If you have been in food service or hospitality management for a while, you have probably come across the cliché about managing a shift like a duck swims in water. The adage goes something like this: from above, a duck seems to effortlessly glide along the water, but if you look below the surface, you will see the duck feverishly paddling his little legs to navigate about. The lesson of the metaphor is that the hospitality and food service manager should have a similar style. While to the guests and staff the manager should look as if he is just floating around calmly working the shift, underneath this cool exterior, the restaurant or hotel manager should be hard at work strategically supporting and controlling the direction of the operation.
I open the article with this cliché because I think the same lesson could be applied to another facet of the hospitality and food service industry--restaurant and hotel financial management. Food Buyers Network often encounters resistance when attempting to facilitate adoption of common financial best practices with independent and regional hospitality operators. Running successful shifts and producing happy guests is a difficult job, but one that all successful operators excel at. Unfortunately, this is not enough to produce a profitable business. Just like successful shifts take hard work, running a profitable business also takes dedication--neither happy guests nor strong income statements happen on their own or by accident. We recognize that many independent and regional operators prefer that their focus remains on daily operations and that they do not want to manage from the office or from a spreadsheet--often feeling that this focus is what differentiates them from national chain operators. While the importance of being engaged in operations and present during shifts is absolutely critical, it is not a substitute for strategic financial analysis and planning. Our recommendation is that even the most engaged operator needs to actively adhere to financial management best practices, even if this aspect of his daily routine goes unnoticed by everyone else--like the duck that seems to just effortlessly glide along the water.
The intricacies of financial management make it impossible to execute this role through gut reactions and "in the moment" decisions. While the intuition of a seasoned operator is critical in achieving profitability goals, this intuition must be harnessed through the use of commonly accepted financial best practices if optimum profitability and performance is to be achieved. The remainder of this article will attempt to highlight a few key reasons to adopt these best practices, as well as to provide a
free excel spreadsheet that can be used for sales projections, budgeting, declining budgets and performance review.
1) The practice of budgeting provides a high-level picture of the financial performance of an operation and allows the operator to understand how a change in one cost or revenue area affects the overall financial picture. It is important to realize that we are talking about relationships between expenses within an operation, not simply looking at each financial factor in a vacuum. For example, a rising food cost when examined as an isolated trend may evoke concern. What if this trend is examined in relation to other financial factors, however? Maybe there was a shift in the product mix towards higher priced items with a higher contribution margin, or maybe there was a menu change that had the same effect. The result of either of these may be a higher price point, resulting in a higher food cost, but more bottom line profit. In that case, maybe the higher food cost is desirable! But what if this higher price point, which produces more per guest profit, actually reduced the number of overall guests, reducing total revenue and profit? Maybe the new menu requires more staff to execute, increasing labor costs and negating any benefit from the higher contribution margin. This is just one of many scenarios that could occur on any given day in the hospitality or food service industry. So, while any seasoned manager could give a thumbs up or down on any financial indicator when examined in a vacuum, it gets much more complicated when trying to understand the financial relationship among each indicator and quantify the result if budgets are not utilized.
2) Another fundamental benefit of budgeting is that it forces operators to make tough business decisions by prioritizing expenses. This is a benefit often overlooked among operators, causing them to forego budgeting. Their thought process goes something like this: "I don't need to budget because I only spend what I need to." Budgets, however, are not designed to differentiate daft decisions from smart ones. Budgeting is a process of prioritizing expenses based on financial realities, regardless of whether each expense when examined on its own seems to be justifiable. The truth is, each expense, examined in a vacuum, may very well have seemed like a good expense, but when the overall impact on the bottom line is understood, it becomes much easier for operators to prioritize and eliminate expenses or to creatively uncover alternative solutions that reduce the initial expense. One of the ways this is achieved is through the use of declining budgets, as you will see in the attached budgeting spreadsheet.
3) Budgeting also provides valuable insight and data to help operators make decisions about future business initiatives. Should you open for breakfast? Should you build a patio? Should you expand the kitchen? Should you renovate the restaurant? All of these could be great ways for operators to improve their businesses, but investing in such initiatives can create huge financial burdens if they fail to perform as expected. Through the use of budgeting, break-even and ROI analyses can be completed that will better define the necessary components of achieving success when looking to undertake such initiatives. Again, the benefit of budgeting in these scenarios is that it looks at the relationship of a given initiative on each of the other expense and revenue areas, rather than judging the merits of a project in a vacuum.
4) Budgeting also creates objective goals that can be easily communicated to the entire management team and staff to ensure everyone is working in concert. The benefit of setting specific, measurable goals has long been understood. When it comes to budgeting and countering negative financial trends, it is much better to provide specific, quantifiable goals than to provide vague direction. For example, setting a weekly labor cost goal of 15% will have a much more significant impact than telling the team to "do better on labor." The objective goals used in budgeting also makes the process of performance review much easier and can create a sense of competition among motivated managers that are determined to "hit the number."
5) The budgeting process often can improve service and operational consistency. As a goal of budgeting is to get a picture of the financial future, operators can use this knowledge to plan accordingly. Specifically, operators can allocate for future expenses ahead of time to ensure that they are able to meet the needs of the operation while maintaining consistent profitability. Too often, mostly in corporate operations, we find businesses that fail to accurately budget and, therefore, overspend at the beginning of a financial period, forcing the drastic cutting of staff and supplies at the end of the period to try and hit the established financial goal. With proper budgeting, however, operators should be able to consistently and continuously deliver on operational needs while maintaining financial performance goals.
6) Lastly, Food Buyers Network sometimes works with operators that see value in budgeting for new businesses, but not those that have been around for a long time. Their thought is that they have continuously honed and sanded each facet of their operation over the years so that it is always running at maximum efficiency. This might be true if restaurants operated in a vacuum. Instead, restaurants and hotels operate in an ever-changing environment. From labor cost and food cost to economic pressures and political influences, the external environment can drastically alter the financial performance of even the most well run business. The extent of these influences on profitability is often difficult to quantify or understand unless actual performance is gauged against established budgets based on previous financial history.
These are only a few of the reasons that Food Buyers Network recommends that operators adopt budgeting as a financial best practice. To help those interested in pursuing this practice, you can download a free budgeting program here that will enable you to execute sales forecasting, budgeting, declining budgets and performance analysis.
Download Budgeting SpreadsheetDownload White Paper
Countless times, Food Buyers Network has been engaged by food service operations of all sizes to help uncover the reasons behind apparent food cost control and profitability issues. When we begin to investigate potential causes, however, it often becomes quickly apparent that the primary problem is not with restaurant cost control practices, but rather with the restaurant inventory data and food cost accounting methods used to generate the restaurant cost accounting figures. Unless restaurant inventory best practices and proper restaurant cost accounting methods are being observed, food cost control figures will not be able to provide any accurate picture into restaurant performance and profitability. The following article will examine some of the critical restaurant inventory and food cost accounting best practices to ensure reliable restaurant cost control figures.
Deciding What to Count & Remaining Consistent
One of the most important best practices in creating accurate food cost figures is remaining consistent with what items are counted during each restaurant inventory. When it comes to making the determination of what should be counted, there is a wide range of industry practices. Some operators believe in counting every item in the restaurant, whereas others focus only on high dollar and sensitive products, such as meats, seafood and poultry. Regardless of your particular inventory methodology, the important thing to remember is that the decision must be consistently executed during each inventory. In other words, make a decision about what gets counted each inventory, and stick to it. Altering what gets counted will create anomalies in your inventory value delta between two consecutive periods, skewing the actual food cost figure.
The Right Time & Date
Achieving accurate restaurant inventory figures is greatly dependent on ensuring the correct date and time of the physical restaurant inventory. Specifically, it is critical that inventory is valued prior to the use or consumption of any product for revenue attributable to the next food cost accounting period. Further, it is equally critical that inventory is valued after all product has been consumed for all food revenue that will be attributed to the current food cost period. For example, if a restaurant manager wanted to calculate a food cost for the month of August, then inventory should occur once all food production has ceased on the last day of August, but before any food is consumed on September 1. Simply put, this means that the inventory should be either taken after the close of business on the last day of the period, or before the start of production on the first day of the following period. Unfortunately, this typically means late night or early morning counts.
There are additional benefits, as well, to executing inventory during non-operating times. Counting during these times, while not enjoyable, typically enables those executing the restaurant inventory to focus on the task at hand, which is ensuring that an accurate restaurant inventory is executed. Attempting to take an inventory during operating hours means trying to manually adjust and contend with products being removed from storage as needed or put back into storage during end of shift procedures. Further, if a manager is involved in the counting process, it is very likely that there will be frequent interruptions to the inventory process because of other operational needs that require attention.
The Right Tools & Technology
The days of the black inventory ledger used to manually count product, update pricing and calculate extended values is gone. At least, they should be. Today, restaurant managers and operators have access to a wide range of food cost control and restaurant inventory tools: from the ultra-expensive and complex food cost control and restaurant inventory software programs, to the do-it-yourself Excel spreadsheet program. With the relative ease of creating a restaurant inventory program in excel, this should be the bare minimum for restaurant operators. To save some time, restaurant managers and operators can download either our simple restaurant inventory template or the more complex product management program from our website. Both of these tools are free.
Using Proper Inventory Count Sheets
Accurate inventory figures begin with count sheets that are designed properly. First, inventory count sheets should be in storage shelf order. This eliminates the need to shuffle around looking for the right product on the count sheets. This not only saves time during the inventory process, allowing for a more concentrated focus on the task at hand, but also helps to ensure that inventory is being counted in a shelf-to-sheet fashion, which will be discussed shortly. Second, inventory count sheets should display not only the product name, but also the inventory unit of measure and the price associated with that unit of measure. This information enables the counter to ensure that they are counting product by the correct unit of measure.
Often times, products will be stored in various locations. In such cases, these products should be listed multiple times on the inventory count sheets. Again, this will help ensure the critical process of counting in shelf-to-sheet fashion.
Organizing the Storage Areas Prior to Inventory
One of the best ways to ensure accurate counts is to spend about an hour prior to starting the inventory organizing all storage areas. Specifically, products should be grouped together in "zones" and organized with labels facing forward and in a straight line, as much as possible. For those highly motivated operators, we recommend labeling these zones to make it easier for others to store product, organize shelves and take inventory. Taking the time to organize storage areas prior to beginning the inventory process will not only
expedite inventory and ensure more accurate counts, but
affords the opportunity to "touch" each product and
get a feel for what is on the shelves--a critical component to ongoing product management.
Further, product should be stored on shelves in the unit in which they are removed from storage during operations. For example, unless entire cases of #10 cans of tomato sauce are used at once during prep procedures, they should be stored on the shelf in cans, not in the original case. The same methodology should be applied to all products in storage. Storing product in these smaller units will ensure that proper inventory and product orders are taken and will make it much easier for operators to quickly look at shelves and notice any anomalies or potential shortages.
Two People Completing the Inventory
As inventory values are used for the calculation of financial figures, it is always recommended that two people work together to execute an inventory. This helps avoid the temptation of manipulating inventory figures to gain advantageous results, as well as helps avoid any counting oversights.
Following the Proper Order: Shelf-to-Sheet
To ensure that all inventoried products are counted, we highly recommend that operators start at the top left of a storage area and work their way to the bottom right, using what is on the shelf to determine what gets counted next, rather than using the product order on the count sheets to determine this. If the inventory count sheets are in order of shelf storage, then this should be a relatively easy process. This is the number one cause for counting errors, in our experience.
Accurately Counting the Inventory Unit of Measure
As we discussed previously, restaurant inventory count sheets should display the inventory unit of measure, as well as the associated cost, to ensure that product counts reflect these specific units and costs. For example, counting pre-portioned steaks by the "each" will have disastrous effects on food cost accuracy if the inventory unit of measure used to determine the inventory product value is "pound."
Further, it is important that operators accurately represent the on hand value of each product by accurately measuring the product based on the assigned unit of measure. This, of course, is relatively easy for those items whose inventory unit of measure can be visually identified, such as those counted by "each." However, if the unit of measure is a weight, then a scale should be used to create the on hand value. Every restaurant operator should have a heavy duty scale that can be used during inventory to count such items. It is worth noting that ensuring accurate weight counts is critical not just for creating accurate food cost figures, but so that accurate product usage variances can also be calculated. You can learn more about how to create product usage variances here.
Price Changes
It is imperative that before valuing a current inventory, that product prices are updated to reflect current costs. While there are several pricing methods, such as first-in-first-out (FIFO), last-in-first-out (LIFO), and average price paid, our recommendation is to use the simplest method, last price paid. Using the last price paid pricing model for calculating inventory means that all products inventoried will be assigned a cost based on the most recent invoiced price for that product. To ensure that inventory values are correct, though, the cost of each inventoried product on the count sheets or inventory program must be adjusted to reflect the most recent invoiced cost of the product.
New Items
Prior to beginning the inventory process, new items should be added to the inventory count sheets. If they are forgotten, however, and those completing the inventory are following the "shelf to sheet" counting process, then these items should be detected during inventory, though they will need to be written down in margins until they can be added to the count sheets at a later time. We highly recommend that any new products are immediately added to the count sheets when they are brought into inventory, as it is not uncommon for us to look at historical inventory count sheets when doing operational audits and to find the same products written in the margins month after month because the time was never taken to update the inventory count sheets. This will often result in counting inaccuracies.
Determining the Inventory Unit of Measure
Determining the inventory unit of measure should be aimed at creating the most accurate inventory figures. Therefore, we recommend that product be counted in the smallest whole unit in which it is stored. So, in the previous example of the tomato sauce, an operator should use "can" as the inventory unit of measure, and ensure that the corresponding inventory cost for this product reflects this unit of measure. In other words, it is critical that the cost associated with tomato sauce is the cost per can, not case. It is not uncommon for us to find unit costs on inventory sheets that do not reflect the inventory unit of measure used for counting. For example, we often find items inventoried by the "each," but that have a unit of measure cost by the "case." Obviously, issues such as these create huge inventory value issues, greatly skewing food cost.
As previously mentioned, specific products are often stored in multiple storage locations and in different storage containers. For example, the tomato sauce from the above example may be stored in cans in dry storage, but in plastic 1/3 pans in the walk-in. In cases such as these, we recommend using multiple inventory units of measure. As we already mentioned, products that are stored in multiple locations should be listed multiple times on the inventory count sheets, and the inventory unit of measure in each instance should reflect how the product is stored in that specific location.
Invoice Cut-Off Dates
Another critical mistake is the failure to assign invoices to the correct accounting period. More specifically, the amount of an invoice needs to be posted to the correct food cost accounting period based on the exact date that the product was physically received into inventory. Usually, this date is the date of the invoice, unless it was a drop-shipped item.
We often find problems with this at the beginning and end of food cost accounting periods. Rather than posting invoices to the correct food cost period based on the date the product was received into inventory, invoices are posted to the day they are recorded in the general ledger, accounting system or inventory program. Often times, we will find this is being inconsistently practiced--the accounting department codes the invoices correctly in the general ledger, but the inventory manager codes them incorrectly in the inventory system. In either case, these mistakes will lead to incredibly inaccurate food cost figures.
Proper General Ledger Account Coding
Another common restaurant cost accounting issue we run across when executing audits is the inconsistent coding of invoices to the correct general ledger/P&L account. While the actual number and methodology of these general ledger accounts will differ from operation to operation, the key to accuracy is ensuring that once they are established, invoices are coded accurately, month after month, to the established accounts.
Often times, single invoices will contain products attributable to multiple general ledger accounts, such as food, paper and chemical. This is especially true for broadline invoices from suppliers such as Sysco and US Foodservice. Because of this, it is critical that operators review each invoice carefully and create coded sub-totals that reflect the specific general ledger accounts represented on the invoice. We often find that operators will mistakenly code the entire invoice to a single general ledger account, creating inaccuracies in the resulting income statement figures.
Reviewing & Verifying the Results
Once an inventory is complete, it is important to review the results to ensure their accuracy. There are a few red flags that may indicate possible errors.
1) The overall food cost percentage changed, in either direction, by a significant amount--usually by more than 1.5% without any known explanation.
2) A scan of the product extensions uncovers particular products that have an unusually high on-hand value. Often times, this will be due to data entry mistakes or improper costs assigned to the unit of measure.
3) A scan of the product extensions uncovers products with a zero value, indicating that the product may have been missed during inventory.
4) There are major on-hand dollar fluctuations in food cost categories, such as produce, meats, grocery, etc. Such shifts may indicate a counting error in an item within that category. Examining the category on-hand amounts makes it a bit easier to target possible counting mistakes.
5) There is a major shift in the total inventory on-hand value.
As a final take-away, operators should always be able to explain WHY a food cost figure changed during a given period, regardless of whether it was a positive of negative shift. It is not enough to get excited about a good food cost if the reason behind it is unknown. It is very possible that an unexplained shift in food cost is due to an inventory or accounting error, rather than improved food cost control practices. If the shift is accurate, it is critical to understand the underlying reasons so that behaviors can be altered or duplicated, depending on the direction of the shift.
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There is a critical difference between financial accounting and
financial management/cost accounting, though this distinction is not
always fully realized by some restaurant operators and managers. While
financial accounting generally involves the preparation of strictly
financial reports and statements, often for external use, financial
management and cost accounting is the process of creating and analyzing
these statements, as well as non-financial data and reports, for the
purpose of making decisions and constructing systems that improve
organizational profitability and efficiency. This difference is
illustrated by the disparity between the standard accounting income
statement outlining aggregate performance, which provides very limited
operationally-ready data, and an operational profit and loss statement
that lays out both targeted financial and non-financial data so that
key issues can be identified and opportunities realized. A more
simplistic example would be that financial accounting reports would be
used for tax purposes, whereas financial management reports would be
given to operations to assist with decision making. As both the purpose
and end-user is different, it should follow that the format, content
and level of detail should also differ in these reports. Most corporate
operations have a good grasp of financial management and have systems
in place to maximize the organizational benefits of this function.
Despite the high degree of precision and attention given to financial
management among chain operations, independent operators often struggle
to operate as effectively with respect to the use of financial
management reports.
The first common issue among some independent operators and regional
chains is the inability to generate timely reports. As the purpose of
these reports is to provide information that identifies current
operational trends and opportunities to assist in decision making, it
is important that these reports represent recent activity so that
decisions are based upon an accurate depiction of the current
situation. If reports are not generated in a timely manner, the
identifiable issues may no longer apply or may have grown to the point
of causing critical damage to an organization. Neither situation is
desirable. In the first scenario, management will have missed an
opportunity to address an operational deficiency that could be due to
poor performance, theft, improper purchasing or receiving, etc.
Whatever the reason, it will probably reappear at some point, as it was
not identified and corrected. In the second scenario, management will
have missed the opportunity to head off an operational issue that has
become costly to the organization. Therefore, to react to emerging
trends and opportunities identified by financial management reports, it
is critical that they are processed, distributed and analyzed quickly.
Another way of looking at the need for timeliness with respect to
financial management reports is if you look at the use of these reports
as a method of behavioral modification. When issues and opportunities
(or positive results) are identified through these reports, it is
important that the necessary behavioral modification that is needed to
address the identified issues occurs relatively soon after the
behavioral issue. Behavioral science teaches us that coaching somebody
on a mistake that is in the distant past does not have a strong effect
on modifying behaviors. While there are many reasons why an
organization might consistently produce untimely reports, one common
reason for this is an overly acute concern for report accuracy. While
financial management reports need to be accurate, they can be less
accurate than financial accounting reports. The reason for this is tied
to the report’s objectives. While perfect accuracy is both necessary
and critical for accounting statements, perfect accuracy is not as
critical for the identification of trends and opportunity areas, which
is the objective of the financial management report. If this is
understood, many operations may find it easier to generate timely
reports so that operational decisions can be made, even if the more
accurate financial accounting reports have not yet been processed.
Often times, communicating this fact to those responsible for report
generation will cause them to alter their priorities and improve their
efficiency. This simple step can give operators a powerful tool for
improving profitability.
Another common issue is an operator with little accounting experience
and who is, therefore, uneasy about directing the accounting “pro” as
to how and what reports need to be generated and in what time frame. As
has been previously mentioned, the goal of financial management reports
is to improve operational efficiency and profitability. The
determination, therefore, of what financial management reports need to
be generated should be determined by the operator. Just like financial
accounting reports are created and formatted according to the
instructions of the end user, such as the IRS, financial management
reports, likewise, need to be generated based on the direction given by
their end user, the operator. If an organization is large enough to
have an accounting department headed up by a CFO or controller with a
strong hospitality background, this is not necessarily a huge problem,
as this individual should be able to guide accounting towards the
production of reports that will be operationally actionable. If,
however, an organization does not have the luxury of a large, seasoned
accounting department or executive, it becomes the responsibility of
the operator/owner to instruct the “accounting” employee as to what
management reports are necessary. It is also worth noting that an
accounting professional with a long history in the accounting field may
not know what information to provide on management reports if their
accounting background does not include hospitality experience. Under
these circumstances, the operator must again “coach” the professional
on what kind or information and report styles are important for running
the operation. Whatever the situation for a given operator, it is
critical that they question the reports that they are being given to
ensure that they provide adequate information for making operational
decisions. Remember, just because current reporting contains accurate
information and meets generally accepted accounting principles, that
does not mean that your financial information is being collected and
reported in a manner that best enables management to make operational
decisions.
While the exact content, format and detail of management reports should
be determined by the specific nature and necessity of an operation,
there are certain characteristics that are often incorporated into
financial management reports. First, detail is critical. Specifically,
data should be broken down into identifiable categories. Consolidating
data into actionable categories facilitates the identification of
operational and cost trends. The level of category detail should be
determined by the level necessary for the data to be “actionable.”
While being overly detailed can confuse and hide the existence of
trends, being overly general can make information difficult to
translate into actionable decisions. For example, expressing alcohol
expense and cost on the P&L under the general “alcohol” umbrella
can make it difficult to determine whether the issues are with beer,
wine or liquor. Therefore, expressing data in specific categories, in
this example beer, wine and liquor, will be extremely helpful in
identifying trends. Second, in addition to detail, reports should
include comparative data. While the type of comparative data varies,
the common forms are prior period, same period during prior year and
budget. These forms are most common in profit and loss statements, the
backbone of the financial management reports. Using such information
puts data and information into an understandable context. By comparing
current statements to prior historical performance, as well as the
budget, operators are able to better identify trends. The manner in
which data is expressed is also critical to understanding information
presented in reports, such as expressing data in dollars, as a
percentage of sales and as a cost per cover. Again, these expressions
are critical in evaluating a P&L statement. The P&L is only one
of many financial management reports that an operation should have in
use. Operations should also be using sales summary reports that
calculate daily and weekly sales, labor and guest statistic
information, as well as cash flow reports, cost of goods management
summary reports, inventory level reports, etc. The exact reports used
by an operation and the level of detail necessary will vary by
operation, but what will not vary is the effectiveness that the proper
use of financial management reports can have on improving operational
efficiency and profitability.
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