7 Formulas for Successful Financial Management

Financial management is key to successful maintenance of any food-based business. Inventory, product costs, and profit margins are important factors to consider in any business. If it seems like a lot to consider, that’s because it is! Don’t worry—fortunately, there are formulas that will assist with the calculation of these factors. I strongly recommend to calculate and review the following formulas at least weekly, or as often as you see necessary.

7 Formulas for Successful Financial Management

·       Break-Even Point (BEP)

·       Cost of Goods Sold (COGS)

·       Overhead Rate

·       Food Cost Percentage

·       Beverage Cost

·       Gross Profit

·       Profit Margin

Remember, there are other things to consider in addition to the financial management of a business; employees, scheduling, labor cost, and more come to mind. The formulas should serve as a handy reference to monitor the financial health of your restaurant, food truck, or food-based business.

 

Break-Even Point (BEP)

The break-even point (BEP) is when a company produces the same amount of revenues as expenses, either during a manufacturing process or an accounting period. This number will help you determine how much you must earn in sales to earn more profit or investment. Simply put, if a business has a high break even point, it will have lower profits. Conversely, if the business has a low break even point, it will have high profits. Continually operating above the BEP, will earn profits; below BEP incur loss. Operating right at BEP? No profits, no loss.

To calculate BEP, you must know (or approximately know) your variable and fixed costs:

Fixed costs are costs that never (or infrequently) change. Rent, insurance premiums or loan payments, and taxes are examples of fixed costs.

Variable cost are costs that change frequently, such as utilities, food, supplies, and labor.

Calculating BEP includes more than just knowing your fixed and variable costs. Break even points can be calculated using different metrics, including units and sales volume. The key data when calculating the break even in units or sales volume are:

·       Selling Price: the prices for which you are selling your products

·       Variable Cost of Goods Sold: costs that are incurred in order to make each sale

·       Contribution/Gross Profit: the difference between the selling price and variable cost/cost of goods sold

·       Fixed Costs: costs that do not vary with output

The following formulas are as mentioned above:

Break Even (Units)

Total Fixed Costs ÷ Contribution = Break Even (Units) 

Break Even (Sales Volume)

Brake Even Units * Selling Price = Break Even (Sales Volume) 

Example: A bakery is selling custom birthday cakes. The selling price is $100, the variable cost/cost of goods sold is $20, and the fixed costs are $2,000

To find the contribution/gross profit, plug in the numbers provided using the formula and solve

Fixed Cost (FC): $2,000

Remember, the gross profit is the difference between the selling price (SP) and the variable cost/cost of goods sold (COGS)

SP ($100) – COGS ($20) = GP ($80)

FC ($2,000) ÷ GP ($80) = 25 birthday cakes      

The baker needs to sell 25 cakes in order to cover costs of running the business

 

Cost of Goods Sold (COGS)

The cost of goods sold (COGS) is the amount of money spent on items to produce the products that sold within the business. Typically, this calculation is used for inventory because it can assist you in analyzing what will be purchased for your business.  The COGS will determine whether a purchase fits your budget, or guide you to make changes to fit your budget.

COGS = Amount Available* – Ending Inventory

*The amount available (AA) is the sum of the beginning inventory (BI) and purchases (P).

Example: Chef began with $1,000 of inventory at the beginning of the month. During the month, she purchased another $300 of inventory. At the end of the month, $300 of inventory remained. How much inventory did she sell during the month?

a.     Beginning Inventory ($1,000) + Purchases ($300) = Amount Available ($1,400)

b.     Amount Available ($1,400)  –  Ending Inventory ($300) = COGS ($1,100)

 

Overhead Rate

The overhead rate is the total of indirect costs for a specific reporting period, divided by an allocation measure. Examples of Indirect costs salaries, advertising, and utilities. The overhead rate is more difficult to measure because it consists of indirect materials, labor and other costs that are not easily traced to produced units. To assign overhead costs to individual units, compute an overhead allocation rate. To get the allocation rate, follow the following 3 steps:

1.              Add up the overhead total

       Sum the estimated indirect materials, labor and all other product costs not included in direct materials and direct labor (both fixed and variable overhead).

2.              Compute the overhead allocation rate

       To figure the allocation rate, an activity level is required. Choose an activity that closely relates to the costs incurred. The one most commonly used is direct labor hours. Divide the overhead total by the number of direct labor hours.

3.              Apply Overhead

       Multiply the overhead allocation rate by the number of direct labor hours needed to make each product.

To calculate the overhead rate, use the following formula:

Total Indirect (Fixed) Costs ÷ Total Amount of Hours Open = Overhead Rate

 

Food Cost Percentage

When expressed in a percentage, the food cost is simply one's net food purchases divided by the restaurant's net sales. Food cost determines your restaurant’s profitability, so review it checked often to maintain food cost control.

To calculate your food cost, use the following formula:

a.     Opening Inventory Value + Cost of Purchases – Closing Inventory Value = Usage Amount

b.     Usage Amount/Food Sales Revenue = Costs of Goods Sold (%)

 

Pour Cost

Pour Cost is the amount of liquor to make a drink to its selling price. Expressed as a percentage, pour cost is calculated by adding the cost of the product used and dividing it by the cost of the product sold.  As with food cost, there are ways of controlling pour costs. Influences are based on factors such as drink cost, drink prices and product loss.

To calculate your pour cost, you may use the following formula: 

Pour Costs = Inventory Usage  Sales

 

Gross Profit

Gross profit is the profit a company makes after deducting the costs associated with making and selling its products, or the costs associated with providing its services. The following is the formula used to calculate the Gross Profit of a business:

Gross Profit = Revenue - Cost of Goods Sold

Profit Margin

Profit Margin is the amount by which revenue from sales exceeds costs in a business. Profit margins are expressed as a percentage, and measure how much out of every dollar of sales a company actually keeps in earnings. Keep in mind that there are other profit margins, and they have different formulas with each. When the words profit margin is used by themselves (in reference to the over business) the following would be the correct formula to use:

Profit Margin = Net Income  Net Sales (Revenue)

 

Keep these formulas in mind in the operation of your food-based business.  Financial management is a key element to running a successful business. Keep in mind is that there are professional services for this kind of financial management, in addition to inexpensive ways to manage this side of operations on your own.