How to Calculate Labor Cost in Restaurant Operations?

Calculating restaurant labor costs can help a restaurant measure its health and potential profitability. It is essential for restaurants to understand and calculate labor costs so the managers can understand what it takes to run the restaurant, except for daily utilities and grocery expenses. 

Staff is a crucial part of a restaurant to give optimum services to the customers, and this is the most expensive and recurring expense a restaurant has to bear at any cost. It is because the staff and workers will take up salary every month for the services they provide. Calculating the labor costs allows a restaurant manager to analyze how much they are spending on staffing and how these operating costs affect sales and profitability. 

A detailed expense report on labor costs will assist managers in taking effective steps to reduce them if necessary or allocate financial resources more effectively to make the staff more productive. Keeping a tab on labor costs is critical because, no matter what, it will help you keep your restaurant business afloat in the competitive food service industry.

Now, let’s understand more about the labor costs in restaurant operations, how to calculate them, and tips for managing the labor costs. 

What is Labor Cost in Restaurant Operations?

Labor costs in restaurants, like in other industries, are defined as the amount of money paid to the staff compared to sales generated over a given period. This often includes pay for salaried and hourly workers, taxes, and other employee benefits. Prime labor costs are around 60% of revenue, which means an average labor cost is around 30%. 

A few examples of some common labor costs in a restaurant include:

• Wages and salaries
• Employee benefits, like health insurance and retirement plans
• Payroll taxes, like employee contributions to social security
• Overtime pay
• Employee training costs
• Uniforms and equipment
• Bonuses and incentives

Efficient labor cost management is important for your restaurant as it helps in cash flow management. It is because if you know this figure, then you will understand whether most of your profit is going to pay off the salaries of your employees. Hence, you can take the right action (increase the food price slightly) to easily pay off the salaries and mark your profits as well.

Besides, you can hire employees if you see that you have financial resources that you can use to strengthen your team while ensuring profit. So, labor costs can help you make the right decision regarding spending and hiring new staff in many ways.  

Key Components of Labor Costs

Restaurant owners or managers must understand the key components of labor costs, including direct and indirect labor costs. This knowledge is essential to ensuring effective financial management across all restaurant operations.

1. Direct Labor Costs

These expenses are directly related to the tasks performed by employees who deliver different services at the restaurant. It includes the following aspects.

• Salaries and wages for all the kitchen staff and servers
• Overtime pay or additional work
• Employee benefits and payroll taxes

2. Indirect Labour Costs

These expenses are associated with employees who support the restaurant operations but are not directly involved in the service delivery. Examples include:

• Training costs for employees
• Uniforms required for employees
• Employee meals

So, overall, when we combine all the costs (direct and indirect), a restaurant should spend less than 30% of the profit earned on labor costs. For instance, you should spend a minimum of $3 on labor costs if you have earned a profit of $10 from a dish.

Besides, there should be a balance; labor costs cannot be too high or too low. Too high labor costs will make the business less financially stable, and too low indicates that you have less staff, which can become a problem when there is a high-demand season.

How to Calculate Labor Cost Percentage

There are several ways to calculate a restaurant’s labor cost percentage. Below, we will analyze two labor cost percentage formulas.

• Labor costs as a percentage of sales
• Labor costs as a percentage of total operational expense

Labor Costs as a Percentage of Sales

The most common formula for calculating labor costs is to find out the labor as a percentage of sales. Let’s understand the simple formula and then learn how to calculate it.

Labor Costs as a Percentage of Sales = (Total Restaurant Labor Costs / Total Restaurant Revenue) x 100

This is a simple formula, and here’s how it works.

• Determine the labor cost of a restaurant. This cost usually includes all the money that the business pays its employees throughout the year.
• Determine your restaurant’s revenue. This is the amount of money your business takes in before any taxes or other deductions are made. You can often find this number in your POS system dashboard.
• Divide the restaurant’s labor cost by its annual revenue.

For example, a restaurant business spent around $200,000 on its staff. Let’s understand the breakdown.

1. Salaries and wages = $100,000
2. Overtime pay = $20,000
3. Paid time-off = $20,000
4. Payroll taxes = $40,000
5. Employee benefits = $20,000

Then, the total revenue generated by the restaurant was $800,000/year. So, we get a labor cost percentage of 25% if we divide $200,000 by $800,000 and multiply it by 100, which is less than the industry benchmark of 30%. 

Labor Costs as a Percentage of Total Operating Costs

There is another way to find labor costs as a percentage of total operating costs. The purpose of this metric is to understand how much portion does labor costs take up in the entire operating cost. The formula for this is similar to labor costs as a percentage of sales; just the denominator changes from total revenue generated to total operating costs. Let’s look at the formula mathematically.

Labor Costs as a Percentage of Operating Costs = (Total Restaurant Labor Cost/Total Restaurant Operating Cost) X 100

The steps are only slightly different in this case: 

• Determine your restaurant’s annual labor cost. This cost includes the money the business pays to its employees throughout the year.
• Determine the total operating costs of doing business. This includes sales and costs for food, drinks, marketing, rent, and any other expenses.
• Divide the restaurant labor cost by total operating costs, and then multiply it by 100.

For instance, a restaurant calculates the labor cost to be $50,000, which includes wages for part-time and full-time employees, overtime pay, employee benefits, paid time off, and payroll taxes. Now, the restaurant manager will add all the operating costs. Let’s understand the breakdown.

1. Labor = $50,000
2. Rent = $20,000
3. Utilities = $5,000
4. Food and Beverages = $25,000
5. Marketing = $5,000
6. Other Operating Expense = $10,000

Hence, the total operating costs become $106,000. The labor costs turn out to be 47% if we divide $50,000 (labor costs) by $106,000 (total operating costs) and multiply it by 100. This means that 47% of the total operating costs are dedicated to labor costs. We can say that for every dollar spent on running the restaurant, 47 cents go towards staffing expenses. 

Ideal Labor Costs in a Restaurant

The labor cost percentage across all types of restaurants has increased by 31.6%, according to a study by BDO. The value of the average labor cost percentage depends upon the type of restaurant you run.

1. Quick Service Restaurants (QSRs): 25-30%
2. Fine Dining Full-Service Restaurants (FSR): 30-35%
3. Casual Dining Full-Service Restaurants (FSR): 25-30%
4. Night Clubs and Standalone Bars: 18-24%
5. Bars (located outside the restaurants): 30%

Hence, that’s why it is best to ensure that your labor costs remain below 30% regardless of what restaurant you are running. 

Common Challenges in Calculating Labor Costs

Calculating labor costs for restaurants presents challenges. Here are some of them, which can sometimes increase or decrease labor costs.  

1. Seasonal Fluctuations

Seasonal variations became a major challenge for restaurants for several reasons. Sometimes, demand may go up in particular periods, for instance, during the festive season, requiring higher staffing and thus a high labor price. However, controlling the workforce becomes challenging during off-seasons to avoid difficulties in expanding on many employees.

2. Variability in Employee Hours

Variations in employee hours often complicate labor cost calculations. Tracking and managing hours becomes crucial with different shifts, part-time and full-time employees, and other unexpected absences. 

3. Handling Multi-location Operations

Managing labor costs becomes more complex for restaurants with multiple locations. Each location may have unique staff requirements and wage rates. This makes consistent labor management difficult for restaurant managers.

Tips for Managing and Reducing Labor Costs

You must know how to manage and reduce labor costs if you want to maintain profitability in the restaurant industry. This means you must use certain tips, which are strategic practices, to manage the situation.

1. Scheduling Strategies

You can implement demand-based scheduling to ensure the staff levels match customer traffic. This helps avoid overstaffing or understaffing during slow periods or peak seasons, respectively. Try using tools like automatic scheduling software to optimize all shift assignments based on demand. 

2. Cross-training Employees

Enabling your staff members to perform multiple roles enhances their flexibility and efficiency. You can do this with the help of extensive cross-training programs and seminars. This means there will not be any need for specialized staff during peak hours or absences. All the cross-trained employees can fill in to improve services when needed. 

3. Utilizing Technology to Track and Manage Hours

Make sure to invest in robust software that helps track and manage hours at your restaurant. Leverage automated timekeeping systems and workforce management software to streamline payment processing and reduce manual errors. Real-time data also helps address restaurant issues by identifying them and leading to efficient labor management. For a comprehensive solution, consider exploring workforce management software options like Taqtics to optimize your operations.

4. Reduce Employee Turnover

It is crucial to reduce employee turnover to manage labor costs at the restaurant. When you hire the right people and offer them competitive pricing, you are hiring a perfect person who has the potential to drive up sales. So, do not be afraid to spend more on labor costs if you think their capabilities will skyrocket sales and help you score a better and higher profit.  

Wrapping up,

Labor costs are crucial because they help determine your restaurant’s financial status. Accurate costs also help you identify areas for improvement in your restaurant’s operational efficiency. For tips on optimizing your processes, explore this guide on How to Improve Restaurant Operations Management.

There are three key pieces of information that you require to know your labor costs: a time period (labor costs are calculated over a set period), total labor costs (add all the costs directly or indirectly related to employees), and total operating costs/sales (whichever metric you prefer). The industry benchmark for labor costs is usually 30%, but this value may differ depending on the type of restaurant you operate.

A Quick-Service Restaurant (QSR) will have lower labor costs than a fine-dining restaurant. This is because QSRs have fewer staff but automatic machines that can prepare food quickly. Meanwhile, a fine-dining restaurant has staff but does not have fancy kitchen equipment. So, overall, it depends upon the type of service you want to give to the people. 

Soumyajit