Most restaurant owners and operators don’t know the difference between purchases and cost of goods sold for their restaurant. Isn’t it time you understood and got a leg up on your competition? Keep reading as this post covers exactly that!
All tables are full, reviews are good, everyone is leaving those restaurant doors with a smile – but the bottom line is still not where you want it to be. Is this a situation you can relate to as a restaurant owner?
If that is you then this article is a must read for you.
While there are many reasons for the low levels of profit, food cost is often a major factor.
With just some adjustments to your accounting system, things can start looking significantly different in your accounting records, and most importantly, more accurate. In this read, we educate you on the concepts inventory, purchases, and cost of goods sold. Most importantly, we help you distinguish between the purchases and cost of goods sold, as they are actually different!
To start with, we look at both concepts separately in a general accounting sense.
Table of Contents
Concept Refresher for Purchases Versus Cost of Goods Sold
Inventory – Inventory is the products, such as food and beverages, that has been bought by the restaurant and not yet sold to the customers. To understand better, specifically for restaurants, this is the meat sitting on the line, frozen food in the freezer, fresh produce in the walk-in, beer in the kegs, liquor on the liquor cabinet, soda bags yet to be used and so on. These are the items that will either be sold by themselves or combined with other ingredients to produce the finished product sold to customers.
Cost of Goods Sold (COGS) – The cost of goods sold is the cost of the merchandise that was already sold to the customers. For restaurants, this is the true cost associated with what goes on the plate or in the cocktail that is served. This is easiest calculated over a weekly or monthly time period.
Purchases – Purchases are the items bought from vendors that will be sold to customers. For restaurants, these are the purchases that will be used in the final product, such as the restaurant plate or glass of wine. The nuance here is that purchases do not always equate exactly to the cost of goods sold, as certain items remain unused from period to period. Purchases not used, later become inventory, those that are used during the time period become the cost of goods sold.
While inventory is reported on the balance sheet, COGS and purchases are recorded on the income statement.
Again, this is where it gets a bit confusing, and the difference between COGS and purchases is crucial. Most restaurant owners fail to make the final step between purchases and the cost of goods sold (as this requires a week-end or month-end adjustment).
Think of a retailer that sells only cookie boxes. He started the year with 100 boxes, and during the year purchased 500, and at the end of the year was left with 200 boxes. His inventory will be the remaining 200 boxes, calculated at this cost, while the COGS will be the cost of 400 boxes (100 boxes + 500 boxes – 200 boxes = 400 boxes). Do not worry, we will dive into the math here shortly and it will all make clear sense.
Now that you understand the concept and the differences between the three, we take a look at it using an actual accounting example to put this newfound restaurant information into action.
Understanding the Difference Between COGS, Inventory, and Purchasing
If you have some storage space in your restaurant kitchen, chances are high that you purchase your food for the restaurant in bulk.
Be it for economies of scale, easy logistics, buying power, ease of production or whatever reason. When you purchase these foods in advance, it is not immediately an expense. Until the time you sell it, it serves as your inventory, an asset on your balance sheet. Only when it is served to the customer’s table, is when it becomes your COGS.
To better understand this, let’s take a look at an example.
Purchases are goods purchased by the restaurant and are recorded at cost. This section will only represent the cost of one particular good individually (mathematically purchases = purchases for a defined period). Cost of Goods sold represents the cost of the goods you sold that are incurred to convert purchases into a sellable product (Mathematically, COGS = Starting inventory + Purchases – Ending inventory).
It is the month of February in your accounting period. You buy fresh vegetables from the farmers market at the cost of $500 for the month. This is a purchase and will be recorded at $500 in the books for the month of February. Now, you use these veggies to make several menu items. You also have some veggies worth $100 left after the month of January. Then you use only $300 worth veggies from February’s purchase, meaning you had $200 in fresh vegetables remaining at the end of the period.
So for the month of February,
Starting Inventory (January ending inventory) = $100
Purchases = $500
Ending Inventory (February ending inventory) = $200
Cost of Goods Sold = Starting Inventory + Purchases – Ending Inventory
Or $100 + $500 – $200 = $400
Remember yes the inventory ($200 in vegetables) will become a cost next month as those vegetables are consumed. From an accounting perspective and to ensure that we have an accurate cost of goods in each period, you must keep your inventory in a separate entry and on the balance sheet at cost.
The next section helps us understand why.
Understanding the Reporting Differences Between Purchases and Cost of Goods Sold
Let’s continue with the same example. For February, you can see that your COGS represents only the costs of food that were sold in that week. And say your sales were $900, so keeping it simple, you can say that your gross profit was sales – cost = $500 ($900 minus $400). If you had simply included the costs of the entire purchases for this month, your costs would be $500. And gross profit would be $400 for the month of February. Comparing the two scenarios, we know that the first one gives a more realistic and honest picture.
This example excludes the other fixed and variable costs, but adding those in, the true COGS would likely net a profit versus the losses of the reporting with simple purchases.
Many restaurant business owners record purchases when it was made and include it in the food cost under the category of COGS. This is a great first step, but oftentimes restaurant owners mix the next and more important step, recording their inventory adjustments.
Now that you know that it makes sense to do it this way, you could be feeling overwhelmed by the additional work it takes to keep those proper records. This system of recording purchases and inventory to properly track the cost of goods does not have to be that difficult if you have the right structure and systems in place.
Our next section will deep-dive into just that.
Doing Cost of Goods Sold in Practice
Now it is time to solve the bridge between restaurant theory and practice.
The first step is to set up a specific time frame for your restaurant accounting system, both for your profit and loss reporting and inventory recording. It could be 1 week, 2 weeks, monthly (like in most restaurants), or any period that is suitable for you.
This step will put you in either of the two situations:
- You run profit/loss reports in the same period as the inventory report.
- You run profit/loss more times than you monitor your inventory.
For Those Running Profit and Loss Reports in the Same Period as the Inventory Report
When in the situation of similar reporting periods, it is a bit easier, you can just enter an adjustment from your purchases ( which are recorded in your COGS ) to inventory on your balance sheet every time.
Remember we are simply putting the accounting formula for cost of goods sold into action:
COGS = Beginning inventory + purchases during the period – ending inventory
This entry depends on if you are increasing or decreasing inventory. I also recommend setting up chart of account items for ‘Change in Food Inventory’ and ‘Change in Beverage Inventory.’
To Record an Increase in Inventory
This example shows you what happens when your inventory increases from the previous month. For example, say you’re finishing July reporting, and your food inventory is valued at $1,500. Last month at the end of June, your food inventory was valued at $1,250, and you recorded this in your books.
Now, let’s create a journal entry:
I will use two items from your chart of accounts: Change in Food Inventory (Cost of Goods) and Food Inventory (Asset).
|Change in Food Inventory||$250|
To Record a Decrease in Inventory
Let’s reverse the example so you can see the opposite case. This example shows you what happens when your inventory decreases from the previous month.
For example, say you’re finishing July reporting, and your food inventory is valued at $1,500. Last month at the end of June, your food inventory was valued at $1,750, and you recorded this in your books.
Now, let’s create a journal entry:
I will be using two items from your chart of accounts: Change in Food Inventory (Cost of Goods) and Food Inventory (Asset).
|Change in Food Inventory||$250|
For Those Running Profit and Loss Reports More Times Than You Monitor Your Inventory
As a precursor, I try to avoid this method at all costs and recommend the previous method to keep accurate verifiable accounting records.
When you are in the situation of not having a regular inventory, you need to determine the percentage of sales, and then transfer the remaining amount of purchases to inventory.
So for example, you determine food cost to be around 30%, then for every $1,000 sale, you will need to ensure all purchases over $300 are moved to inventory resulting in a COGS of $300. So if we have $500 in purchases we need to adjust and remove the excess purchases of $200.
The same journal entries outlined work conceptually here. For example, if we have purchases in excess of our estimate of ‘consumed inventory, we use the following:
|Change in Food Inventory||$200|
Let’s reverse the example; so for example, you determine food cost to be around 30%, then for every $1,000 in sales, you will need to ensure all purchases over $300 are moved to inventory resulting in a COGS of $300. If we have $200 in purchases we need to adjust inventory and add $100 to the cost of goods for the period.
|Change in Food Inventory||$100|
While it could seem a bit daunting to estimate this percentage and it has room for errors. If your inventory count is lower/higher when you actually do the inventory reporting, then you can always adjust the difference at the end of the quarter into your COGS. Additionally, if this happens often, you can adjust your food cost percentage.
Now You Understand the Difference Between Purchases and Cost of Goods!
Doing this practice has more than just realistic bottom-line benefits. Isolating your food cost will also force you to look at these costs and control them if it is beyond the industry standards, or if it fluctuates as per your historic records.
It gives a better structure to your reporting system and does not require a significant extra effort from your side or your accountant’s side. With the hope that these multitudes of benefits should be convincing enough for you to go and make those changes to your reports or warrant a meeting with your accountant.