Food Math is Still Overwhelming, Part II

We understand that crunching the numbers for your food operation can feel overwhelming. But avoiding them can only lead to bad things. Our goal in this post is to help you break down the numbers in a way that is simple and empowering. We can work together to identify where improvements can be made and how your business can thrive.

In the context of a food selling operation, understanding the difference between gross margin and net margin is crucial for assessing profitability and making informed business decisions. Let's break down these concepts and apply them to a real-world example of a fast casual pizza eatery.

Gross Margin vs. Net Margin: The Basics

GROSS MARGIN is the difference between the selling price of a product and its cost of goods sold (COGS), expressed as a percentage of the selling price. It represents the profit made before accounting for other operating expenses.

But first, we must determine the cost of goods sold or COGS.

GROSS MARGIN = (REVENUE - COGS) / REVENUE x 100

NET MARGIN, on the other hand, takes into account all business expenses, including COGS, labor, rent, utilities, insurance, and other overhead costs. It represents the true profit of the business after all expenses have been paid.

NET MARGIN = (REVENUE - ALL BUSINESS EXPENSES) / REVENUE x 100

In part 1 of our Crunching the Numbers series, we studied the margins of the fictional Fast Casual Pizza Eatery. If you recall, our fast casual pizza eatery determined the COGS for a pizza is $5 which it then sold for $10.

So the formula once again is: GROSS MARGIN = (SELLING PRICE - COST / SELLING PRICE x 100) = 50%

At first glance, a 50% gross margin might seem impressive. However, this doesn't account for the numerous other expenses involved in running the business.

Net Margin Calculation: To calculate the net margin, we need to factor in additional costs:

1. Labor: Typically 25-35% of revenue in fast casual restaurants
2. Rent: Often 5-10% of revenue
3. Insurance: Around 3-6% of revenue
4. Utilities: Approximately 3-5% of revenue
5. Marketing: 3-6% of revenue
6. Other miscellaneous expenses: 5-10% of revenue

Let's use middle-range estimates for our calculation:

Labor: 30% of $10 = $3 Rent: 7.5% of $10 = $0.75 Insurance: 4.5% of $10 = $0.45 Utilities: 4% of $10 = $0.40 Marketing: 4.5% of $10 = $0.45 Miscellaneous: 7.5% of $10 = $0.75

Total additional expenses: $5.80

Net Margin Calculation: SELLING PRICE: $10 while COGS: $5 and ADDITIONAL EXPENSES: $5.80 so this determines that ALL BUSINESS EXPENSES: $10.80

Net Profit: $10 - $10.80 = -$0.80 (a loss)

NET MARGIN = (-$0.80) / $10 x 100 = -8%

Industry Standards

In the fast casual restaurant industry, typical gross margins range from 60% to 70%. Net margins, however, are much lower due to the high operational costs. The average net margin for fast casual restaurants ranges from 6% to 9%, with some highly efficient operations reaching up to 15%.

Our example pizza eatery, with its negative net margin, is clearly underperforming compared to industry standards.

Adjusting the Price for Profitability

To achieve an industry-standard net margin, the pizza eatery needs to increase its selling price. Let's aim for a 7% net margin (mid-range of industry standards) and work backwards to determine the appropriate selling price.

If we keep all expenses the same except for those directly tied to revenue (like some taxes), we can calculate the required revenue:

Required Net Margin: 7% Total Fixed Expenses: $5 (COGS) + $5.80 (Other Expenses) = $10.80

Required Revenue: $10.80 / (1 - 0.07) = $11.61

To account for slight increases in revenue-based expenses, let's round up to $12.

At a $12 selling price:

Gross Margin: ($12 - $5) / $12 x 100 = 58.33%

Net Margin: ($12 - $10.80) / $12 x 100 = 10%

This price adjustment brings both the gross and net margins closer to industry standards. However, to ensure long-term profitability and account for potential fluctuations in costs, it would be wise to price the pizza at $15.

At a $15 selling price:

Gross Margin: ($15 - $5) / $15 x 100 = 66.67%

Net Margin: ($15 - $11.80) / $15 x 100 = 21.33%

This higher price point provides a cushion for unexpected expenses and allows for reinvestment in the business, while still remaining competitive in the fast casual market.

Conclusion

Understanding the difference between gross margin and net margin is crucial for the success of any fast casual eatery. While a 50% gross margin might seem profitable, it's essential to account for all operational expenses to get a true picture of profitability. In our example, increasing the pizza price from $10 to $15 transforms the business from operating at a loss to achieving a healthy net margin that exceeds industry standards. This price adjustment ensures the business can cover all expenses, reinvest in growth, and remain financially stable in the competitive fast casual dining landscape.

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