Restaurant Break-Even Analysis Explained: All You Need to Know
Running a successful restaurant requires excellent taste, an eye for curating a creative menu, and a knack for designing an inviting atmosphere.
Supplementally, you need business sense, which many new restaurateurs may not have right out of the gate. What matters most is the willingness to learn and create systems that can maximize profits while still producing high-quality menu items that will keep your customers coming back for more. After all, nearly 17 percent of restaurants fail in their first year, and a large contributor to that is being unable to earn more than they spend per meal.
Calculating your break-even point is a key figure in the operations of your restaurant, and refers to the amount of revenue required to cover the total fixed and variable expenses accrued during a particular time period.
Conducting a break-even analysis is a great way to get a handle on your inventory (and your menu), to make sure you’re spending on the right things, and not wasting money on the wrong ones.
In this article, you will learn:
- The definition of a break-even analysis
- The difference between fixed and variable costs
- How to calculate your break-even point
Understanding the Key Terms
To calculate a break-even analysis, you first need to have a handle on your fixed costs and variable costs. That means you’ll have to dig for data in your books before you can calculate your break-even point.
Fixed costs are recurring, constant costs that are incurred regardless of sales. That includes rent, salaries, licensing fees, insurance premiums, and the like. Anything that provides you a constant monthly bill is a fixed cost. Fixed costs are different from one time expenditures, like buying a new stand mixer or a point of sale device.
Variable costs are recurring costs that change from period to period. This includes costs like food and ingredients, hourly wages, and utilities. If you think about it, you’ll rarely buy the same exact amount of the same ingredient each month, much in the same way you’ll never pay the same exact amount for electricity each month.
When you have your fixed and variable costs per month, you can start breaking down the components even further. Let’s dive into the other data you’ll need to calculate your break-even analysis.
Total Fixed Costs (TFC): the total $ amount of fixed costs for your business
Total Variable Costs (TVC): the total $ amount of variable costs for your business
Total revenue: the total $ amount of income generated
Average Revenue Per Guest (ARG): the total $ revenue ÷ # of guests
Variable Cost Per Guest (VCG): TVC ÷ # of guests
Total Sales: the total $ amount of revenue generated through sales
You can get this data through an inventory management system, or with some elbow grease and some good ol’ fashioned bookkeeping. No matter what method you choose, when you have all the data you need, it’s time to crunch some numbers.
What Is A Break-Even Analysis?
Break-even analysis can be tough for restaurants: You’re measuring today’s financial performance with information and data based on accounting data from the past.
Before understanding what a break-even analysis is, you must first understand what a break-even point is.
A break-even point illustrates how many customers you need to serve in order for your restaurant to make a profit, depending on how much money the average customer spends. The amount of revenue needed is based on the sum of your total fixed and variable expenses over a specific time period. Your break-even point calculation counts on accurate expense accounting and data from your POS system about customer check averages.
Break-even analysis also relies on figuring out your fixed and variable costs. Here’s an explanation of the two.
What Are Fixed And Variable Costs?
To conduct a break-even analysis, the first numbers you need to compile are your fixed and variable costs. Then, identify your mixed costs.
How To Determine Your Fixed Costs
Your total fixed costs are your expenses that have to be paid and are not dependent on sales. These costs typically don’t change much from month to month. Example of fixed costs include:
- Insurance, rent, and property tax
- Internet and phone
- Advertising and marketing costs
- Utility bills
- Permits and licenses
How To Calculate Variable Costs
Variable costs are expenses that fluctuate in accordance with the number of menu items you sell to customers. Your restaurant’s total variable costs change when your sales volume varies. Examples of common variable costs include:
- Labor costs
- Food and beverage costs
- Takeout containers or disposables
- Credit card processing fees
Identifying Mixed Costs
Mixed costs can be classified as the in-between expenses that are partially fixed and partially variable. For example, your water or electricity bill may differ slightly with the changing seasons, but typically these bills will stay within a range. Group mixed costs with fixed costs and use a monthly average to calculate your break-even point.
Break-Even Point Calculations and Formulas
If you’re calculating your break-even point manually, there is a textbook formula for that:
Break-Even Point = Total Fixed Costs / (Average Revenue Per Guest - Variable Cost Per Guest)
In restaurant industry terms, the units represent the customer counts (or customer “covers”) themselves. Unit price is the dollar amount of a restaurant’s “customer average.”
Some restaurants will have already figured out their estimated margins on menu items based on an advanced analysis of the cost of ingredients and recipes. However, some restaurants don’t have an organized chart of accounts categorized into fixed and variable costs in order to accurately calculate an exhaustive break-even analysis.
So, if you find yourself in the second group, the following variation of the original formula works well. You only need three numbers: total fixed costs, total sales, and total variable costs:
Break-Even Point = Total Fixed Costs / (Total Sales - Total Variable Costs / Total Sales)
This formula allows you to easily calculate your restaurant’s break-even point in sales dollar once you’ve categorized your fixed and variable costs for a specific period of time. You simply need to gather basic accounting reports without factoring in customer counts or the dollar averages per customer.
Whichever formula you use, you are essentially calculating the answer to this question: what sales volume do you need to offset your total fixed costs, taking into account variable costs for each menu item sold? When you know how many customers you need to serve to break even, you can make wiser decisions about what steps you need to take next.
Let’s break this down further to see break-even calculations in action.
Think about your break-even point in dollar amounts. For example - in a specific time period, at what sales volume did my total contribution margin break-even my bottom line, canceling out my total fixed costs? After this, each additional dollar earned should have gone straight to your net income.
To further understand this principle, we need to learn about something called a contribution margin.
The contribution margin is how much of a product’s price actually nets a profit. If your turkey sandwich is sold for $10 and costs $5 to produce (including labor, ingredients, and time), your turkey sandwich contributes $5 to your profits.
Let’s learn how to calculate the percentage of each sales dollar that is ready to cover your profits and fixed costs by using this formula:
Break-Even Point = Total Fixed Costs ÷ Contribution Margin Ratio
We can get to this calculation using a series of formulas:
- Contribution Margin = Total Sales - Total Variable Costs
- Contribution Margin Ratio = Contribution Margin / Total Sales
- Contribution Margin Ratio = (Total Sales - Total Variable Costs / Total Sales)
- Break-Even Point = Total Fixed Costs / (Total Sales - Total Variable Costs / Total Sales)
With this formula, we remove the customer count component and answer the question, “When did I break even and begin adding profit to my restaurant’s bottom line?”
Let's take a look at an example.
Average sales price
Less: Average cost price per unit
Average contribution margin (break-even point)
$3000 / $5 = $600 units
If your average sales price per unit is $10 and your average cost per unit is $5, then the difference between the two is $5. If your fixed costs for the month are $3,000, then your average contribution margin is $3,000/$5 = 600 units. So, your restaurant will only make a profit if you make more than 600 units of sales per month. If you make less, then you suffer a loss.
Buying Time To Focus On The Important Things
If you read through this article, wiped the sweat from your brow and thought, “I need to hire an accountant,” you’re not alone. After all, restaurant owners commonly encounter difficulties with accounting.
Suffice to say, most people open restaurants with a love of food, not a love of math. Investing in things like bookkeeping software, an inventory management system like MarketMan, or even hiring someone to look over the books can go a long way in keeping your business healthy.
Despite the complexity, the numbers can’t tell you all the answers either. Your break-even point provides valuable insight into how much money you need to make to clear your costs, as well as places you might be able to trim some fat.
However, restaurants still need a human touch. The food needs to be good, the menu needs to be streamlined and enticing, and perhaps most importantly, the customer has to feel welcomed, appreciated, and respected in your establishment.
Calculating your break-even point can help you focus more time and effort on the more challenging parts of owning a restaurant, by helping you set the right goals with the right figures in mind.