What Are Prime Costs?

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As a restaurant owner or manager you may have asked yourself, “What are prime costs?” If so, you’re not alone. Prime costs are all expenses directly related to the production of a good or service. That said, keep in mind that prime costs do not account for indirect costs. These costs must also be considered when accounting for restaurant costs. Indirect costs are business expenses not directly related to the production of your product or service.

Examples of direct costs versus indirect costs

Direct costs

  • Ingredients
  • Labor (hourly employees)

Indirect costs

  • Manager salary
  • Advertising
  • Physical location utilities

What’s the difference between prime costs and other costs?

You may be wondering “What are the differences between a prime cost and any other cost?” While each metric is individually important, there are substantial differences when it comes to specific costs. Breaking costs down into categories allows you a more in-depth look at targeted aspects of your business. 

For example, gross income specifically accounts for all costs related to the business before taxes are deducted. Similarly, labor cost is a measure of the overall cost of employee payroll as well as manager salary. Prime cost allows you to specifically identify the direct cost associated with producing a product such as a plate of food.

What are the applications of prime costs for restaurants?

When managing any business, it’s essential to reduce production costs to increase ROI (return on investment). In the restaurant business, your product is the plate of food you provide. If you provide a sit-down experience with wait staff then your service is the experience guests have in your restaurant.

Since your prime cost provides the baseline for your ROI, you should be aware of its fluctuations on a weekly or monthly basis. Some reasons for these fluctuations could include inflation of ingredient prices or inefficient and irregular processes. Without knowledge of your prime costs, it’s difficult to know the production processes’ effect on the business overall. The prime cost metric can give insight into the effectiveness of a manager or employee. It could also show you that certain menu items need a price increase due to market inflation.

How do you calculate prime cost?

As with most business metrics, prime cost has its own unique formula. Simply take the cost of raw materials to produce an individual unit and combine it with the cost of labor specifically used for that unit:

Total prime cost = Direct material cost + Direct labor cost

You can also expand the scope to consider what are prime costs during a given shift. To do this, consider direct material costs as well as labor hours for the entire shift. If you notice a negative trend in this large scope data, then you can visit individual items produced during that shift. Use the collected data to identify shortcomings of individual products or processes.

Differences between prime cost and conversion cost

Those savvy in business metrics may wonder how prime and conversion costs differ. Although both have a focus on the production process they provide two unique perspectives.

Prime cost provides an overview of all direct expenses related to production. Conversion costs by definition provide an overview of all direct and indirect expenses related to converting those raw materials into your product. Namely, the conversion costs related to your product may also include electricity to run cooktops, manager salaries, delivery fees, etc. Although these metrics are different, it would be beneficial to consider the data of both to truly maximize your outcomes. 

Prime cost limitations

As with other business metrics, prime cost has its own specific uses. It’s not an indication of the performance of a business as a whole. There are more appropriate metrics to identify the value of a company such as gross income. That means uses for prime cost are usually limited to identifying trends in individual unit production costs. Although the scope of prime costs can be expanded, you must consider that the data will lose some accuracy.

If you want an overview of labor costs including salaries, then prime cost will not be appropriate. Similarly, if you have many indirect material expenses which contribute to the production of your unit, then prime cost may be very limited in its usefulness to you.

What is the average prime cost of a restaurant?

While prime cost is most beneficial when compared with previous data it can be helpful when compared to other restaurants. This can help you set some goals as you start using prime cost to improve your ROI.

The average expected restaurant prime cost is around 55 to 65%. Of course there is wiggle room here as each restaurant is unique and may have different needs. However, the general concept is the same. If your prime cost is 60%, that leaves 40% of the sale to go toward utilities, administrative costs, and salaries. Also, you must consider that higher prime costs mean higher product costs to establish profit. If your sale price is too high because of inefficient production expenses, you may lose customers or your business. It’s no wonder tracking your prime costs is exceptionally important.

How to lower prime costs

We’ve explained what prime cost is, how to calculate it, and what it measures. Now what? As previously mentioned, prime cost affects the baseline for your product’s sale price. If you can lower the prime cost associated with your product you have two possible outcomes:

  1. You can reduce the cost to the customer, or
  2. The business earns more money per sale

Either result is definitely something to strive for. The key is to identify reasonable room for improvement and set achievable goals based on your prime cost data. For example, if two shifts have a similar production outcome but their prime cost differs, then you can study the process differences and implement changes in the less efficient shift.

Understanding prime costs is important for your restaurant

Prime cost is an important business metric that can help you identify strengths and weaknesses in your production processes. In the case of a restaurant, your production costs might take into account things like food costs, inventory expenses, and labor costs

Take time to gather prime cost data and review it on a weekly or monthly basis. This information can be utilized by managers and owners to set reasonable goals aimed at lower production costs. This will provide more value to customers and the business as a whole.

Prime cost has a specific function similar to other metrics. While it’s not always useful within its own limited context, it is very efficient at measuring production costs and helping to identify process issues.

What solutions are there for calculating prime costs in my restaurant?

As you can tell, the concept of prime costs can become quite technical. You shouldn’t be expected to know exactly how to calculate them. That said, a good basic understanding is helpful, which is what we’ve hoped to provide in this post.

Does collecting prime cost data seems daunting? Then consider taking a look at our restaurant reporting and analytics software. In addition to tracking prime cost data, we provide product margin analysis, geographical analysis, and live inventory management. 

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Leverage Technology to Manage Restaurant Labor Costs

Between increased costs, labor shortages, and socio-economic complexities - staying on top of labor costs is more important than ever for franchise owners.

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