Planning For Profit

Chapter 10Planning For ProfitMain IdeasFinancial Analysis and Profit PlanningMenu AnalysisCost/Volume/Profit AnalysisThe BudgetDeveloping the BudgetMonitoring the BudgetTechnology toolsFinancial Analysis and Profit PlanningIn addition to analyzing the income statement (the P&L statement) managers must undertake a thorough study of three additional areas of analysis to assist in planning for a profit. These three areas are:Menu AnalysisCost/Volume/Profit (CVP) AnalysisBudgetingFinancial Analysis and Profit PlanningMenu Analysis concerns itself with the profitability of each menu item sold.CVP analysis deals with the sales dollars and volume required to avoid an operating loss and to make a profit.Budgeting allows managers to plan their next accounting period’s operating results by projecting sales, expenses, and profits to develop a budgeted income (P&L) statement.Menu AnalysisMenu analysis involves marketing, sociology, psychology, and emotions.Guests respond best to menu item descriptions, the placement of items on the menu, prices, and item popularity rather than to financial analyses.Menu AnalysisManagers perform menu analysis using one or more of the following operational variables:Food cost percentageItem popularityContribution marginSelling priceVariable expensesFixed expensesMenu AnalysisThree of the most popular systems of menu analysis are food cost%, contribution margin, and goal value analysis.The matrix analysis provides one method for comparisons between menu items.A matrix allows menu items to be placed into categories based on whether they are above or below menu item averages for factors such as food cost %, popularity, and contribution margin. Menu AnalysisMenu AnalysisFood cost percentage method: the operator seeks menu items that have the effect of minimizing overall food cost percentage.Contribution margin approach: the operator seeks to produce a menu that maximizes overall contribution margin.Menu AnalysisMenu AnalysisTo analyze a menu using the food cost percentage method, managers separate menu items based on two variables:1. Food cost percentage2. Popularity (number sold)Menu AnalysisThe characteristics of the menu items that fall into each of the four matrix squares are unique and thus should be marketed differently.Menu AnalysisMenu AnalysisContribution margin per menu item is defined as the amount that remains after the product cost of the menu item is subtracted from the item’s selling price.Selling PriceProduct Cost Contribution Margin per Menu ItemMenu AnalysisTo determine the total contribution margin for the menu, the following formula is used:Managers determine the average contribution margin per item, using the following formula:Total SalesTotal Product Costs Total Contribution MarginTotal Contribution MarginNumber of Items SoldAverage Contribution Margin per ItemMenu AnalysisContribution margin is the amount available to pay for labor and other expenses and to generate a profit.To analyze a menu using the contribution margin approach, managers separate menu items based on two variables:1. Contribution margin2. Popularity (number sold)Menu AnalysisThe characteristics of the menu items that fall into each of the four matrix squares are unique and thus should be marketed differently.Menu AnalysisSome users of the contribution margin method of menu analysis refer to it as menu engineering and classify the squares used in the analysis with colorful names:“Plow horses” (square 1)“Stars” (square 2)“Dogs” (square 3)“Puzzles” or sometimes “Challenges” (square 4)Menu AnalysisA frequent and legitimate criticism of the contribution margin approach to menu analysis is the it tends to favor high-priced menu items over low-priced ones, since higher priced menu items, in general, tend to have the highest contribution margin.Menu AnalysisMenu AnalysisWhen conducting a menu analysis the foodservice operator seeks to answer the following questions:Are my menu items priced correctly?Are the individual menu items selling well enough to want to warrant keeping them on the menu?Is the overall profit margin on my menu items satisfactory?Menu AnalysisGoal value analysis uses the power of an algebraic formula to replace less sophisticated menu averaging techniques.The advantages of goal value analysis are many, including ease of use, accuracy, and the ability to simultaneously consider more variables than is possible with two-dimensional matrix analysis.Menu AnalysisGoal value analysis evaluates each menu item’s food cost percentage, contribution margin, and popularity but unlike the two previous analysis methods introduced, it includes the analysis of a menu item’s non-food variable costs as well as its selling price.Menu items that achieve goal values higher than that of the menu’s overall goal value contribute greater than average profit percentages. As the goal value for an item increases, so too does its profitability percentage. Menu AnalysisThe goal value formula is as follows:A x B x C x D = Goal ValuewhereA = 1.00 - Food Cost %B = Item PopularityC = Selling PriceD = 1.00 - (Variable Cost % + Food Cost %)Menu AnalysisMenu AnalysisMenu AnalysisThe computed goal value carries no unit designation; that is, it is neither a percent nor a dollar figure because it is really a numerical target or score.Every menu will have items that are more or less profitable than others.A loss leader is a menu item that is priced very low, sometimes even below total costs, for the purpose of drawing large numbers of guests to the operation.Menu AnalysisItems that do not achieve targeted goal value tend to be deficient in one or more of the key areas of food cost percentage, popularity, selling price, or variable cost percentage. A purely quantitative approach to menu analysis is neither practical nor desirable. Menu analysis and pricing decisions are always a matter of experience, skill, insight and educated predicting.Cost/Volume/Profit Analysis Each foodservice operator knows that some accounting periods are more profitable than others.A Cost/Volume/Profit Analysis can help managers predict and plan for profitability. At the break-even point, operational expenses are exactly equal to sales revenue.Cost/Volume/Profit Analysis Cost/Volume/Profit AnalysisA cost/volume/profit (CVP) analysis helps predict the sales dollars and volume required to achieve desired profit (or break-even) based on known costs.CVP calculations can be done on either the dollar sales volume required to break-even or achieve the desired profit, or the number of guests (covers) required that must be served to break even.A contribution margin income statement shows P&L items in terms of sales, variable costs, contribution margin, fixed costs, and profit.Cost/Volume/Profit Analysis Cost/Volume/Profit AnalysisContribution margin for an overall operation is defined as the dollar amount that contributes to covering fixed costs and providing for a profit.Contribution margin is calculated as follows:Total SalesVariable CostsContribution MarginCost/Volume/Profit AnalysisTo determine the dollar sales required to break-even, managers use the following formula:To determine the number of guests that must be served to break-even, the following formula is used:Fixed CostsContribution Margin %Break-Even Point in SalesFixed CostsContribution Margin per Unit (Guest)Break-Even Point in Guests ServedCost/Volume/Profit Analysis Cost/Volume/Profit AnalysisTo determine sales dollars and covers to achieve the after tax profit goal, use the following formula: To convert after-tax profit to before-tax profit, compute the following:Fixed Costs + Before-Tax Profit Sales Dollars to Contribution Margin % = Achieve Desired After-Tax Profit After Tax Profit 1-Tax Rate = Before Tax ProfitCost/Volume/Profit AnalysisIn terms of calculating the number of guests that must be served in order to make a profit, use the following formula:Fixed Costs + Before-Tax Profit Contribution Margin per Unit (Guest)= Guests to Be Served to Achieve Desired After-Tax ProfitCost/Volume/Profit AnalysisWhen calculating sales and covers to achieve break-even and desired after tax profits, managers can easily remember which formulas to use if they remember the following:Contribution margin % is used to calculate sales dollarsContribution margin per unit is used to calculate sales volume in units (guests) Cost/Volume/Profit AnalysisManagers who understand the CVP analysis concepts, can predict any sales level for break-even or after-tax profits based on their:Selling pricesFixed costsVariable costsContribution margins. Cost/Volume/Profit AnalysisLinking Cost/Volume/Profit Analysis with Goal Value AnalysisCost/volume/profit analysis is used to establish targets for the entire operation, whereas, goal value analysis evaluates individual menu items against those operational targets. Therefore, the two analyses can be strategically linked.Cost/Volume/Profit AnalysisLinking Cost/Volume/Profit Analysis with Goal Value AnalysisCost/Volume/Profit AnalysisGoal Value AnalysisFood cost % from contribution margin income statementFood cost % goalGuests served to achieve desired after-tax profitTotal average number of covers per menu item goalSelling priceSelling price goalLabor and other variable cost % from contribution margin income statementVariable cost % goalCost/Volume/Profit AnalysisLinking Cost/Volume/Profit Analysis with Goal Value AnalysisBy looking at these two analyses, managers can learn how the overall goals of the operation affect menu item profitability. Conversely, they can see how changes made to menu items will affect the overall profitability of their operations. Cost/Volume/Profit Analysis Cost/Volume/Profit Analysis Cost/Volume/Profit Analysis Cost/Volume/Profit AnalysisMinimum Sales Point (MSP) is the sales volume required to justify staying open for a given period of time.The information needed to calculate a MSP is:Food Cost %Minimum payroll cost needed for the accounting periodVariable Cost %Cost/Volume/Profit AnalysisFixed costs are eliminated from the calculation because even if volume of sales equals zero, fixed costs still exist and must be paid.In calculating MSP, Food cost % + Variable cost % is called the minimum operating cost. Cost/Volume/Profit AnalysisThe MSP formula used is:Corporate policy, contractual hours, promotion of a new unit, competition and other factors must all be taken into account before the decision is made to modify operational hours.Minimum Labor Cost 1-Minimum Operating Cost = MSP  orMinimum Labor Cost 1-(Food Cost % + Variable Cost %) = MSPThe BudgetThe budget, or financial plan, will detail the operational direction of a unit and its expected operating results.The budget should not be a static document. It should be modified and fine-tuned as managerial accounting assesses data about sales and costs that affect the direction of the overall operation. The Budget Just as the P&L tells managers about past performance, the budget is developed to help them achieve their future goals.The effective foodservice operator builds his or her budget, monitors it closely, modifies it when necessary, and achieves desired results.Budgeted RevenueBudgeted ExpenseBudgeted ProfitThe BudgetBudgeting is best done by the entire management team, for it’s only through participation in the process that the whole organization will support the budget.Foodservice budgets can be considered as one of three main types:Long-range budgetAnnual budgetAchievement budget.The BudgetThe long-range budget is typically prepared for a period of three to five years.The annual budget is for a one-year period or, in some cases, one season. Managers may also use quarterly (three-month) budgets to plan for revenues and costs throughout the budget year.The achievement budget is always a shorter range (perhaps a month or a week) estimate. It provides current operating information and thus assists in making current operational decisions. The BudgetTo establish any type of budget, managers must have the following information available:Prior period operating resultsAssumptions of next period operationsGoalsMonitoring PoliciesThe BudgetThe BudgetTo determine a food budget, managers compute estimated food cost as follows:Last Year’s Food Cost per Meal = Last Year’s Cost of Food / Total Meals ServedLast Year’s Food Cost per Meal + % Estimated Increase in Food Cost = This Year’s Food Cost per MealThis Year’s Food Cost Per Meal x Number of Meals to Be Served This Year = Estimated Cost of Food This Year The BudgetTo determine labor budget, compute the estimated labor cost as follows:Last Year’s Labor Cost per Meal = Last Year’s Cost of Labor / Total Meals ServedLast Year’s Labor Cost per Meal + % Estimated Increase in Labor Cost = This Year’s Labor Cost per Meal This Year’s Labor Cost per Meal x Number of Meals to Be Served This Year = Estimated Cost of Labor This YearThe BudgetThe BudgetBudgeting for utility costs is one of a foodservice operator’s biggest challenges. This is due to both the instability of energy prices and the impact of the weather on usage.Strategies for reducing energy usage should include:Investigating the installation of smart lighting systems that automatically turn off lights when storage areas are vacant.The BudgetReplacement of all incandescent lighting with an appropriate type of electric discharge lamp (such as fluorescent, mercury vapor, metal halide or sodium) wherever possible.The use of dual-flush, low-flow or waterless toilets to reduce water waste. Installing low-flow faucet aerators on all sinks to cut water usage by as much as 40%; from a standard 4 gallons per minute to a cost-saving 2.5 gallons a minute. The BudgetImplementation of an effective preventive maintenance program for all cooking equipment including frequent and accurate temperature recalibrations.Reducing waste disposal costs by implementing effective source reduction plans as well as pre and post-production recycling effortsEstablishing Operating GoalsManagers should establish budgets for each of the following areas:Meals servedRevenueFood costsLabor costsOther expensesProfitThe BudgetSome foodservice operators relate revenue to the number of seats they have available in their operation. The formula for the computation of sales per seat is as follows:Total SalesAvailable SeatsSales per SeatThe BudgetSome operators elect to utilize the yardstick method of calculating expense standards so determinations can be made as to whether variations in expenses are due to changes in sales volume, or other reasons such as waste or theft.The BudgetDeveloping Yardstick Standards for Food Step 1. Divide total inventory into management designated sub-groups, for example, meats, produce, dairy, and groceries. Step 2. Establish dollar value of subgroup purchases for prior accounting period. Step 3. Establish sales volume for the prior accounting period. Step 4. Determine percentage of purchasing dollar spent for each food category.The BudgetDeveloping Yardstick Standards for FoodStep 5. Determine percentage of revenue dollar spent for each food category.Step 6. Develop weekly sales volume and associated expense projections. Compute % cost to sales for each food grouping and sales estimate.Step 7. Compare weekly revenue and expense to projection. Correct if necessary.The BudgetDeveloping Yardstick Standards for Labor Step 1. Divide total labor cost into management designated sub-groups. Step 2. Establish the dollar value spent for each subgroup during the prior accounting period. Step 3. Establish sales volume for the prior accounting period. Step 4. Determine percentage of labor dollar spent for each subgroup.The BudgetDeveloping Yardstick Standards for LaborStep 5. Determine percentage of revenue dollar spent for each labor category.Step 6. Develop weekly sales volume and associated expense projection. Compute % cost to sales for each labor category and sales estimate.Step 7. Compare weekly revenue and expense to projection. Correct if necessary.Profit AnalysisAs business conditions change, changes in the budget are to be expected because budgets are based on a specific set of assumptions; if these assumptions change, so too will the budget.Budgeted profit levels must be realized if an operation is to provide adequate financial returns for owners and investors.The primary purpose of management is to generate the profits needed to continue the business and budgets help them do just that. Technology ToolsSoftware required to do menu analysis, break-even analysis and budgeting is readily available. Specialized software in this area is available to help managers:Evaluate item profitabilityConduct menu matrix analysisPerform break-even analysisBudget revenue and expense levelsBudget for profit levelsTechnology ToolsAssemble budgets based on days, weeks, months, years, or other identifiable accounting periods.Conduct performance to budget analysis.Maintain performance to budget histories.Blend budgets from multiple profit centers (or multiple units) to create multi-unit budgets.Perform budgeted cash flow analysis.