Poradnik Restauratora 11/2012
Prices in food-service establishments, regardless of market segment and location, are dictated by the market. Restaurateurs therefore have limited influence over selling prices. To a much greater extent, they can shape the margin level. In order for costs and their amounts to be managed, they must be continuously monitored.
If a restaurateur wants to conduct active promotion and compete effectively in the market, they must have reliable information on unit production costs. Otherwise, they may easily choose the wrong strategy and lose a great deal.
Restaurant managers most often have general information about the level of raw-material consumption, energy costs, wages and the lease of the premises. Unfortunately, this information is not sufficient for effective management of margins on the sale of specific products. It is necessary to determine the unit cost of producing each product. This cost is determined according to the definition of the Technical Cost of Production, which is the sum of the direct costs associated with preparing a dish and a portion of the indirect costs associated with maintaining the restaurant.
Restaurants that manage inventory using an integrated inventory-management system can precisely determine the cost of raw-material consumption. Information about raw-material costs obtained from recipes is theoretical in nature. It is therefore important to conduct frequent, systematic stocktaking aimed at determining actual raw-material consumption; then these costs will not raise doubts.
In addition to raw-material costs, information about other direct and indirect costs is also needed to determine the Technical Cost of Production. If a restaurant does not keep records of working time, energy consumption and orders, a number of simplifications and allocation keys must be used in the calculations. In the case of general overhead costs, the use of allocation keys is already unavoidable. Because of these simplifications, the process of calculating the Technical Cost of Production may be subject to errors.
An example of calculating the Technical Cost of Production
Let us use an example. A restaurateur decided to examine the margin on the sale of one of the restaurant’s popular dishes. Because the restaurant manages its inventory, information is available on the cost of the raw materials used to produce this particular dish. Based on information about the time required to prepare the dish, the restaurateur can estimate the unit cost of labour and the gas consumed. Problems arose when analysing the share of general costs. It turned out that allocation keys had to be introduced. An allocation key derives from the assumption that costs are divided on the basis of the behaviour of a selected, known quantitative or monetary value. Such a value may be, for example, the number of customers visiting the restaurant.
If the monthly cost of cleaning three restaurant dining rooms needs to be divided, the calculations can be based on the information that, during the month, the first dining room received 4,000 guests, the second 1,500 guests and the third 2,500 guests. On the basis of this information, the cleaning cost can be divided in proportion to the number of guests: the first dining room—50% of the costs, the second—19%, and the third—31%. Similarly, cleaning costs can be broken down according to the share of sales volume or the floor area of the individual dining rooms.
In our example, allocating general costs on the basis of the share of revenue from the sale of the analysed dish in total revenue indicated high product profitability. Using, for the calculation, a key based on the time for which the means of production were used indicated a complete lack of profitability. Each of the adopted keys appeared valid, yet produced an entirely different result.
In our example, the amount of the Technical Cost of Production based solely on direct costs raised no doubts. Introducing general costs into the calculation caused the calculation results to become unreliable. By definition, the Technical Cost of Production cannot be based solely on direct costs.
If most of a bar’s or restaurant’s sales are based on just a few products, it is possible to calculate the full Technical Cost of Production precisely without arbitrarily dividing indirect costs. With a narrow product range, the BIP (Break Event Point) indicator also becomes effective; it will indicate how many products must be sold in order to cover the fixed and variable costs of running the restaurant. Simple calculation and the BIP indicator work perfectly in drive-through coffee-shop chains or fast-food chains.
If a restaurateur intends to operate in the premium segment, conduct diversified sales in many areas, carry out active promotion and compete effectively in the market, they must have reliable information about unit production costs. Otherwise, they may easily choose the wrong strategy and lose a great deal.
Management accounting and cost monitoring
Effective monitoring of the Technical Cost of Production in a restaurant is possible provided that the system for collecting information about unit costs is set up properly. The basis is inventory management and management accounting, which differs from ordinary fiscal accounting in that, alongside costs classified by type, it also includes a division of costs by cost centre and type of activity. Such a division of costs makes it possible to conduct complex unit-cost calculations. Importantly for calculating the Technical Cost of Production, management accounting provides greater scope for assigning general overhead costs to individual areas, types of activity and processes. This makes it possible to eliminate many allocation keys or make them more reliable.
In traditional accounting, there is one common general overhead cost, which may possibly be divided into cost centres (e.g. dining room one, dining room two, kitchen). In management accounting, alongside cost centres, types of activity appear (e.g. breakfast sales, catering, corporate events). This solution significantly improves the quality of unit-production calculations.
Management accounting can replace fiscal accounting in reporting obligations, while at the same time being used to control areas, types of activity and unit production costs. Management accounting may be kept in one of two forms: using a variable-cost system or a full-cost system.
Variable-cost accounting
Management accounting kept under this system makes it possible to perform what is known as a process-costing calculation, based on the division of costs into fixed and variable costs. This makes it possible to calculate the level of sales efficiency using the BIP indicator mentioned earlier.
Because of its simplicity and its reference to sales value, variable-cost accounting works particularly well in production and retail sales in the food-service sector. It describes costs perfectly under conditions of incomplete utilisation of production capacity. It illustrates short-term changes in costs much better than other methods (e.g. in year-on-year daily-sales analyses commonly used in coffee shops).
A significant disadvantage of process costing is its poor fit with the standard format of traditional fiscal reports. In this case, fiscal reporting is more difficult. This is probably why this type of management accounting is rarely used.
Variable-cost accounting focuses on comparing unit cost with unit revenue, and is therefore perfectly suited to analyses of the profitability of operating sales. It also works well in controlling areas of a restaurant’s activity, because it makes it possible to control the variable costs over which employees have a direct influence.
Full-cost accounting
In Poland, management accounting using the full-cost method is encountered most frequently. It is widely known to credit analysts and financial experts. This method is used in large production units or sales chains that value products at standard prices. In full-cost accounting, there is a greater need to use allocation keys, which may distort calculation results to some extent. The absorption-costing calculation used here describes short periods much less effectively, concentrating on long periods.
Both cost-accounting models described above have their own distinct methods for calculating the Technical Cost of Production. Knowledge of them is useful when estimating the costs of complex production processes.
Because of the high share of the human factor and the nature of production, the Technical Cost of Production in a restaurant will never be estimated as precisely as it is in industrial production processes. In this case, it is not the method but the correctness of the costs included in the estimates that is most important.
Is it worthwhile?
The Technical Cost of Production is an extremely effective tool for gaining a competitive advantage. Accurate and reliable information about production costs or the cost of sales determines the effectiveness of a promotional campaign, helps set a strategy and eliminate loss-making areas of activity.
Before a restaurateur decides to estimate the Technical Cost of Production, they should answer the question of whether they are able to conduct systematic analyses and maintain inventory-management, working-time recording and management-accounting systems at a high level. The precision with which the Technical Cost of Production is estimated depends precisely on the quality of the process of collecting and assigning data.
An appropriately detailed chart of accounts is of great importance to the reliability of estimates of the Technical Cost of Production. Greater detail in cost aggregation increases the precision of its estimation; at the same time, meticulous event recording increases the labour intensity of the cost-collection and posting process. It is important, when collecting data, to avoid all simplifications and allocation keys as far as possible. The best route to the precise measurement of electricity, water and gas costs is the installation of sub-meters.
It should be remembered that occasional estimation of the Technical Cost of Production is labour-intensive and often subject to errors. In order for it to be a precise control tool, it should be calculated systematically and automatically, and every observed cost variance should be explained in detail—just as in the case of other control tools, such as periodic stocktaking and daily cash reports.
Wojciech Moszczyński