Do you know how to calculate overhead rate in your restaurant? If you don't, how are you measuring profitability?
Featured in this post is:
- An overview of why overhead rate is important in restaurants.
- A calculator and formula you can use to calculate your overhead rate.
- 5 tactics you can use to lower your rate and your costs.
The History of Restaurant Overhead
From the humble beginnings of selling food for profit in ancient Rome up until today, restaurateurs of all stripes have attempted to determine the profitability of their businesses. Why? It helps businesses see how they can be more successful. Simple accounting principles arose from the need to make measurement possible.
Luca Bartolomeo de Pacioli, a thirteenth century mathematician from Italy often regarded as the “Father of Accounting,” is credited with the creation of the notion of cost accounting, which is the basis on which businesses of all kinds - including restaurants - calculate profitability. This allows for the recording of all costs incurred during day-to-day activities in a way that can be analyzed to improve operations and (hopefully) help make more money.
What is Overhead Rate?
Overhead rate is just one form of cost accounting.
It is the total of all indirect business costs for a specific time period and dividing by some type of allocation measure. Examples of such costs include:
So for example, if you wanted to determine your overhead rate for the current month, you would total up all of your indirect costs (such as your rent and technology costs) and then divide those by an allocation measure (such as the total number of scheduled labor hours for the month) to get your overhead rate.
It is important to note that the cost of overhead can be calculated using either actual costs or budgeted/forecasted costs. This is important because if you compute your overhead rate with forecasted figures you can compute your predetermined overhead rate; which is a great way to model or forecast your operations. Additionally, there are a wide range of allocation measures to use, such as direct labor hours (the most common), direct labor costs, or even inventory costs.
Why Is Overhead Rate Important?
Why does knowing how to calculate overhead rate matter to restaurateurs? Simply put, lower overhead means greater profit.
If you can get a handle on what your overhead rate is, you can start determining strategies to reduce it. We all know that restaurant profit margins can be thin, so any way you can reduce costs while maintaining the same quality of service means you make more profit.
As Joe Bastianich says in his book ‘Restaurant Man’: “...it’s a nickel-and-dime business, and you make dollars by accumulating nickels.”
Calculate Your Own Restaurant Overhead Rate
Using the example of direct labor hours, here is a calculator for you that we have put together to compute your own business’ overhead rate for one month.
To use it, simply total up your indirect business costs for a month and input that value in the first line. Then total up your direct labor costs from your employee scheduling software and input that value into the second line. The output value will be your overhead rate expressed as a percentage:
5 Strategies to Reduce Restaurant Overhead Costs
So now you understand what overhead rate is, why it’s important, and how to calculate it. But now that you see the result, you might not be happy with it.
So let’s turn our attention to ways in which you can lower the overhead rate in your restaurant to improve profitability.
While there is no one “magic bullet” to do this, as every business is different, here are 5 strategies to employ that will drive your costs down and bring profits up:
1) Reduce Your Restaurant Labor Costs
Take a look at the data that comes out of your restaurant POS system and match that up with the data from your integrated employee scheduling software. Do you see any areas that could be tweaked for improvement? Perhaps you are scheduling one too many servers on weekday evenings. If you can reduce your monthly labor hours (and associated labor costs), you can dramatically reduce your overhead rate.
2) Ask Your Staff
Another way to reduce overhead is to use the collective knowledge of your staff.
As a manager, owner, or operator, it is tempting to think that you know everything that is going on in your business which impacts profitability, but that is not always the case. A quick and rewarding way to identify excess overhead is to simply ask your staff if they know of anything that can be done - you might be surprised at what you discover!
An even better way to keep your staff in this optimization mindset is to set up a reward system for identifying overhead drivers. For example, let your staff know that if they have an idea for reducing overhead and you are able to implement it they will get something like a gift card - incentivization works!
3) Optimize Your Restaurant Technology
A large driver of overhead in modern restaurants is legacy technology. Things like land line telephones, old POS systems that cost a fortune to upkeep, or even expensive management/payroll software. Do your research and see if there are modern, cost-effective restaurant technology solutions that allow you to trade in a legacy system for a cheaper, more modern system.
4) Reduce Waste
Forget about ordering inventory for bulk discounts. Unless you have a crystal ball, spoilage will offset any gains you might make from bulk ordering for the sake of saving a buck. Instead, focus on reducing inventory wastage. Practice just-in-time (JIT) orders and keep inventory to a minimum by looking at smart inventory solutions like BlueCart - which can automatically reorder supplies as they run low. Perform regular stock audits and make sure you reconcile all deliveries with your purchase orders.
5) Sublease Space
Unless you operate a food truck or pop-up, your restaurant’s storefront will account for a large proportion of your indirect costs. That’s why it is crucial to make sure you keep this cost as low as possible.
While the most obvious tactic is to negotiate the best lease possible for your restaurant (or consider renting if market forces allow), another option to consider is to sublease your existing space to a complimentary business. For example, if your business operates a lunch and evening service have you considered subleasing your kitchen space in the morning to a caterer or food truck that can make use of your space without interfering with your operations?
Restaurant Overhead Rate
Calculations aren't every restaurant owner's cup of tea, but they're an important part of the job that help to keep your doors open. Take some time, do the math, and start working on ways to get your overhead rate to be as low as possible.