can then compare it to their Actual Food Cost, which is simply the actual cost of all the food that the restaurant used for a given period.

The mark of truly great food cost control is how closely a restaurant’s actual costs approach their theoretical costs; an exact match would mean they’re portioning perfectly, and have no breakage or shrinkage. The difference between the two is the true measure of efficiency in food cost control; it’s called the Actual vs. Theoretical Variance and reducing it to its lowest possible point is the goal.

Now the Real Story

Back to our example…

RESTAURANT (A) FOOD COSTS = 32.1% OF SALES

  • ACTUAL FOOD COST = 32.1 % OF SALES
  • THEORETICAL FOOD COST = 29.5% OF SALES
  • This means Restaurant (A)’s Variance from Theoretical Cost is 2.6% of sales.

RESTAURANT (B) FOOD COSTS = 32.8% OF SALES

  • ACTUAL FOOD COST = 32.8 % OF SALES
  • THEORETICAL FOOD COST = 31.9% OF SALES
  • This means Restaurant (B)’s Variance from Theoretical Cost is .9% of sales.

The Conclusion?

Restaurant B is doing a far better job managing their food costs, as their breakage, shrinkage, and portioning mistakes amount to only .9% of sales, while Restaurant A’s are 2.6%!

The Loss Multiplier: If each restaurant does $1,000,000 per year in sales, then Restaurant A’s extra 1.7% of costs amounts to lost profits of $17,000. Ouch! What if the chain has 24 restaurants and ½ of them are worse than that? That’s at least 12 x 17,000 = $204,000 in lost profits — and in many companies it could go completely undetected due to the sole focus on actual costs.

Fixing the Real Problems

The surest way to drive profit dollars to the bottom line is to identify the biggest “profit leaks” in an operation, find where they’re occurring, determine their root causes, and then put fixes in place (i.e. more frequent inventories of those items, contract compliance checks, etc.) It doesn’t require selling even one more meal… you simply keep more of the profits from each meal already being sold.

To begin, once the overall variance from theoretical cost is known, the best practice for reducing it requires identifying the individual ingredients with the largest variances by dollar volume, and analyzing their use to spot waste, theft, or overcharges. In a typical operation with hundreds of items in inventory, it can be a daunting task.

The investigation begins with the store that has the highest variance for each spotlighted item. For example, if chicken breasts represent the greatest dollar variance from ideal theoretical cost company-wide, and a restaurant in Albany, NY shows the greatest dollar variance of all stores, the investigation would start in Albany and center on:

  • Proper receiving to ensure inventory amounts are accurate.
  • Proper invoicing to ensure costs are correct.
  • Proper usage in preparing recipes.
  • Proper portioning.
  • Proper tracking of waste.
  • Identifying the reasons for inventory adjustments.

The Tools Required

The accurate measurement of Actual and Theoretical food costs requires the following for every store and commissary in the company:

  • Accurate local market pricing for all ingredients.
  • Accurate beginning and ending inventory counts to determine usage.
  • Accurate ingredient amounts specified for all recipes.
  • A system for accurately recording waste
  • A system for capturing, in real time, recipes sold and their associated ingredients’ costs (and for depleting from inventory the individual ingredients).

Having all of this information on demand, so you can troubleshoot food cost issues in real time, requires processing a mind-boggling amount of data, which is best accomplished with an enterprise software system designed to do so.