When receiving an order from a vendor, it’s second nature to glance at the invoice and check that each item is in the delivery. But how often do you take a step back and look at the prices of each of those items? If you’re like a lot of restaurateurs, not often enough.
This can result in a huge disparity in food cost variance.
Measuring and responding to food cost variance is absolutely essential for restaurants of any size. If you don’t know how much you’re spending on ingredients, you can’t:
Likewise, because food costs are 25 to 35 percent of every dollar of food sales, being attuned to price variance can mean the difference between being in the black, the red, or closing the doors completely.
Calculating Price Variance
Cost variance (aka price variance) as a concept isn’t all that complicated: it’s just the difference between expected (also called “standard”) costs and actual costs. Ideally, the two sides (actual and standard) should be more or less in balance, which will also mean you’re more or less on budget.
Calculating your cost variance gives you a sense of where you stand and can explain why the numbers came out the way they did.
The equation for restaurant food cost variance is:
Cost Variance = (Actual Price x Actual Quantity) – (Standard Price x Standard Quantity)
The “actual” parts of the equation are pretty simple:
- Actual Price is what you pay for an ingredient. As you’re well aware, Actual Price varies based on seasonality, market trends, and a ton of other factors outside your control.
- Actual Quantity is even easier — it’s just the amount of an ingredient you purchase.
In contrast, the “standard” parts of the equation are more theoretical.
- Standard Price should be derived using historical data so that an ingredient’s price fluctuations are smoothed out to the average price over a particular period.
- Standard Quantity is the amount of an ingredient that you plan to buy. When calculating Standard Quantity, it’s important to factor in breakage. For example, in a case of potatoes, one might be rotten. Peel them for fries or mashing and even more product is “lost.”
When calculating Standard Quantity, acknowledge that some waste is inevitable. Challenge back of house employees to practice good habits in regard to waste and portioning.
If the guidelines are too lenient, there’s no reason for the BOH to be mindful about waste. Make them too strict and you’ll inflate the overall price variance by pitching the Standard Quantity too low.
Getting a Baseline
Figuring out cost variance can be quite a challenge, so for restaurants who don’t have a set process yet, we recommend setting up a short term study. Here’s how to get started:
Use a Market-Basket Approach
If you’ve ever heard of the 80/20 rule (no, not the one about side work and tipping), that’s basically how the market-basket approach works. The idea is to focus on just a few items (around 20% of them) that have a big impact (80%) on your expenses, so it’s okay to cherry-pick (for now) the ones that are easiest to track.
You probably have a gut sense of which ingredients make up the bulk of your food costs, but if you don’t, do some back-of-the-napkin math to figure it out, or just check your inventory records.
Pick a Time Frame
For this exercise, we’d suggest picking a week or a month to start.
Be specific, and if you can, choose a boringly normal week. While it won’t account for unexpected price hikes caused by crop shortages or natural disasters, it’ll be more realistic than using numbers based on holiday or summer rush periods when both costs and revenues tend to be higher.
Set Some Standards
Now that you’ve chosen ingredients and a time frame to focus on, think about how much you’d expect to pay for each ingredient (Standard Price) and how much you’d expect to buy (Standard Quantitiy). These two numbers should stay in alignment, meaning that you might need ten cases of a product over the course of the month, but shouldn’t grant yourself a cut rate for buying in bulk if you’ll be receiving undiscounted biweekly deliveries.
Actualize the Actuals
Be vigilant about using real numbers from the time frame you chose, even if it takes a little longer to dig up those invoices.
Use that information to find the Actual Price and Actual Quantity of the market-basket items you’ve decided to track. And don’t take the easy way out by relying on GL accounts unless they happen to be so granular that they accurately reflect a single ingredient.
Run the Numbers
Plug the numbers into the price variance formula up above and there’s your variance.
But don’t stop there: Do some quick math to figure out what it looks like over the course of a year. A small variance may not seem like a big deal, but when multiplied by 12 or 52, it might seem a little more dire.
Interpreting the Results
You’ve got a number, but what does it mean? If it’s positive, you have a favorable cost variance, which means actual costs are lower than standard costs. A negative number means it’s an unfavorable variance because actual costs are higher than standard ones.
In general, a variance of around 10 percent is acceptable, but that percentage depends on your situation. Restaurants that have recently implemented new ordering or inventory processes might not mind a larger unfavorable variance, so long as it soon levels out to a more sustainable status. On the other hand, restaurants squeaking by on razor-thin margins might not be able to weather even a 10 percent unfavorable variance.
Regardless of the outcome, think about why an item’s price variance looks the way it does. According to Management Accounting Quarterly and Accounting Simplified, here are a few common reasons for price variance:
Reasons for Favorable Variance
Reasons for Unfavorable Variance
- Lower market prices than expected
- Higher market prices than expected
- Better negotiation with your vendors
- Suppliers with more bargaining power
- Efficient ordering practices
- Inefficient buying or rush orders
- Improved portion and waste control
- Substitution of lower-quality ingredients
While most of the reasons for favorable price variance are undoubtedly good, don’t get complacent. Market prices are inherently fickle, bulk orders only make sense if you can use the stock before it spoils, and lower-quality ingredients are always a gamble.
Similarly, although some reasons for favorable variance are outside your control (how could you know that a nasty hurricane season would cause orange prices to skyrocket?), others should be addressed immediately before they affect the bottom line.
Reacting to Restaurant Cost Variance
Once you’ve thought through the reasons for an ingredient’s price variance, it’s time to take action.
For favorable price variance, the best move is to think about ways to replicate that with ingredients that aren’t quite up to snuff. For example, if you’ve cracked the food management code for pistachios, consider using similar techniques for croutons.
Dig Into the Details
When ordering the same item from multiple vendors, it’s worth figuring out who offers the most competitive pricing. For folks overseeing multiple stores, splitting out the data by location may provide some insight.
No matter how you approach the problem, keep the the 80/20 rule in mind; focus on items with the highest impact so you see tangible benefits, not just a few dollars saved per period.
Ask Vendors What’s Up
Don’t be afraid to reach out to vendors to ask why the price has been so unstable or to renegotiate. In some cases they’ll tell you that an item’s price has risen so much that they had to pass on the cost to their customers, but you also might be the victim of an invoicing error.
If their answers don’t satisfy you, shop around. A competing supplier might be the answer to price variance problems.
Be Vigilant About Internal Controls
Carefully monitor waste, portioning, and theft.
Using an extra tablespoon of butter in that sauteed swordfish might not seem like a big deal, but if you serve eight plates per day, in a year you’ve fattened up the Actual Quantity by more than 90 pounds. Not even butter can make that taste good. Encouraging proper food management protocols will ensure you’re not buying extra stock because it’s being misused.
Adjust the Sale Price
Ultimately, price variance is really about balancing actual numbers versus standard numbers. If you’ve optimized actual costs and quantities, it may be time to consider adjusting sale prices based on COGS.
May the Costs Be Ever in Your Favor
Phew! Does it all seem too overwhelming to manage? Don’t give up. There are solutions that track the price of every ingredient you purchase, alerting you to both favorable and unfavorable variance.
What's your preferred method for controlling price variance? Let us know in the comments below!