What Is The Average Profit Margins For Restaurants? 

Understanding average profit margins is crucial to ensuring the restaurant business is profitable. An average profit margin is a financial metric that measures a restaurant’s ability to convert sales into profits. Basically, it represents the percentage of sales that actually converts into profit. 

The average profit margin varies for each business, and it majorly depends on the type of industry. The average net profit margin is 7.71% for businesses across different industries, according to an NYU Report on US Margins. However, this isn’t the ideal figure that restaurants should aim for. 

Average profit margins depend on the type of restaurant and its location, and understanding these may be difficult, especially when you are just starting out. However, calculating them is straightforward when you understand a few important terms. So, let’s understand everything related to average profit margin to make the calculations easier and learn the factors that contribute to deciding the margin values. 

What is a Profit Margin?

A profit margin refers to an estimate to which a business makes money. It is usually expressed in percentages and represents a portion of the same business’s sales revenue. In other words, the amount of profit expressed as a percentage of annual sales is your restaurant’s profit margin.

For example, a restaurant reports that it achieved a 45% profit margin during the last quarter. This means the profit margin is $0.45 for each dollar of sales generated.

Profit margin is of two types: gross profit margin and net profit margin. Gross profit margin helps assess a particular organization’s financial health. It is the profit that remains after subtracting the cost of goods sold (COGS). 

Net profit margin, on the other hand, measures how much net income or profit an organization generates as a percentage of its revenue. It is also termed the ratio of net profits to revenues for a restaurant business.

What is the Average Profit Margin for Restaurants? 

Restaurant profit margin is usually calculated by dividing net income by net sales. It can vary between 0% and 15%, but the average ranges between 3% and 5%. However, it can vary widely depending on factors such as location and type. 

Let’s have a look at the average profit margins for different types of restaurants.

Now, let’s have a look at the average profit margins of restaurants based on different regions.

How to Calculate Profit Margins? 

You can use the following profit margin formula to calculate your margin. Here’s the formula for gross profit margin.

Gross Profit Margin = [(Revenue – Cost of Goods Sold)/Revenue]*100

Here is the formula for net profit margin.

Net Profit Margin = [(Revenue – All Costs)/Revenue]*100

Here, revenue refers to your restaurant’s sales in dollars or your local currency. 

The cost of goods sold is the price you paid for the raw ingredients for the menu items sold.

All costs refer to your restaurant’s total operating expenses, which include COGS, labor, rent, utilities, technology, etc. 

Let’s understand this with an example. Suppose you run a pizza house and want to calculate your net profit margin and gross profit margin for last year. 

First, you must find all of the inputs for the formula, which often starts with the annual revenue. Let’s say your revenue in 2023 was $1 million, as per the POS reports. Now, when you calculate your entire food and beverage inventory costs to figure out the cost of goods sold, the expense turns out to be $300,000 on ingredients. 

Finally, you assess your operating costs and find out that the total amount is $900,000. 

To calculate the gross profit margin, you will only require the costs of goods sold. 

Gross Profit Margin = [(Revenue – Cost of Goods Sold)/Revenue]*100

= [($1,000,000 – $300,000)/$1,000,000]*100

=[$700,000/$1,000,000]*100

=70%

The same thing will be done to calculate the net profit margin, except you will have to add inventory and operating expenses to reach the final value. 

Net Profit Margin = [(Revenue – All Costs)/Revenue]*100

=[($1,000,000 – $900,000)/$1,000,000]*100

=[$100,000/$1,000,000]*100

=10%

Hence, your restaurant’s gross profit margin for last year was 70%, while your net profit margin was 10%.

How to Improve Profit Margins?

Several factors may lead to your restaurant’s annual profit margins to decline. These include the following: 

1. Increased supplier costs 
2. Sudden economic changes
3. Shifts in customer base
4. Poor employee retention rates
5. Increased competition
6. Rising operation costs
7. Poor pricing
8. Unoptimized marketing
9. Rising interest rates. 

While your profit margins are dwindling, then there are two ways you can approach this matter. 

1. Increase the Sales Volume As Compared to the Expenses (increase sales while keeping expenses down) 
2. Decrease Expenses As Compared to Sales Volume (reduce the expenses while retaining the sales volume) 

So, either you will have to increase the rates of items or dishes sold in your restaurant or try to reduce the expenses. When talking about reducing restaurant expenses, it comes down to three elements: costs of goods sold, labor, and overhead. 

To manage these expenses, there is a rule of thumb that restaurant managers can follow: keep one-third of revenue for the cost of goods sold, another one-third of revenue for labor, and try to adjust the overhead expenses with the remaining revenue. 

Strategies to Improve Profit Margins

To overcome these challenges, you must devise some strategies to improve your profit margins over time. These include:

1. Conduct an Audit to Understand the Expenses. 

You need to take a comprehensive look at how you are spending money at your restaurant. This involves checking on your acquisition and retention strategies, and any other crucial factors that impact your restaurant’s revenue generation or production costs.

Analyze your expense reports regularly to identify unnecessary spending. This involves conducting an audit to find gaps in your sales process and lower any disproportionate number of prospects.

2. Implement Cost Control Measures

Automation is the need of the hour, and restaurants can also be a part of it. Try doing strategic cuts by using online software to place orders. Apart from that, here are some other tips to reduce such expenses:

• Check issues you might be having currently, like unnecessary staffing
• Pay invoices as early as possible to get potential discounts from vendors or suppliers
• Find services or subscriptions that you might not be using regularly and cut them from your budget. 

3. Invest in Menu Engineering

Increasing prices at your restaurant means boosting revenue on every dish you sell. It means you can boost your profit margin if you can raise your outlet’s prices strategically without alienating too many customers. Make sure to conduct extensive market research and competitive benchmarking. This involves thoughtfully shaping and understanding your buyer personas. It means you must be prepared to use some trial-and-error methods when changing the pricing.

4. Focus on Smart Staff Scheduling 

Labor costs are another significant aspect that could drain profits. Hence, overscheduling and underscheduling both pose a threat to your secured profits. Underscheduling leads to poor customer service and increased workload on available staff, and overscheduling leads to overtime and unnecessary expense when the foot traffic is relatively low. 

That’s why you should determine the days, months, seasons, or occasions when there is a high amount of rush in your restaurants and when it is less. So, you can accordingly schedule your staff to meet the projected sales and reduce your labor costs. For instance, you can hire additional staff (temporary, freelancers, or part-time employees) to meet the seasonal demand during Christmas. 

5. Utilize Technology

Restaurant owners might be reluctant to invest in restaurant software, such as inventory management, workforce management, point-of-sale (POS), and others, given the nature of profit margins. However, these are not expenses but rather investments that will pay for themselves in the long run. 

For instance, POS systems assist in inputting and tracking customer orders, ensure accuracy when it comes to orders (no more manually making bills), allow you to keep track of employee performance, manage inventory, and provide a 360-degree view of your restaurant business.

The insights gathered from the systems help you analyze where the gap is, and you can work on building the bridges. Let’s understand this: the software can provide insights into employee performance and help you find the under-performers. So, you can focus on retraining of those employees or understand what’s distracting them from meeting their goals and improve your customer service. 

Wrapping Up,

You must understand how to measure profit margins correctly if you are looking to ramp up your profit margin to compete with nearby restaurants. Many factors may reduce the profit margins. Still, as a restaurant manager, you should come up with strategies to optimally cut operational costs such that there is no compromise on customer service or food quality. 

Maintaining and improving profit margins in the restaurant industry is a complex task due to the rising competition. Hence, certain things must be kept in mind to ensure you move in the right direction and increase your profit margins effectively. 

Soumyajit