Labor cost and labor cost percentage are two of the most critical metrics to keep an eye on within your broader restaurant operating costs.
Why? Because labor is generally one of the highest restaurant expenditures (often second to rent). Restaurant labor costs make up 30-35% of total revenue on average in the foodservice industry, according to Chron. What's more, the cost of labor is ever-increasing.
Nearly half of restaurant owners reported escalating labor cost increases in a 2019 report. As a result, many were forced to increase menu prices or reduce the amount of staff.
So, what is labor cost and labor cost percentage? And how can restaurant owners calculate them accurately?
Labor cost describes the total dollar amount your restaurant spends on labor, including pay for salaried and hourly workers, as well as taxes and employee benefits. The amount you spend on labor also affects your prime cost – the total cost of goods sold plus total labor cost – which is the metric that many restaurateurs use to examine their restaurant’s efficiency. The operating cost of labor needs to be factored in with your other ongoing costs, rent, and food.
Let’s explore how to calculate and reduce the labor costs in your restaurant. But first, we’ll review the basics — download the free restaurant numbers and metrics calculator below and follow along.
What are the operating costs of a restaurant?
Restaurants have three main buckets for operating costs. They are:
Labor costs: These include paying your servers, cooks, dishwashers, cashiers, greeters, and managers.
Food costs: This includes how much you need to pay for your food and beverage supplies and can fluctuate with the cost of your menu items. It can be calculated as a restaurant’s cost of goods sold.
Rent: Your rent and utilities will vary by your location, but it’s important to factor in what percent of your total sales you’re paying in rent.
When you are first starting, you’ll likely accrue some restaurant start-up costs like new equipment, physical improvements, and probably marketing materials like a website. But start-up costs won’t be factored into your standard operating costs.
How do you calculate labor cost in a restaurant?
Let’s break it down.
What is labor cost?
New restaurateurs may be surprised to learn that labor cost includes more than just hourly wages. Here are some other things that factor into your labor cost calculation:
Salaried employee wages
Hourly employee wages
Sick and vacation days
Basically, anything that can be categorized as “labor-related” goes into your labor cost percentage calculation.
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How to calculate restaurant labor cost by hours worked
Toast integration partner HotSchedules recommends calculating labor costs in a slightly different way. Here’s their reasoning:
“Let’s say you’re a manager at a Mexican restaurant. At 3:30 p.m. on a Tuesday, one guest comes in and sits at the bar. They order two beers and settle on the free chips and salsa. As a manager tracking sales and labor together, you have to ask yourself: Who actually worked for that single guest?
Chances are it was just the bartender. But – and this is the tricky part – you still had to pay a server, a hostess, and a line cook, who really didn’t have anything to do with this transaction.
In this example, your labor as a percentage of sales would be through the roof, so cutting labor would be the obvious solution, right? Actually, no. You can’t cut the only cook. What if the guest had ordered enchiladas?”
HotSchedules recommends measuring labor cost percentage sales per labor hour. Using historical data gathered from your POS system analytics, you can make solid projections to guide your labor and your schedule. Here’s how to do it:
Separate or split employees with the same salary into groups. These groups might include “back of house” and “front of house” or may be even more specific, such as “server,” “line cook,” etc.
Add together the total number of hours worked in each pay group for hourly employees. Let’s say total hours worked for servers for the week was 400.
Multiply the hourly rate by the total number of hours worked. Say the hourly rate for servers was $7.25 — consult the Department of Labor to find out the hourly rate for servers in your state. 400 times $7.25 equals 2900.
Divide this by the number of weeks in a year (or months in a year if doing monthly budgeting). In this case, you’re dividing 2900 by 52 weeks in a year, which equals 56. Now you know, on an average week, you’re paying $56 per hour worked.
Add together the wages in each pay grade to determine total labor costs by hour worked. You may pay $56 per hour worked for servers, but for line cooks and management, that number will be different. Add together all of them to determine total labor costs by hour worked.
How to calculate restaurant labor cost percentage
There are a few ways to calculate labor cost percentage. We’ll be diving into two labor cost percentage formulas in particular: labor as a percentage of sales and labor as a percentage of total operating costs.
Download our restaurant metrics Excel template at the link below to calculate your labor cost. Then, read on to learn how to calculate labor cost percentage in an easy, accessible way. We'll also give you a few tips on lowering your labor costs while keeping your restaurant running at peak performance.
Labor as a percentage of sales
Labor cost percentage based on sales is the most common formula. Here’s how it works:
Determine your restaurant’s labor cost. This cost includes all the money that the business had to pay to its employees throughout the year.
Determine your restaurant’s revenue. Revenue, in this case, is your bottom line: the amount of money that your business takes in before any taxes or other deductions have been made. You can find this number in your POS system dashboard.
Divide your restaurant’s labor cost by its annual revenue. For example, if the restaurant paid $300,000 a year to its employees and brought in $1,000,000 a year in sales, divide $300,000 by $1,000,000 to get 0.3.
Multiply by 100. This final number is your restaurant’s labor cost percentage. In this example, it is 30%.
Use this formula to determine your labor cost percentage based on revenue.
Labor as a percentage of total operating costs
Labor cost percentage can also be calculated relative to total operating costs. In this case, the steps are only slightly different.
Determine your restaurant’s annual labor cost. This cost includes all the money that the business had to pay to its employees throughout the year.
Determine your total operating costs. Total operating costs are the total cost of doing business; not just sales, but including costs for marketing, rent, food, drink, and any other expense.
Divide labor cost by total operating costs For example, if labor costs $9,000 per month and total operating cost is $15,000 per month, divide $9,000 by $15,000 to get 0.6.
Multiply by 100. This final number is your restaurant’s labor cost percentage. In this example, it’s 60% of the total cost of doing business.
Use this formula to determine your labor cost percentage based on total operating costs.
What percentage of cost is labor?
Guidelines from White-Hutchinson Leisure and Learning consulting group say that restaurant labor costs should come in at less than 30% of revenue, and food and labor costs should be less than 60% of the revenue. Fine dining, however, may have higher labor cost percentages than fast casual eateries.
How can I lower labor costs?
The answer isn’t to just pay your employees less or to schedule fewer shifts. Here are just a few creative ways restaurants are lowering labor costs:
Pay an employee when they are supposed to start instead of when they clock in. Clock-in reinforcement is a feature of many point of sale systems, including Toast.
Offer bonuses to reduce absenteeism.
Be wary of overtime rules. Many states require employers to pay time-and-a-half or even double-time to employees who work over 40 hours in a given workweek. Hire and schedule enough employees to avoid overtime costs.
Keep an up-to-date tally of how many hours your employees have actually worked versus how many they were scheduled for. That way, you can spot potential overtime offenders before it becomes a problem.
Cross-train and turn your employees into jacks of all trades. For example, if your hostess can jump in when a server goes home sick, she can keep diners happy without adding extra payroll.
Schedule willing employees for a split shift so you're amply staffed at the right times.
Go paperless. Remove tedious pen-and-paper processes from your payroll and labor management processes with products designed specifically for restaurant payroll.
Reducing restaurant labor costs doesn’t always mean cutting staff or hours or increasing prices. By using the right tools and keeping close track of the relevant restaurant operating expenses, then looking at trends, you can work smarter and operate more efficiently as a business.