Guest post by Peter Baskerville.
Entrepreneurs interested in opening a restaurant may think that an experienced cook and a good location will undoubtedly bring in huge profits for their business. In reality, the restaurant industry is characterized by small profit margins — around 2 to 6 percent on average according to the Restaurant Resource Group. Below is a post from Peter Baskerville on the nature of profit in the restaurant industry.
Is the restaurant industry characterized by high profit margins or razor-thin margins?
I would say both. From what I have experienced and observed, the restaurant industry achieves high gross profit margins which surprisingly translates into razor-thin net profit margins. Let me explain.
Gross profit is the difference between the selling price and the cost of goods sold (COGS) or, if you like, the cost of the ingredients and raw materials that made up the meal and drinks. These gross profit margins will range around 70% for financially viable restaurants. I.e. $70 of a $100 restaurant bill is gross profit.
Net profit is the amount left over from the gross profit after deducting the overheads (wages, rent, utilities) and financial charges (interest on loans, equipment leasing costs). Wages costs in the restaurant business is high, sometimes as much as 35% of sales. So half the gross profit is used up in just paying for the staffing. After the rest of the overhead and financial charges have been deducted, a restaurant is in the top percentile of profitable ones if it manages to keep 10% of sales as net profit.
Sadly, because restaurants can take many years to reach the top percentiles of profitability and are susceptible to losses from a wide range of sources (seasonality, staffing changes, waste) the vast majority of restaurants are probably just providing a wage to the owner with razor-thin net profit margins as the bonus.