COST / VOLUME/ PROFIT

RELATIONSHIPS
IMPACT OF COST TO SALES
RELATIONSHIP
 Good cost to sales relationship DOES NOT
automatically result in restaurant profit
 It is possible that…

1. Higher food cost percent – obtainable by

lowering menu prices or by increasing
food cost, thus giving each customer
more for his money and may result to
additional customers to increase
profitability despite the higher food cost
percent
IMPAC T OF COST TO SALES
RELATIONSHIP
 Itis possible that…
2. Lower food cost percentage achieved by
raising menu prices or lowering costs –
may result in fewer customers and lessen
profit.
3. Lower menu prices will lessen profit
because there is an insufficient increase in
the number of customers to offset the high
cost percentage
IMPAC T OF COST TO SALES
RELATIONSHIP
 Therefore:

Management must examine the cost/

volume/ profit relationship of the
foodservice operation in the light of its
competition, it’s customers’ willingness to
pay higher prices, the effect of lowering
costs on quality of food, beverage and
service among other factors applicable to
their operation
Fig. 3.1. The Grandview Bistro, Current
Sales and Prime Cost
Sales $ 1, 049, 043.00 100%
Cost of Sales 351, 429.00 33.5%
Cost of Labor 257, 016.00 24.5%
Cost of 311, 896.00 29.7%
Overhead
Profit 128, 702.00 12.3%
Fig. 3.2. The Grandview Bistro, Necessary Sales Level to Earn an
Acceptable Profit When Prime Costs Increase as a Percentage of
Sales

Sales $ 1, 500, 000.00 100%

Cost of Sales 600, 000.00 40.0%
Cost of Labor 450, 000.00 30.0%
Cost of 311, 896.00 20.8%
Overhead
Profit 138, 104.00 9.2%
Fig. 3.3. The Grandview Bistro, Zero Profit with
Reduced Prices and Sales at Original Level

Sales $ 1, 049, 043.00 100%

Cost of Sales 419, 617.00 40.0%
Cost of Labor 317, 530.00 30.3%
Cost of 311, 896.00 29.7%
Overhead
Profit 0.0%
Fig. 3.4. The Grandview Bistro, Loss Resulting from Decreased
Sales (Prime Costs as a Percentage of Sales Remains as
Originally Planned)

Sales $ 650, 000.00 100%

Cost of Sales 217, 750.00 33.5%
Cost of Labor 159, 250.00 24.5%
Cost of 311, 870.00 48.0%
Overhead
Profit (38, 870.00) -6.0%
COST/ VOLUME/ PROFIT
EQUATION
 Sales= Cost of Sales
+ Cost of Labor
+ Cost of Overhead
+ Profit
 Sales = Variable Cost
+ Fixed Cost
+ Profit
 S = VC + FC + P
 The Grandview Bistro Income Statement, Year Ended
December 31, 20xx

Sales
Food $891,687
Beverage 157,356
Total Sales 1,049,043
Cost of Sales
Food $312,090
Beverage 39,339
Total Cost of Sales $ 351, 429
Controllable
Expenses
Salaries & Wages $209,809
Employee Benefits 47,207
Other Cont.Expenses 162,602
Total Cont. Expenses $419,618
Income before OC, etc $277,996
Occupancy Costs $ 89,169
Interest 13,875
Depreciation 46,250
COST/ VOLUME/ PROFIT
EQUATION of Grandview Bistro
S = VC + FC + P
Sales = $1,049,043
Variable Cost (VC)=
Food Cost $312,090
Beverage Cost 39,339
Variable Labor Cost 102,806
Total Variable Cost $454,235
** Variable Labor cost is 40% of the total
salaries and wages and employee benefits
COST/ VOLUME/ PROFIT
EQUATION of Grandview Bistro
 S = VC + FC + P
Fixed Cost (FC)=
Fixed Labor Cost $154, 210
Other Controllable Expenses 162, 602
Occupancy Costs 89, 169
Interest 13, 875

Depreciation 46, 250

Total Fixed Cost $466,106
** Fixed Labor cost is 60% of the total
COST/ VOLUME/ PROFIT
EQUATION of Grandview Bistro
 S = VC + FC +P

$1,049,043 =454,235+ 466,106 + 128,702

VARIABLE RATE
 is the ratio of variable cost to dollar sales
 Determined by dividing variable cost by

dollar sales
 Expressed in decimal form
 VR = VC / S

= 454, 235 / 1,049,043

= 0.433
• 43.3% of dollar sales is needed to cover the

variable cost
• As the sales increase, the total dollars

spent to cover these costs will increase but

the percentage will not change
CONTRIBUTION RATE
If 43.3% of dollar sales is needed to cover
variable costs, then the remainder (56.7%)
is available for other purposes, namely:
1. Meeting Fixed Costs
2. Providing Profit
 As sales increase, an increasing number

of dollars will be available to be used to

meet fixed costs and provide increased
profit.
 If fixed costs can be controlled by

management, there will be more profit for

the company
CONTRIBUTION RATE
Contribution Rate is determined by
subtracting the variable rate from 1

CR = 1 – VR
= 1 – 0.433
CR = 0.567
BREAK EVEN POINT
 Defined as a point at which the sum of all
costs equals sales so that profit equals
zero
 This means that dollar sales are just

sufficient to cover both variable and fixed

costs exactly but insufficient to provide
any profit
 Break even point = BE
COST/ VOLUME/ PROFIT CALCULATIONS FOR

THE GRANDVIEW BISTRO

 Sales = $ 1,049,043
 Variable cost = $454,235
 Fixed Costs = $466,106
 Profit = $128,702
 Variable Rate = 0.433
 Contribution Rate = 0.567
Formula to determine level of dollar sales
required to earn a profit set by management

Sales = Fixed Costs + Profit

Contribution Rate

$1,049,043 = $466,106 + 128,702

0.567
= $1,049,044
To determine the break even point for
Grandview Bistro

Sales = Fixed Costs + Profit

Contribution Rate

= $466,106 + 0
0.567
= $822,056
Break Even Point COST/ VOLUME/
PROFIT EQUATION of Grandview Bistro

 S = VC + FC +P

$822,056 =355,950+ 466,106 + 0

No profit oriented business would want to
operate at break even. The sales level
achieved by The Grandview Bistro was
$1,049,043, which was $226,987 beyond
BE. There are no additional fixed costs
after BE but there are additional variable
costs incurred per dollar sales after BE is
reached.
VC = S x VR
= $226,987 x 0.433
VC = $98,285
CONTRIBUTION MARGIN

 Dollaramount remaining after variable

costs have been subtracted from sales

Contribution Margin = Selling Price

- Variable cost (item)
- Also known as gross profit on sales
CONTRIBUTION MARGIN

Example:
If the menu item sells for $12 and its cost is
$5. What is the contribution margin?
Contribution Margin = Selling Price
- Variable cost (item)
CM = $12 – 5
CM = $7.00
** Find the contribution margin for food and
beverage sales of The Grandview Bistro
NUMBER OF CUSTOMERS REQUIRED TO
BREAK EVEN
Example:
If the financial records of a small restaurant
indicated sales of $2M and the variable
cost of $850,000 in a period when 7,850
customers were served, find the number of
customers needed to be served to break
even.
NUMBER OF CUSTOMERS REQUIRED TO
BREAK EVEN
Step 1: Find the average sales
$48,000 / 3,000 = $16.00

Step 2: Find the average variable cost

$18,000 / 3000 = $6.00

Step 3: Compute for the Contribution

Margin
CM = Average sales – Average Variable Cost
= $16.00 – $6.00
CM = $ 10.00
NUMBER OF CUSTOMERS REQUIRED TO
BREAK EVEN
Step 4: Use the formula to compute for the
number of customers require to break even
Break even in = Fixed costs
Customers Average Contribution Margin

Assuming that the fixed cost is $30,000…

BEP in customers = $30,000 / $10

= 3,000 customers
NUMBER OF CUSTOMERS REQUIRED TO GET
DESIRED PROFIT
** If management wishes to determine the
number of customers required to achieve a
given profit, the formula would be:

# of Customers = Fixed costs + Profit

Average Contribution Margin
NUMBER OF CUSTOMERS REQUIRED TO GET
DESIRED PROFIT
Example 2:
Compute for the number of customers required for
The Grandview Bistro to break even and to get
the desired profit. Assume that the average food
sale is $27.87 and is 85% of the total sales

Total average sale = $27.87 / 0.85

= $32.79
NUMBER OF CUSTOMERS REQUIRED TO GET
DESIRED PROFIT

The previously calculated average contribution rate

is 0.567. To find the contribution margin…

Average contribution margin = SP x CR

= $32.79 x 0.567
Average CM = $18.59
NUMBER OF CUSTOMERS REQUIRED TO
BREAK EVEN

The fixed cost for The Grandview Bistro is

$466,106.

Break even in = Fixed costs

Customers Average Contribution Margin
= $466, 106
$18.59
= 25, 073 customers
NUMBER OF CUSTOMERS REQUIRED TO GET
DESIRED PROFIT
To determine the number of customers to
achieve the profit of $128,702, use the
following formula:

# of Customers = Fixed costs + Profit

Average Contribution Margin

= $466,106 +$128,702
$18.59
= 31,996 customers
NUMBER OF CUSTOMERS REQUIRED TO GET
DESIRED PROFIT
Assuming that the restaurant is open 365 days
during the year, what is the average number of
covers each day?

31,996 customers
=
365 days

= 88 customers /covers per day

COST CONTROL AND THE COST/VOLUME/
PROFIT EQUATION

Assume that the new operating budget of The

Grandview Bistro has been adopted and is in
effect. However, the manager has not been
controlling variable costs adequately. As a result
excessive variable costs are developing largely
due to inefficiency and waste. Problems such as
spoilage of raw materials and poor scheduling of
staff are common causes of these excessive
costs.
COST CONTROL AND THE COST/VOLUME/
PROFIT EQUATION
The excessive variable costs had increased the
variable rate from 0.433 to 0.515. What should
be the new sales level required to earn the
$143,910 profit and fixed cost of $484, 046
indicated in the budget if variable rate is 0.515.
Use the formula

Sales = Fixed Cost + Profit

Contribution Rate
= $484,046 + 143,910
1 – 0.515
Sales = $ 1,294,755
COST CONTROL AND THE COST/VOLUME/
PROFIT EQUATION
This indicates that an additional $193,260
($1,294,755 - $1,101,495) in sales is needed to
earn the target restaurant profit. Additional sales
are required to earn the planned profit to cover
the increase in variable cost.

If management had done a better job in controlling

the variable costs, there is no need to generate
more sales just to get the required or budgeted
restaurant profit.
REMEMBER…
1. Lowering the contribution margin will
necessitate increasing volume in order to
achieve a given target profit. Sometimes the
higher volume may not be attainable in a given
operation because of limited seating capacity,
realistic turnover rates or even limited size of
the market
2. Higher contribution margins, although
requiring fewer customers, may not be an
adequate answer if it means raising sales prices
beyond the capacity or willingness of customers
to pay.
REMEMBER…
3. Establishments with low menu prices and low
contribution margins are successful because
they are able to maintain high business volume
4. Some with similar prices, contribution margins
and sales volume may be unsuccessful because
of higher fixe cost
5. The differences in the levels of profit and
relative success can be traced to differences in
fixed costs
6. An ideal restaurant is the one who has high
contribution margin, high sales volume and low
fixed costs
REMEMBER…
7. Once satisfactory level for costs, sales and sales
volume has been determined, it is necessary for
management to control costs so that the
business can achieve the profit level planned in
its budget