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How to Make Your Profit-&-Loss Statement One of Your Most Valuable Tools

Creating and maintaining a profitable restaurant depends on successful decision-making and management of several key areas.

The most commonly cited areas have to do with service, food, concept, location and cleanliness. While managing these issues is important, even crucial to the success of most operations, so is paying attention to and managing the numbers or the financial side of the restaurant.

Restaurants don't go out of business because they have slow service, a poor location or even mediocre food. Restaurants go out of business because they fail to make a profit. Being on a busy street and having great food and attentive service helps, no question; but everyone knows restaurants lacking in these areas have managed to make money and stay in business for years. Conversely, there have been scores of restaurants with more than adequate food and service, and even a prime location, that are long gone.

There is one common characteristic that I have noticed from working with literally hundreds of independent restaurant operators over the past two decades. The really good ones, those who manage to be successful year after year, are not only adept at creating high standards of service and food quality in their restaurants, they also understand and pay close attention to the financial side of their business..

. . . your P&L should be able to tell you where your operational challenges are and where you need to focus your attention. -- Jim Laube

These financially astute operators know that every decision and activity that takes place on the operational side of their restaurant is eventually reflected in their numbers and the one report that is most indicative of how well (or how bad) their restaurant is being managed is their profit-and-loss statement (P&L).

Your P&L should tell you whether your restaurant is profitable, if your costs are too high or if your sales are too low and whether you're making progress or falling further behind. In short, your P&L should be able to tell you where your operational challenges are and where you need to focus your attention.

P&L Basics

The P&L statement reports a restaurant's sales, expenses and profit (or loss) for a period of time, such as a month, a quarter or a year. It shows how much in sales the restaurant took in and what it cost or the amount of expenses it took to earn or generate those sales.

Below is the basic formula for determining profit:

Sales less expenses equal profit or net income (if expenses exceed sales, then the P&L will show a loss). The goal for management is to find the most effective ways to maximize sales and minimize expenses to maximize profit or net income.

If profit is insufficient, management is faced with the task of increasing sales, decreasing expenses or both. The P&L should provide management not only with the bottom-line profit or loss information but be a tool to help determine the best ways to improve profitability by analyzing the statement in more detail.

Not All Restaurant P&Ls are Created Equal

Some restaurant P&Ls are virtually useless as far as providing insights into how a restaurant is performing. The following discussion will show you how to turn your P&L into one of the most important tools to understand and evaluate how your restaurant is doing.

Following is an example of a common P&L format that accountants often apply to many different types of businesses. Unfortunately, this format also gets applied to many independent restaurants.

Let's assume that the above numbers are accurate. The various accounts may appear to be logically organized, beginning with sales, and then cost of sales, followed by the remaining expenses listed in alphabetical order. The operator learns the net income for the period but, unfortunately, little else.

Some of the main shortcomings of this standard "one-size-fits-all" format include:

• The cost of sales percentages is expressed as a percent of "total sales," not as a percent of the corresponding sales category. For example, food cost is not 26.1 percent as the P&L indicates. Food cost as a percentage of food sales is 32.1 percent. Likewise, beverage cost is not 5.2 percent; rather beverage cost, as a percent of beverage sales, is 27.9 percent. The costs of sales percentages should be presented on the P&L like this:
  
• "Expenses" are not grouped or categorized in any logical or meaningful manner. Rather, the expenses are listed in alphabetical order. This makes it impossible to quickly see important expense categories like marketing, utilities and payroll.
• Prime cost is not a separate line item on the P&L. One of the most important numbers on any restaurant P&L is prime cost. Prime cost is the total of cost of sales plus all payroll-related costs including management salaries, hourly staff and all payroll taxes and benefits. Prime cost is a crucial number because it includes the most volatile expenses in virtually any restaurant and comprises up to 90 percent of the costs that are actually controllable by management in the short term.
• It would be difficult to compare the results of this restaurant with another restaurant or with industry averages or standards. Comparing the operating results of a restaurant against industry averages or standards is usually a very valuable exercise for most operators. It can quickly highlight where the restaurant is performing acceptably or negatively relative to other restaurants and quickly identify potential problem areas. Using this type of P&L format makes it impossible to quickly and easily get a sense of how this restaurant is doing compared with other operations.

An Industry-Standard P&L Format

Now let's recast the numbers from the P&L above into what I'll call a "restaurant industry-standard" P&L format:

Prime cost. First, notice that payroll costs have been grouped and prime cost has been calculated and is highlighted just below the payroll category. For reasons already mentioned, all restaurants should keep close watch on their prime cost. For most table-service restaurants, the goal should be to keep prime cost at or below 65 percent of total sales. In a quick-serve restaurant, prime cost should be kept at 60 percent of sales or less. As prime cost exceeds these percentages, the chances of generating an adequate bottom-line profit, in most restaurants, become increasingly difficult.

Expense categories. As you work your way down the P&L you'll see that the various operating expenses have been grouped into categories such as direct operating expenses, marketing and utilities. A more detailed report would also be available to show the balances in the individual accounts that are included in these summary categories.

Many operators like to receive a summary version of the P&L so they can quickly scan the key numbers and get a sense of how the restaurant performs. Some operators only delve into the numbers further if something doesn't make sense or appears to be out of line.

Controllable and non-controllable expenses. There are controllable and non-controllable costs and expenses. Controllable costs are those that are deemed controllable or can be influenced to some degree by the restaurant management and staff. Non-controllable expenses include occupancy costs like rent, property taxes and building insurance as well as other expenses like interest and depreciation over which management has virtually no control or influence.

Controllable profit. Separating the controllable from non-controllable makes it possible to calculate one of the more important margins on any restaurant P&L, "controllable profit." Controllable profit is a key indicator of management's effectiveness in managing the restaurant's sales and controlling costs and expenses. It is the purest number to evaluate management's effectiveness, because it reflects only those line items over which they exert any influence or control.

Many restaurants that pay their managers an incentive based on financial results use controllable profit to, at least partially, determine the amount of the incentive. I've worked with several restaurants whose management incentive bonus kicked in whenever controllable profit exceeded 25 percent of gross sales and increased as controllable profit hit 28 percent and then 30 percent or higher.

As a rule, a table-service restaurant will require a controllable profit as a percentage of total sales of 18 percent to 20 percent to have a shot at earning a respectable net income before tax. In a quick-serve restaurant, it's usually a little higher, around 23 percent to 25 percent.

The National Restaurant Association's Uniform System of Accounts

Several years ago I practiced as a CPA and adviser to independent restaurants. One of my services was to assist in the preparation of the monthly financial statements of 10-15 restaurant clients.

While many of my clients' P&L formats were similar, many closely resembled the one-size-fits-all format discussed above. All these companies' P&L formats had unique characteristics. I began noticing it was common to get telephone calls from a bookkeeper or general manager, with questions like, "Our ice machine went down last week and we had to buy ice. Where do we cost-code ice?" or "We had a private party and bought decorations and ornaments; where should we charge these costs?" Especially when I was pressed for time, my standard reply was, "it sounds like a miscellaneous expense to me." It was an expedient way of handling a phone call, but I discovered that one of the biggest operating expense categories for some of these restaurants became their "miscellaneous account."

Most of these restaurants' expense categories were not reflective of the types of costs found in a restaurant environment. As a result many of their operating expenses were getting lost in "miscellaneous." Obviously it's difficult to control a cost if you don't even know what it is.

About that time I attended a restaurant accounting seminar and learned about the National Restaurant Association's Uniform System of Accounts for Restaurants. I immediately saw some advantages for my clients. (See "Advantages of Using the National Restaurant Association's [NRA] Uniform System of Accounts and NRA Industry Operations Report," below.)

Accrual-Basis Accounting: The Key to an Accurate, Useful Restaurant P&L

While running the risk of losing our non-accounting types, it's crucial for your restaurant's P&L to be prepared on the "accrual," not the "cash," basis of accounting. All this means is that all of the costs and invoices for food, beverages, utilities and other expenses need to be recorded and reflected in each period's P&L as of the date the products were actually received (usually the invoice date) or the services were rendered whether or not the invoices were actually paid.

In addition, expenses such as property taxes that are paid only once or twice a year need to be accrued or allocated equally to each reporting period. For example, if a restaurant's annual property tax expense is around $12,000, then it would be appropriate to accrue or record a $1,000 property tax expense on each monthly profit-and-loss statement. Not doing so would overstate net income by $1,000 in most months and tell the operator that the restaurant was more profitable (or less unprofitable) than it really was.

Payroll accruals. While we're on the subject of accrual accounting, payroll deserves special attention because many, many independent restaurants don't account for their payroll expense properly and as a result their P&Ls are not accurate and of limited value.

It's common for independent restaurants to prepare their P&Ls on a monthly cycle and process their payroll every two weeks. This means that their P&Ls reflect the sales of 30 or 31 days, with the exception of February on nonleap years. Since payroll is processed every two weeks, it's common for the bookkeeper to record the payroll from two payroll periods each month and reflect this amount of payroll expense on the monthly P&L.

The problem with this is that payroll is now understated by as much as 10 percent to 12 percent in most months because there are 30-31 days of sales and only 28 days (14 days times two payroll periods) of payroll expense. To make up for this, the accountant will then record three, two-week payroll periods every three months. So in four months of the year, payroll expense on the P&L is overstated by as much as 30 percent because there are 42 days of payroll reflected in these months (14 days times three payroll periods).

Be sure your accountant is "accruing payroll" and doing it accurately. In other words, if you have a 31-day month with bi-weekly payroll periods, the accountant should add or "accrue" three days of payroll-to-payroll expense so the P&L reflects 31 days of sales and about 31 days of payroll expenses.

The payroll accrual can be estimated by calculating the average payroll cost per day of the latest payroll period. For example, if the total payroll expense for the latest bi-weekly payroll period was $14,000 including payroll taxes, the average amount to accrue per day would be $1,000. While recording an accrual like this would not be 100 percent accurate, it's 90 percent to 95 percent more accurate than doing no accrual at all.

Monthly Versus Four-Week Accounting Periods

In my financial management seminars I often ask how many participants prepare their financial statements every month. The majority of the audience usually has a hand in the air. I tell them to assume they just received their latest P&L and ask if it would be a useful exercise to compare the results of the current month with the previous month. Answer: Usually not because there were a different number of days this month than last.

What about comparing the current month this year with the same month last year? This may not be valid either if, like most restaurants, you do 45 percent to 60 percent and even more of your weekly sales on two days of the week, normally Friday and Saturday. You may not want to get too excited about a 12 percent year-to-year sales increase this month, if this year's sales included five weekends.

With these and other shortcomings inherent in monthly P&Ls, many restaurants, including nearly all of the larger chain operators, prepare their financial statements every four weeks. They have 13 four-week periods a year, instead of 12 monthly statements. Four-week reporting periods usually make sense in a restaurant environment for a number of reasons:

Better comparability of your numbers. Operating numbers of any kind are much more meaningful and useful if they can be compared with something like a budget or prior period(s). On a four-week cycle, every P&L reflects the sales and expenses of four Mondays, four Tuesdays, four Wednesdays and so on. This usually makes it much more useful in comparing current numbers with the prior period and the same period last year.

Easier to plan for physical inventories. Again, I go back to my seminars where I ask those who do their financials monthly whether they really believe they get a good, accurate ending inventory value when the month ends on a Friday night. The response is always the same: laughter and admissions that when the month ends on a Friday, the ending inventory calculation may not be all that accurate. When the month ends on a busy night like Friday, when it's finally time to take the inventory, most staff members are tired and ready to go home. The last thing anyone wants to do is count product. Plus, on a Friday night anyway, there's often lots of product on the shelf to count. Ever been tempted yourself to take some shortcuts?

Many companies on the four-week cycle end their periods on a Sunday. Sunday is generally a slower day for most restaurants so they're able to do some pre-inventory organizational work during the day or early evening. Also, Sunday night is when inventory should be at its lowest level of the week. So there's less product to count.

Compliments a weekly cycle for the preparation of weekly reports. It's no secret that most of the really successful restaurants in the country know their prime cost (cost of sales and labor costs) every week, not just once a month. If you're calculating food and beverage costs weekly, then you're on the same physical inventory cycle for your weekly prime cost report and four-week P&L.

May eliminate the need to accrue payroll. Finally something your accountant can get excited about. This goes back to what we discussed above regarding payroll accruals. Restaurants that pay their people bi-weekly and have monthly financial statements must then accrue two or three extra days of payroll in each 30- or 31-day month to show an accurate payroll expense.

The four-week cycle eliminates the need to accrue payroll when your pay period is biweekly. Every P&L will reflect 28 days of actual sales and actual payroll. Result: Payroll is easier to account for and probably more accurately reflected on your P&L too.

Resistance to the Four-Week Cycle

While a four-week accounting/reporting cycle makes a lot of sense operationally, many smaller restaurant companies avoid it because of resistance from their bookkeeper or accountant. Here are some common reasons or excuses you may hear from your accountant when they contest the conversion to a four-week accounting cycle.

Bank statements come monthly, not every four weeks. True, but most banks will cut off your statement when you want; just give them a schedule with your four-week cut-off dates. When you have online access to your bank account information, this becomes a mute point because the accountant can get the information to prepare the bank reconciliation at any time without having to wait for the statement to arrive in the mail.

What about expenses such as rent, lease payments and utilities that we pay once a month? It's fairly easy to set up a schedule on a spreadsheet and expense 11/12ths of each monthly payment and place the remaining 1/12th into a prepaid account. Once a year the balance in the prepaid accounts are expensed into period 13.

What about sales tax that's paid monthly? Many states will allow you to pay sales taxes 13 times a year instead of 12 monthly payments. If not, it's still not difficult to keep sales tax payments on a monthly schedule.

Our accounting software won't accommodate a 13-period year. Then update your accounting software. Nearly all accounting software packages priced above $50 today have flexible reporting period capabilities. Even the latest version of QuickBooks will handle a four-week period. (For more information, see "Counting Your Beans With Confidence.")

There may be some valid reasons to hang on to a monthly reporting cycle, but every operator I've ever met using the four-week system would never consider going back to monthly financials. Anything you can do that helps improve your understanding of how your restaurant performs is worth considering.

The Quicker You Can Review It, the Faster You Can Act on It

Unlike a fine wine, your P&Ls do not get better with age. One trait that I've noticed among exceptional operators is that they get their P&Ls in their hands very soon after the end of each reporting period. It's common for them to get a least a preliminary P&L two or three days after the period ends.

The sooner you get your P&L, the more relevant the information and the faster you know if you can relax or discover that you've got a problem on your hands. Operators that allow their accountants to complete their financials two or three weeks after the period end up getting stale information and if food cost or operating expenses are out of line, what can they really do about it at that point? Look at how much time has passed and how much money they've probably lost compared with knowing about such problems 10 days or two weeks earlier.

With the technology that is available today, there's no excuse for you to wait several days to get your numbers. Here are a few thoughts on reducing the time it takes:

• Make it a priority. You, the owner, have got to make getting your financial statements quickly a priority, not just for your bookkeeper or accountant but your entire organization. Accountants must have invoices, sales reports, ending inventory and other information to do their job, so it's imperative that the restaurant managers be part of the process as well.
• Get your managers and accountant together. Have your accountant make a list of all the information needed to prepare the financial statements and highlight those items that come from the restaurant (nearly all of it will). Have a meeting with your managers and accountant to determine the format this information should be in so the accountant can quickly complete the financial statements. Prepare a schedule showing what information should be routed to the accountant and when it's due. Also, identify what manager is going to have ultimate responsibility for seeing that this gets done on time each period.
• Get online access to your bank. As we discussed above, accountants will use the "bank statement in the mail excuse" for a slow turnaround. When you gain online access to your bank, usually for a nominal fee, if any, the accountant can have access to your deposit and check information daily in real time so the bank reconciliation can be completed the day after the end of the month.
• Process invoices, payments and daily sales reports daily or weekly. Don't wait until the end of the month for your accountant to begin processing transactions.
• Don't wait on missing invoices. Have your accountant create a checklist of all recurring expenses. If invoices are missing have vendors fax or e-mail invoices that you haven't received or have your accountant book an estimate in the case of a utility or similar expense and reverse it when the invoice is received.

Putting these simple steps into practice can dramatically reduce the waiting time and enhance the usefulness of your P&L and other financial reports. Napoleon said, "The right information at the right time is 9/10ths of any battle." While managing a restaurant isn't the same as waging war, most independent restaurant operators would probably agree that creating an adequate profit each month is nothing less than an ongoing battle fraught with fighting challenges on several fronts.

The more informed you are of your constantly changing sales, cost and profit picture, the better your chances will be to identify and respond to problems and make more educated decisions concerning your restaurant. Make sure you're getting all you can out of your P&L, one of your most important controls for guiding your restaurant to profitability and success.

Advantages of Using the National Restaurant Association's (NRA) Uniform System of Accounts and NRA Industry Operations Report

The Uniform System of Accounts

Many operators find it helpful to compare their restaurant's financial and operating data with industry averages to get a sense of how their restaurant performs in comparison with other restaurants. Preparing your profit-and-loss statement in a format consistent with the NRA's Uniform System of Accounts makes comparison with the Restaurant Industry Operations Report a very simple exercise, and provides some critical advantages, including:

• Gives restaurant operators a "common language" based on a well-thought-out and "industry specific" means of understanding and analyzing a restaurant's operating performance.
• Allows for the easy comparison of one restaurant's operating numbers with other restaurants that use the same format.
• Provides detailed instructions for accurately classifying (cost-coding) the many expenses associated with operating a restaurant.
• Allows for easy comparison with industry averages that are published annually in the National Restaurant Association's "Restaurant Industry Operations Report."
• Gives restaurant operators credibility when making presentations to bankers and investors to finance growth and expansion.

When making presentations to bankers and investment professionals to raise money, "always" format your financial projections using the Uniform System. Attach a footnote with your projections, which reads something like, "These projections are presented in conformity with the National Restaurant Association's Uniform System of Accounts." This tells bankers, lenders and investment professionals you've done your homework, you know what's going on in your industry and it lends more credibility to your numbers as well.

For even more effect, compare your projections with industry averages found in the NRA's "Restaurant Industry Operations Report," addressed later in this article. I've found that doing this has impressed bankers and investor types more than anything else in a loan package or business plan.

The Uniform System of Accounts for Restaurants has been in use for more than 30 years and has been updated and revised several times. It is the NRA's largest-selling book. The latest edition was published in 1996 and includes a comprehensive expense dictionary to help you classify the many types of expenses you incur operating a restaurant.

Over the years, I have converted many restaurants from their own proprietary chart of accounts to the NRA's Uniform System. While it takes some time and can be a little disruptive, once the dust is settled, not one operator ever regretted it. The Uniform System proved to have many advantages over their previous one and, most importantly, it gave them a better understanding of what their numbers told them and how their restaurants perform.

Restaurant Industry Operations Report

The National Restaurant Association publishes restaurant industry averages on profit-and-loss statement financial results and other operational data in their Restaurant Industry Operations Report. Each year about 2,500 to 3,000 independent restaurants from across the United States participate. The results are compiled by national public accounting firm Deloitte & Touche LLP.

So that operators can more closely compare their results with restaurants like their own, the Restaurant Industry Operations Report presents this information in the following four categories:

• Full-service restaurants - average check under $15.
• Full-service restaurants - average check $15 to $24.99.
• Full-service restaurants - average check over $25.
• Limited-service restaurants.

Some data is further broken down by:

• Type of establishment (Food only, food & beverage).
• Menu theme (hamburger, American, Mexican, Asian, pizza, steak/seafood, sandwiches/subs/deli, other).
• Restaurant location (hotel, shopping center or mall, sole occupant, other).
• Sales volume (in $000s - Under $500, $500 to $999, $1,000 to $1,999, $2,000 & over).

The NRA is no longer offering the Uniform System of Accounts for Restaurants and the Restaurant Industry Operations Report on it's website. For P&L templates and cost coding info based on the USAR go to Restaurant Chart of Accounts.