Understanding Cost of Goods Sold
Why is Cost of Goods Sold essential and how can it help you grow your business?
COGS by itself is a window into one part of the business model which can then be used to adjust, evaluate, and target improvements in the supply area. How much did I spend on food which was sold this month? Am I buying the right food for my restaurant? How can I increase net revenue without raising prices? These are all questions that relate to the cost of goods sold and that a savvy restaurant operator takes into consideration when assessing the profitability of his or her business.
Having high gross revenue in any business is exciting. But if it’s costing you a lot to get your product in your door and into the hands of a customer, your business likely isn’t maximizing efficiency. Let’s first look at some common food supply errors that will in turn affect your COGS.
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1. A lot of spoiled food
Maybe you bought too much of an item or perhaps your business relies on products with short shelf lives. Either way, this will affect your COGS as it’s food that is taken off the shelf, but whose value is not compensated by a sale.
Selling all frozen and canned food is not a great restaurant plan, unfortunately, and there will always exist some amount of expired food. Monitoring these losses and adjusting based on demand will make your restaurant run more efficiently with less wasted food.
2. Unaware of bulk options
If you use a lot of one item, you can save significantly over time by buying it in bulk— as long as it doesn’t spoil. If you use 50kg of flour per month, it’s certainly not in your best interest to buy 1kg bags every time you need flour. Not all decisions will be this easy but finding the most price-efficient option while upholding quality for your customers comes with the restaurant-owner territory.
3. Inefficient food use
All restaurants encounter management challenges and they’re often not easy to resolve, especially in the early days of a restaurant. Whether you prepared too much sauce and subsequently having to throw it away, or use an excessive amount of butter while cooking, this unnecessary food cost will affect your COGS, and ultimately your bottom line.
Effective management, guidelines for employees, and enforcement of those measures are important in keeping your costs down.
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4. Overpaying for food
You are ultimately responsible for weighing the price-quality of food items that you sell. But you never want to pay too much for an item. Food cost can fluctuate depending on your market and from whom you buy; staying informed on changes and recognizing new suppliers should not be neglected.
Buying from local producers can cut costs on transportation and can also establish mutually beneficial relationships between businesses and entrepreneurs. There are endless opportunities associated with exploring the many food providers within a market.
Now that we know in detail the errors and effects often associated with the supply and management of food before it is served to the customer, we can look at the cost of goods sold formula.
Cost of goods sold formula
🖊️ Beginning Inventory + Purchased Inventory – Ending inventory = Cost of Goods Sold
To calculate your cost of goods sold, you’ll need to know the purchase cost of your inventory; so be sure to have the appropriate info on all transactions related to inventory. Start with the dollar amount of beginning inventory— which is food items available to be used in sales right now.
These items are on the shelf in your restaurant and are carried over from a previous delivery. Now take the purchased inventory, which is equal to whatever food items you’ve bought during that time period (week, month, etc.), and add the dollar amount to your first number.
Next, subtract the ending inventory of the time period, which is the value of what food is left on the shelf that went unsold or unused during that time. The number you are left with is your cost of goods sold. Here’s an example to give some life to the equation:
Here’s an example to give some life to the equation:
Mike’s Pizza Place (January)
Beginning Inventory: €200
Purchased Inventory: €800
Ending Inventory: €400
Cost of Goods Sold: €600
COGS percentage formula
🖊️ Cost of Goods Sold ÷ Sales = Cost of Goods Sold %
Cost of goods sold percentage tells us what percentage of sales was comprised of our cost of goods. Like with COGS, much more is needed to figure out how much profit was made in a given period. But we can get a good idea of how the business is doing on a food supply basis. If your COGS is 80% of your sales – that is, food cost makes up 80 cents of every dollar of sales – some significant adjustments are in order.
COGS% varies depending on the type of restaurant and the food they serve. Most restaurants operate somewhere between 20% and 35%. Mike’s Pizza Place might operate closer to 20% as his main ingredients are quite affordable and do not spoil quickly; allowing Mike to buy in bulk and not worry too much about wasted food.
Whereas a posh steakhouse is certainly running with a COGS% closer to 35%. To attract and maintain a solid customer following, a steakhouse cannot rely on frozen and cheap food. Their COGS% is going to naturally be a bit higher than other restaurants.
Does the higher COGS% mean that the posh steakhouse will earn less money relatively speaking? No. Prices and many other things will play a big role in overall revenue. Customers have a different price expectation when reserving a table at a nice steakhouse to celebrate a special occasion compared to an impromptu trip to Mike’s Pizza Place. So high COGS% is not necessarily a bad thing but those food costs need to be recouped in sales if your restaurant is going to thrive.